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Contract Practice

Lecture 8 – Insurance, Bond and

Warranties

Note:
This set of notes is largely based on the information
from the books as listed in the Reference section
herein, and the author hereby acknowledges that
ownership of copyright of these materials, where
referred to or cited therefrom belongs those authors
and they are adopted for educational purpose only.
While every care has been taken in the assembly of
this set of notes, no responsibility for loss occasioned
to any person acting or refraining from action
occasioned by or as a result of any material included
herein can be accepted by the author.

Contract Practice 2

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Learning Outcomes
The students should be able to understand:
1. The purpose and principles of insurance, bond
and warranties required in construction contracts.
2. The types of insurance and bond commonly
used in the Hong Kong construction industry.
3. The relevant contract provisions relating to
insurance, bond and warranties in SFBC 2005.
4. The doctrine of privity of contract and Contract
(Rights of Third Parties) Ordinance Cap 623
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Insurance

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INSURANCE

Types of insurance commonly required in
construction contracts:
 (i) Employees’ compensation insurance
 (ii) Contractors’ all risks insurance
• Insurance for the Works
• Public Liability Insurance
 (iii) Professional indemnity insurance
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INSURANCE PRINCIPLES

Major Insurance principles include:
 (i) Utmost good faith
 (ii) Insurable interest
 (iii) Indemnity
 (iv) Subrogation
 (v) Contribution

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UTMOST GOOD FAITH

(i) Utmost good faith
 Contracts of insurance are contracts of
“uberrimae fidei”
 Duty of disclosure
 Material fact

INSURABLE INTEREST
(ii) Insurable interest
 The insured must have an insurable
interest in the subject matter insured.
 Insurance Companies Ordinance (Cap 41)
 s.64B states that any policy effected
without insurable interest in the life of the
insured or on any other event is void.

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INSURABLE INTEREST

“Must bear some relationship, recognized by
law, to the subject matter whereby he
benefits by the safety of the property, life or
limb or freedom from liability, and is
prejudiced by any loss, damage, injury or
creation of liability.”
– Frank Eaglestone

INDEMNITY
(iii) Indemnity
 An indemnity is a legal exemption from
incurred liabilities or penalties.
 To place the insured person as nearly as
possible in the same financial position
after a loss as he was immediately before
the occurrence of the loss-making event.

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SUBROGATION
(iv) Subrogation
 What does it mean?

 The doctrine does not apply to life

insurance.
 Joint names insurance in Clause 21.2(1)
and Clause 22.4(1) SFBC
 Cross liability clause

 Waiver of right of subrogation

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CONTRIBUTION
(v) Contribution
 Right of one insurer to claim another
insurer.
 An equitable right between the insurers.
 cannot recover more than his total loss
 Non-contribution clause

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EC INSURANCE

Employees’ Compensation Insurance
a) arising out of or in the course of the employee’s
employment under (“ECO”)
b) principal contractor is deemed to be an employer.
S.40(1) and s.24(1) of ECO.
c) ECO does not limit ordinary civil liability of an
employer.
d) Direct claim from Insurer - s.44 ECO (Wong Po-wah
v Pacific Insurance Co. Ltd. (1988) 2 HKLR 417, CA.)
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“CAR” INSURANCE

A typical CAR policy will include the following
parts:
a) Agreement to insure
b) General exclusions from cover
c) Material damage indemnity
d) Specific exclusions from cover for material
damage
e) Third party cover
f) Specific exclusions from third party cover
g) General conditions
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PROFESSIONAL INDEMNITY
INSURANCE

Professional indemnity insurance (“PII”) is form of liability
insurance taken out by consultant (e.g. architects,
engineers, quantity surveyors, project managers and
other construction professionals), main contractors and
sub-contractors involved in a project to indemnify
themselves against liability for damages arising out of a
breach of their professional duties.

Negligent design is the most common risk to be covered
by PII.

Usually required by a term of the contract of employment.

