Construction Insolvency in Hong Kong - Statutory Demands

Recent headlines in Hong Kong’s newspapers have told of the failures by insolvent sub-contractors to pay wages due to employees. In response to growing public concern, the government convened a meeting with employer associations and trade unions. At the meeting, the three parties "adopted a pragmatic approach in discussing… the problem of the arrears of wages in the industry [and] reached by consensus six immediate measures to tackle related problems". This article considers some of the legal issues relating to arrears of wages.

The Employment Ordinance provides that an unpaid employee of a sub-contractor can claim wages due to him from the principal contractor on site. The principal contractor can then recover the amount paid as a debt due from the sub-contractor.

The Companies Ordinance and the Bankruptcy Ordinance allow a creditor to issue a formal demand for payment of a debt (usually referred to in the ordinances as a "statutory demand"). If a debtor does not deal with the demand within three weeks, the creditor may apply to the court for a winding-up (in a case of a corporate debtor) or bankruptcy order (in the case of an individual). The debtor is entitled to have the demand set aside if it can show that the debt is disputed – the statutory demand process is not a substitute for legal action in the case of disputed claims. But what is the position if the debtor admits the debt but argues that it has a separate claim against the creditor which equals or exceed the value of a statutory demand? Can the demand be set aside?

The courts have recently dealt with the point in two cases arising out of similar circumstances. First, the case of Ho Yip Shing. Handa Contractors Limited employed Ho Yip Shing as a sub-sub-contractor for works at the West Kowloon Reclamation. Disputes arose between Ho Yip Shing and Handa and, in late 2001, Handa sued Ho Yip Shing. Ho Yip Shing served a defence and counterclaim alleging that substantial sums were in fact due from Handa. Meantime, eight of Ho Yip Shing’s employees brought a claim in the Labour Tribunal against Handa for unpaid wages. Handa paid the employees and served a statutory demand on Ho Yip Shing for the amount paid.

Second, Wong Wai Kuen. Wong Wai Kuen was a sub-contractor employed by Polygon Contracting Limited for work on projects at Tseung Kwan O and Siu Sai Wan. Disputes arose between the parties with Wong Wai Kuen claiming payment for work done and Polygon claiming damages for breach of contract. Again, Wong Wai Kuen had failed to pay wages due to its employees. Polygon was ordered by the Labour Tribunal to pay the employees and, having done so, served a statutory demand on Wong Wai Kuen.

The bankruptcy rules set out the grounds on which a debtor can have a statutory demand set aside. One of these grounds is that the debtor "appears to have a counterclaim, set-off or cross demand which equals or exceeds the amount of the debts or debts specified in the statutory demand". Similar grounds are available under the common law for companies to challenge statutory demands.

It was not disputed in either case that when the principal contractor paid wages to a sub-contractor’s employee, the amount paid became a debt due from the sub-contractor to the principal contractor. The principal contractor would then be entitled, in the normal course of things, to demand payment of the amount paid and, if no payment was made, to begin bankruptcy or insolvency proceedings. In each case, however, the sub-contractor argued that sums due to it exceeded the amount of the statutory demand and, therefore, that the demand should be set aside.

The validity of the statutory demands was not in dispute. The issue was whether the counterclaims entitled the court to set aside the statutory demand. The court held in each case that they did. In summary, the court said that claims for debts allegedly unpaid under a construction contract may be set-off against the debt due to the principal contractor under the Employment Ordinance reducing or extinguishing the debt. In those circumstances, there is a real dispute on the debt and the statutory demand would be set aside.

Secondly, even if the claim for payment under the contract could not be set-off (as may be the case, for example, in a claim for damages for breach of a separate contract) it would be a counterclaim that would give the court the discretion under the Bankruptcy Ordinance to set aside the statutory demand. The factors to be considered when exercising such a discretion would include the extent of the connection (if any) between the admitted debt and the counterclaim, whether the debtor seeking to set aside the statutory demand has been guilty of delay in pursuing the counterclaim, the age of the admitted debt and the age of the counterclaim, and the nature and extent of any dispute in relation to the counterclaim.

Analysis

In both cases the statutory demand was set aside because the debtor "appears to have a counterclaim, set-off or cross demand which equals or exceeds the amount of the debt or debts specified in the statutory demand". We anticipate that principal contractors may feel that the current law is not "pragmatic" and that when wages have been paid to employees under the fast track procedures of the Labour Tribunal there should be an equally fast track method for the principal contractor to be repaid. In many cases, however, where the sub-contractor has an arguable claim the court is unlikely to allow a statutory demand to be used and the principal contractor will be forced to sue the debtor for the wages paid to his employees.

© Herbert Smith 2002

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