Recent court case reveals details of a 2004 agreement
The subletting arrangements of mainland contractor China State Construction Engineering (Hong Kong) will come under close scrutiny by Water Supplies Department (WSD) after details of a wholly sublet contract came to light in a recent court case.
“In the light of information in paragraph 6 of the Court’s judgement, the WSD will conduct investigation into this case and take appropriate follow-up action as necessary,” a Development Bureau spokeswoman said in response to enquiries by Construction Post.
She added the department would be conducting regular checks on the subcontracting arrangements of its other contracts.
The case came to light unexpectedly after the Judiciary website published a decision in late October on a legal action taken by a second-tier subcontractor against a first-tier subcontractor of China State.
In a Court of First Instance case, a German specialist drainlining contractor Pfeiffer GmbH won HK$1.02 million for delays caused by San Wai Construction, a business owned by sole proprietor Cheung Hay Kit, on a WSD contract to replace and rehabilitate watermains in four districts in Kowloon.
The court case appeared to be a straightforward dispute on idling costs on a project, but then it all came out as Judge Kevin Zervos explained the background to the dispute.
The smoking gun, as it were, on the subcontracting arrangement came in paragraph 6 of the judge’s decision.
“By an agreement dated 22 May 2004, CSHK subcontracted the whole of the works to SWC which included the terms and conditions of the original contract. SWC in turn subcontracted part of its obligation with respect to the execution of the works of the watermains rehabilitation works to Pfeiffer by an agreement dated 25 January 2005,” Zervos wrote.
China State, a subsidiary of mainland giant China State Construction Engineering International (3311), was awarded the contract worth HK$124.8 million in January 2004 after undergoing a prequalification exercise in October 2002.
Such a subcontracting arrangement was clearly a no-no for the government.
The bureau spokeswoman said Development Bureau has promulgated technical circulars, contract provisions and internal guidelines on sub-contracting practice on public works projects.
Contractors on public works projects could only subcontract part but not the whole of the works and they had to ensure there was no further subcontracting of the subcontract works further down the line.
“Subcontracting the works wholly is a breach of the contract. If any breach of contract is found, actions will be taken in accordance with the conditions of contract and other laid down contractor management procedures as appropriate,” the bureau spokeswoman said.
A company boss at a listed contractor said his company prohibited subletting the whole of a contract to one subcontractor because main contractor staff were required to manage progress and performance, ensure safety and to liaise with the employer and consultants.
“The main risk is when the subcontractor does not perform,” the company boss said.
On reading the judge’s decision, China State’s subcontractor appeared to have put in a miserable performance.
Zervos mentioned the opinion of the consulting engineer on progress.
“From time to time it was pointed out that the submission and processing of water suspension proposals for the rehabilitation works were not being done promptly or in line with the works programme. There had also been complaints from the public as result of the delay in carrying out the works orders which had been noted as being due to a lack of resources and poor workmanship,” Zervos wrote.
Such were the problems that China State paid the price for the delays on the project.
“The Water Supplies Department had imposed liquidated damages on these delays, “the bureau spokeswoman said.
On the wisdom of China State’s decision to sublet the whole of the contract to one subcontractor, a veteran industry consultant said: “On the face of it, yes, an unacceptable risk.”
He noted that a contract worth HK$124.8 million awarded in 2004 would be worth about HK$175 million to HK$200 million today.
“So a very large contract and one that a sole proprietor could not possibly carry the financial risks on,” the consultant said.
In addition, the tender notice stipulated that only Class C contractors were qualified to tender while Sun Wai Construction “almost certainly had no construction licences at all”, the consultant added.
A common way for subcontractors without to a licence to tender for government public works contracts is to borrow the licence of a qualified contractor.
The consultant said with this contract, China State may have had a margin of about five to 10 percent on the subcontract price.
He reckoned the project must have turned into a “nightmare” for China State due to its subcontractor’s underperformance according to the progress recorded by the consulting engineer in the judge’s decision.
In addition, the consultant said contractors who performed badly on public works contracts would have adverse reports filed against them.
The government has a policy of issuing adverse reports if a contractor performs badly on a contract, which in cases of serious underperformance, could lead to a contractor being barred from tendering for public works contracts, a sobering thought for any contractor.
“Moral of the story: Never totally sublet a contract to a subcontractor unless that subcontractor has a balance sheet strong enough to carry the risk of the project and can perform at the standard required for the required government licence,” the consultant said.
China State did not respond to email enquiries by Construction Post for comment for this story.