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INSURANCES UNDER
SFBC2005

Standard Form of Building Contract, Private
Edition – With Quantities 2005 Edition
 Clause 20 – Injury to persons and property
and indemnity to Employer
 Clause 21 – Insurance against injury to
persons or property
 Clause 22 – Insurance of the Works

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Clause 20 – Injury to persons and

property and indemnity to Employer

Clause 20 states that:

 “The Contractor shall be liable for and shall
indemnify the Employer against any
damage, expense, liability or loss in
respect of any claim or proceedings for:

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Clause 20 – Injury to persons and

property and indemnity to Employer

(a) bodily injury to , disease contracted by or

the death of any person arising out of, or in
the course of, or by reason of the carrying
out of the Works and whether arising on or
off the Site, except to the extent that the
injury, disease or death or that person is
due to any act or neglect of the Employer
or any person for whom the Employer is
responsible; and

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Clause 20 – Injury to persons and

property and indemnity to Employer
(b) injury or damage to real or personal
property arising out of, or in the course of,
or by reason of the carrying out of the
Works and whether arising on or off the
Site, to the extent that the injury or
damage is due to a breach of contract or
other default of the Contractor or any
person for whom the Contractor is
responsible.”

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Clause 21 – Insurance against

injury to persons or property

Clause 21.2(1) states:-

 “(a) bodily injury to, disease contracted by
or the death of any person arising out of
or in the course of or by reason of the
carrying out of the Works and whether
arising on or off the Site; and

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Clause 21 – Insurance against

injury to persons or property
(b) injury or damage to real or personal property
other the Works insofar as the injury or
damage arises out of, or in the course of, or by
reason of the carrying out of the Works and
whether arising on or off the Site, including
injury or damage caused by any act or neglect
of the Employer or any person for whom the
Employer is responsible or by collapse,
subsidence, heave, vibration, weakening or
removal of support or lowering of ground water
due to any cause other than....”
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Clause 22 – Insurance of the Works

Clause 22.2 states that:-

“ ... to provide cover against any physical loss
of or damage to the Works, existing
constructions on the Site, temporary works
or materials or goods that are the property
of the insured or for which the insured is
responsible while on the Site, being
fabricated or stored off-Site or in transit by
road, rail, air or marine craft within Hong
Kong or its territorial waters including:
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Clause 22 – Insurance of the Works

(a) costs and expenses in respect of shoring
and propping up, testing, dismantling or
demolishing part of the Works, existing
constructions on the Site or temporary
works, removing and disposing of debris
and damaged materials or goods and
protecting the Works, existing
constructions on the Site, temporary works
and materials or goods;

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Clause 22 – Insurance of the Works

(b) professional fees at the percentage stated in

the Appendix;
(c) all necessary extra costs of express freight or
airfreight; and
(d) all necessary extra overtime labour costs,
incurred in the repair, reinstatement, redesign
and supervision following damage to the Works,
existing constructions on the Site, temporary
works or materials or goods from any cause
excluding ....”
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Clause 22 – Insurance of the Works

There are 3 alternative clauses:

Clause 22A - Insurance of the Works by the
contractor

Clause 22B - Insurance of the Works by the
employer

Clause 22C - Insurance of existing building
and Works by the employer

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Bonds

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BONDS

What is a bond?

Distinction between Insurance and Bond

The Pros and Cons of a Bond.

Some examples of Bond
(a) Performance bond
(b) Bid (or Tender) bond
(c) Advance payment bond
(d) Retention bond
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What is a bond?

“A bond is a promise by deed whereby the

person giving the promise (the obligor or
bondsman) promises to pay another person
(the obligee or employer) a sum of money.”

(Keating on Building Contracts, 6th Edition, p.273)

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Performance Bond
(1) Demand Bond

Edward Owen Engineering v Barclays Bank [1978]
Q.B. 159
 “…we confirm our guarantee … payable on demand
without proof or conditions…it is understood that the
said amount will be paid on your first demand…”
 Held: the bond was a classic on-demand bond
which did not require proof of breach and operated
in effect as a promissory note payable on demand
and on similar footing to a letter of credit.
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Demand Bond

Esal (Commodities) Ltd. and Another v Oriental
Credit Ltd and Another [1985] Vol. 2 Lloyd’s
Law Reports 546

 “We undertake to pay the said amount on

your written demand in the event that the
supplier fails to execute the contract in
perfect performance …”

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Demand Bond
“…we confirm our guarantee … payable on demand without
proof or conditions…it is understood that the said amount will be
paid on your first demand…” - (Edward Owen Engineering Ltd. v.
Barclays Bank International Ltd. [1978] QB159)

“…the Bondsman shall upon demand made by the Employer in

writing and without proof of the said default or conditions
satisfy …” - (Airport Authority Hong Kong v. American Home
Assurance Co. (2000) HCA 17807/99, 2 February 2000)

“…we undertake to pay you, unconditionally, the said amount on

demand, being your claim for damages…” - (IE Contractors Ltd.
v. Lloyds Bank plc and Rafidain Bank (1990) 51 BLR 1)
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Demand Bond

The Surety and the contractor are not entitled to raise
objections based on the construction contract.

