Exemption clauses in the Deed of Mutual Covenant: A built-in shield against liability for building managers?
The Deed of Mutual Covenant (“DMC”) imposes the duty of proper management on a building manager, requiring it to do all that is reasonably required to fulfil this obligation towards the owner’s corporation. As more buildings age and require proper upkeep at substantial costs, the importance of the owners’ corporation’s ability to hold its manager to account continues to grow.
However, exemption clauses in the DMC may present a hurdle. Can a building manager rely upon such clauses to avoid liability for negligence or breach of contractual and fiduciary duty? Isabel Tam and Emily Ting consider the legal position in light of recent case law developments and the impact of the Control of Exemption Clauses Ordinance, Cap. 71.
Introduction
Nature of the relationship between building manager and incorporated owners
In Hong Kong, the vast majority of property owners live and work in multi-storey buildings which are often, in turn, grouped into building estates. Historically, the structure of the built environment informed the development of the rules governing the issues of common interest between apartment owners of the same block or the same estate. This structure has also resulted in the amalgamation of resources through the formation of owners’ corporations, and the creation of the manager’s role which carries out the agreed rules for building management.
Those agreed rules are derived from the building’s Deed of Mutual Covenant (“DMC”), a contractual instrument with statutory backing of the Building Management Ordinance (Cap 344), providing for the appointment of a building manager to act on behalf of all owners.
The relationship between manager and owners’ corporation originates from commercial contract, but in the course of carrying out various management duties, that relationship may have dimensions of agency, tort or statutory obligation. In some instances, the relationship has also been described as the manager acting as “trustee” of interests of the owners.[1] The scope of express and implied authority and management powers depends on the terms of the DMC involved and the sub-DMC (if any). Generally, the overall duty imposed on the building manager by the DMC is one of proper management, which entails doing all that is reasonably required of a manager in the circumstances.[2]
Building manager’s liability for breach of duty
The development of jurisprudence on management in multi-storey buildings has been relatively localised due to the comparatively unique prevalence of the system to Hong Kong. This article focuses on the question of whether, and when, can a building manager accused of negligence or breach of contractual and fiduciary duties, rely upon an exemption clause in the building’s DMC to avoid liability for its actions?
In some instances, the scope and strength of accountability for the manager’s breaches have important repercussions, particularly given that each owner is jointly and severally liable for all of the incorporated owners’ debts and liabilities – each owner could be pursued individually for the whole amount for work done in respect of the whole building but with a right of recovery from co-owners. [3]
The importance of the owners’ corporation’s ability to hold its manager to account has continued to grow, as buildings age[4] with resultant legal implications for upkeep, and with large funds at stake in tendering exercises for renovation[5].
Exemption clauses in the DMC
An exemption clause is commonly included into contracts to exclude or restrict liability for a party which, but for the exemption, would be owed to the other party.
It is often the case that DMCs executed before 1999 contain a term limiting the manager’s liability. DMCs approved after 29 June 1999, when guidelines for DMCs were implemented, cannot exclude liability for ordinary negligence. The Lands Department regularly issues revised guidelines for approval of DMCs, and the latest set of guidelines were issued in June 2021.[6]
Such exemption clauses would commonly exempt the manager, his servants, agents and contractors from liability to owners, unless their acts or omissions involve “criminal liability”, “dishonesty”, or “gross” or “wilful” negligence.[7] Such a clause is the most significant means for a building manager to avoid liability, and protects the manager for matters of mere negligence and contractual breach.
The effect of such an exemption clause in the building management context is not yet settled law.
In as early as 1994, in the case of Discovery Bay Services Management Ltd v Buxhaum [1995] 1 HKDCLR 7, the District Court expressed doubts as to whether such a clause extends to protect the manager against tortious liability arising in negligence.
In Great Source Enterprise Ltd v Sino Estates Management Ltd (CACV 253/2003, 7 May 2004), the Court of Appeal expressed the view that it is “arguable” that an exemption clause was not intended to have such a wide ambit as to exclude a manager’s liability for breach of the DMC. However, the question remained unsettled as the Court of Appeal merely noted that this was a “serious arguable issue”.
However, in Gallium Development Ltd v Winning Properties Management Ltd (CACV 186/2003, 17 September 2004) the Court of Appeal ruled that the exemption clause in question covered the manager’s contractual duties to manage the building in question, as well as fiduciary duties over the funds under its management.
In Pun Kwok Kei v Incorporated Owners of Merit Industrial Centre & another (LDBM 25/2003, 5 August 2004), the Lands Tribunal dismissed all claims against the management company of the building in question employed by the incorporated owners, on the basis that as the manager, it was entitled to rely on the exemption clause provided in the DMC to be exempt from liability in the absence of “wilful negligence” or “default”.
More recently, in Rainbow More Limited v The Incorporated Owners of the Arcadia [2018] HKLdT 30, the Lands Tribunal considered a DMC which vested the powers of building management in the incorporated owners (“IO”) of the building after its incorporation, and which had an exemption clause exempting the IO from liability for acts “not involving criminal liability, dishonesty, or wilful neglect”. It was held that to establish “wilful neglect”, a plaintiff would need to prove that the IO freely chose and knew that it had not done what it ought to have done. The Court did not question the applicability of the exemption clause, but considered that in that case the exemption clause could not avail the IO to exempt it from liability for breach of its duties under the Building Management Ordinance and the DMC.
Effect of the Control of Exemption Clauses Ordinance
Whether or not an exemption clause can be upheld to restrict the manager’s liability may also be subject to the Control of Exemption Clauses Ordinance (Cap 71) (“CECO”).