The Employer may ask for payment of the bonded sum:
 Without the need to start any legal proceeding; and,

 Without the need to prove the actual default of the

contractor.

Certain expressions are commonly used in a demand bond,
such as:
(a) “on first demand”;
(b) “without objections” or unconditionally”;
(c) “notwithstanding any objections from the contractor”
Broccoli C. & Adams L. (2015) 32

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Performance Bond
(2) Default Bond

Trafalgar House v General Surety [1996] A.C. 199
 The terms of bond included the following:
 “if the sub-contractor shall duly perform and observe all
the terms provisions conditions and stipulations of the
said sub-contract on the sub-contractor's part to be
performed and observed according to the true purport,
intent and meaning thereof or if on default by the sub-
contractor the surety shall satisfy and discharge the
damages sustained by the main contractors thereby up
to the amount of the above written bond then this
obligation shall be null and void ...”
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Default Bond

CA held: the claimant was entitled to summary
judgment without a full hearing, on the
claimant's assertion that it had suffered loss
exceeding the value of the bond.

But HL held: the bondsman was entitled to
raise any matter of defence or cross-claim and
that the contractor would have to establish
liability against the sub-contractor before
payment on the bond could be demanded.

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Kono Insurance Ltd. v. Tins’

Industrial Co Ltd [1987] 3 HKC 71

“Now the condition of the above written bond is such that if the
contractor shall duly perform and observe all the terms,
provisions, conditions and stipulations of the said contract on
the contractor’s part to be performed and observed according
to the true purport intent and meaning thereof, or if on default
by the contractor the surety shall satisfy and discharge the
damages sustained by the employer thereby up to the amount
to the above written bond then this obligation should be null
and void, but otherwise shall be and remain in full force and
effect.”

CA Held: Not a demand bond.

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Demand or Default Bond?

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Dragages et Travaux Publics (HK) Ltd v

Citystate Insurance Ltd [2001] 1 HKC 196
"Now the conditions of this Bond are :-
1. The Surety hereby irrevocably and unconditionally guarantees to the Main
Contractor the due performance by the Sub-Contractor of its obligations under
the Sub-Contract.
2. In the event of default by the Sub-Contractor of any of its obligations
under the Sub-Contract, and upon demand in writing made by the Main
Contractor upon the Surety, the Surety shall satisfy and discharge any claims,
actions, damages, losses, charges, costs or expenses whether directly or
indirectly sustained thereby by the Main Contractor up to an aggregate of the
Bonded Sum. …
5. The liability of the Surety under this Bond shall not be avoided or
invalidated by reason of any one or more of the provisions of the Main Contract
or Sub-Contract being or becoming illegal, invalid or unenforceable nor shall
the liability of the Surety be released on the termination of the Main Contract or
the Sub-Contract for any reason whatsoever."
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Dragages et Travaux Publics (HK) Ltd v

Citystate Insurance Ltd [2001] 1 HKC 196

CA Held:

The correct approach to adopt in determining whether a
bond is an “on demand” bond is to ascertain whether the
commitment engaged is conditioned upon the presentation
of documents or upon the actual existence of facts which are
referred to in the documents.

whether a bond was an on-demand bond would depend
upon the construction of the instrument in question and, as
on-demand bonds were potentially “oppressive” documents,
the wordings of these bonds must be drafted in clear and
unambiguous terms.

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Failure to submit a Bond

Clause 33.3 (SFBC 2005 - Private Edition)

“If the Contractor fails to deliver the bond under
clause 33.1, the Employer may withhold an
amount not greater than the value of the bond
stated in the Appendix until the bond is
delivered to the Employer, at which time the
amount withheld shall be released in the next
interim Certificate following the delivery of the
bond.”
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Warranties

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Definition of Warranties

It is a subsidiary or collateral provision to

the main purpose of the contract (e.g. the
sale of goods itself)

Breach gives rise to damages ONLY

It is an agreement itself

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What are Collateral Warranties?

“A collateral warranty is a contract which is

ancillary or ‘collateral’ to a principal contract, such
as a building contract, a subcontract or a consultant
appointment.

It is entered into between the person employed
under the principal contract (e.g. a contractor) and a
third party (known as the ‘beneficiary’) having or
acquiring an interest in the development, such as a
funder, a purchaser, a tenant or a management
company.”
Source: Hoangviendu (2013) Bonds, 42
Guarantees, Warranties and Third Party Rights

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Why are Collateral Warranties

needed?

Doctrine of Privity of Contract – A contract
cannot confer rights or impose obligations
arising under it on any person except the
parties to it. i.e. Only a party to a contract can
enforce the terms of that contract.

A promises B to pay a sum of money to C.
Any contract between A & C? Tweddle v.
Atkinson (1861) 1 B&S 393

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Why are Collateral Warranties

needed?

To provide contractual remedies for interested third
parties against other parties from whom none would
otherwise be available or against whom any remedies
would be limited or uncertain under statute or under
the tort of negligence.

Commonly used in the commercial world as a method
of linking parties who in other circumstances would
not have any contractual relationship, but who are
nevertheless involved in the same overall
undertaking.

Source: Hoangviendu (2013) Bonds, 44

Guarantees, Warranties and Third Party Rights

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Why are Collateral Warranties

needed?

Shanklin Pier v. Detel Products Ltd [1951] 2
KB 854

Plaintiff instructed contractor to buy paint from
Defendant who said the paint, which last for 3 months
only, would last for 7 years.

By the principle of collateral contract, an exception
was created to the doctrine of privity of contract
where a contract may be given consideration by
entering into another contract.

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Contracts (Rights of Third

Parties) Ordinance Cap 623

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Contracts (Rights of Third Parties)

Ordinance Cap 623

The Ordinance provides an exception to the

doctrine of privity of contract allowing a person
not being a party to a contract to enforce the
contract terms directly.

i.e. an alternative to the use of collateral
warranties.

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Contracts (Rights of Third Parties)

Ordinance Cap 623

Section 4(1) states that a third party may enforce a term of a
contract (including a term that excludes or limits liability) if :-
 (a) the contract expressly provides that the third party
may do so; or
 (b) the term purports to confer a benefit on the third party.

The third party must be expressly identified in the contract
by name, as a member of a class or as answering a
particular description.

Section 4(1) applies whether or not the third party has given
consideration for the term, or exists when the contract was
formed.
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Contracts (Rights of Third Parties)

Ordinance Cap 623

Applies to contracts entered into on or after 1st
January 2016.

Not applies to letter of credit, bills of exchange,
promissory notes and other negotiable instrument;
covenants relating to land; contracts for carriage of
goods by air and sea; company’s articles having
effect as a contract; and employment contract.

Contracting parties will be at liberty to contract out the
effect of the Ordinance.

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References

1. Agreement & Schedule of Conditions of Building Contract for

use in the HKSAR, Private Edition – With Quantities 2005
Edition.
2. Broccoli C. & Adams L. (2015) On-demand bonds: a review of
Italian and English decisions on fraudulent or abusive calling,
International Construction Law Review.
3. General Conditions of Contract for Civil Engineering Works
1999 Edition. HKSAR.
4. Hoangviendu (2013) Bonds, Guarantees, Warranties and
Third Party Rights.
https://hoangviendu.wordpress.com/2013/10/07/bonds-
guarantees-warranties-and-third-party-rights/
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References

5. May A. (1995) Keating on Building Contracts, 6th Edition,

Sweet & Maxwell.
6. Murdoch J. & Hughes W. (2008) Construction Contracts: Law
and Management, 4th Edition, Taylor & Francis
7. Ramus J. & Birchall S. (1995) Contract Practice for Surveyors,
3rd Edition
8. RICS (2009) Construction Insurance, 1st Edition, Guidance
Note, RICS Practice Standard

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CONTRACT PRACTICE
Lecture 8 – Insurance,
Bond and Warranties

- The end -

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