The CECO requires exemption clauses to be subject to a “reasonableness” test, i.e., that the term was a fair and reasonable one to be included having regard to the circumstances which were, or ought reasonably to have been, known to or in the contemplation of the parties when contract was made.
Certain contracts are exempt from the CECO. Of relevance in the building management context is paragraph 1(b) of Schedule 1 of the CECO, according to which the CECO does not apply to any contract “so far as it relates to the creation or transfer of an interest in land, or to the termination of such an interest, whether by extinction, merger, surrender, forfeiture or otherwise”.
Does the CECO apply to DMC exemption clauses?
The District Court in Discovery Bay Services Management Ltd v Buxhaum thought it did not, because:
• the enactment of the Building Management Ordinance, which assumes some control over DMC provisions, was an implicit recognition that most of such contracts were not subject to statutory control of unfair terms;
• a DMC was a contract which “relates to the creation or transfer of an interest in land” within Schedule 1 of the CECO; and
• the DMC in question pre-dated the CECO’s coming into force on 1 December 1990.
In the case 陳炳華及另一人 v. 家利物業管理有限公司 [2020] HKCFI 3010, the DMC in question was executed before 1 December 1990. The Court of First Instance expressed the view that the DMC in question did not fall within the exception in paragraph 1(b), Schedule 1 of the CECO, and therefore the CECO ought to apply to the DMC, subject to the issue of the effective date of CECO. The Court adopted the reasoning offered by the learned authors of textbooks that (i) a DMC can only be said to create interests in land to the extent that it creates mutual covenant to regulate the co-owners’ rights and obligations, and (ii) the management function of a DMC and the appointment of a manager do not create interests in the land. However, the Court went on to hold that the CECO would not apply if the DMC was executed before 1 December 1990, when the CECO came into effect.
In another recent case Ng Yui Tong v Taikoo Shing (Management) Limited [2021] HKLdT10, the Lands Tribunal held that the CECO did not apply to the DMC in question, for the simple reason that the DMC was executed before the CECO came into force.
It remains to be seen whether the Court of First Instance’s reasoning in 陳炳華 on whether a DMC is excluded from the CECO due to Schedule 1 will be followed, applied or approved in later cases, especially where the DMC in question is approved or executed after 1 December 1990. Even if DMCs fell within the ambit of the CECO, whether the clause in the question would fall foul of the reasonableness requirement provided for by the CECO, would still ultimately depend on the facts of the case in question.
Until then, a conservative approach would be to assume that exemption clauses in DMCs do generally operate to exempt the manager from liability save for instances of gross or wilful negligence, criminal liability, and dishonesty:
• Gross negligence refers to conduct which are more extreme than ordinary negligence. Whether negligence is gross is a question of fact and degree. Gross negligence has been described as “conduct which a reasonable person would perceive to entail a high degree of risk of injury to others coupled with heedlessness or indifference to or disregard of the consequences”.[8]
• Common examples of criminal liability in the building management context could include bid-rigging in bidding exercises for building repair works[9] and bribery[10].
• Dishonesty would include common law fraud (i.e. fraudulent misrepresentation), where a false representation was made knowingly, i.e. without an honest belief in its truth, or recklessly, i.e. not caring whether it was true or false.[11]
• Dishonesty may also possibly include intentional acts which the manager knows are not in the interests of the owners.[12]
[1] Taikoo Shing (Management) Ltd v Trillon (HK) Ltd [1997] 4 HKC 304, 311F-G
[2] Lo Yuk Chu v Hang Yick Property Management Ltd [1996] 4 HKC 278, 282D
[3] Wong Tak Man Stephen (Liquidator) v Chang Ching Wai [2017] 5 HKLRD 758 §§42-44, involving joint and several liability for the amount owed for a contractor’s performance of refurbishment work of the building.
[4] By the end of 2019, 34% of buildings were aged 40 years or above. See Statistical Highlights: Building management in Hong Kong (ISSHO8/2021), Legislative Council Secretariat, 23 November 2020, accessed at https://www.legco.gov.hk/research-publications/english/2021issh08-building-management-in-hong-kong-20201123-e.pdf
[5] Recent government subsidy schemes also play a part in the increasing amount of funds available for building renovations. For example, under “Operation Building Bright 2.0”, HK$6 billion was earmarked by the government for building maintenance for aged private residential or composite buildings. See Background brief on proposed funding injections and enhancements to Operation Building Bright 2.0, Lift Modernisation Subsidy Scheme, and Building Maintenance Grant Scheme for Elderly Owners, LC Paper No. CB(1)230/19-20(07), Legislative Council Secretariat, 9 December 2019, accessed at https://www.legco.gov.hk/yr19-20/english/panels/dev/papers/dev20191216cb1-230-7-e.pdf
[6] See Legal Advisory and Conveyancing Office Circular Memoranda No. 79A “Revised Guidelines for Deeds of Mutual Covenant”, Lands Department, 28 June 2021, accessed at https://www.landsd.gov.hk/doc/en/practice-note/laco/79Awac_e.pdf; read together with Legal Advisory and Conveyancing Office Circular Memoranda No.79 “Standard Clauses and Revised Guidelines for Deeds of Mutual Covenant”, Lands Department, 5 June 2018, accessed at https://www.landsd.gov.hk/doc/en/practice-note/laco/79wac_e.pdf
[7] For a recent example of a case where an exemption clause excepting gross negligence, dishonesty or criminal acts was sought to be invoked, see Pierhead Garden Management Co Ltd v incorporated Owners of Pierhead Garden [2021] HKCFI 678.
[8] See Red Sea Tankers Ltd & Ors v Papachristides & Ors, the Hellespont Arden [1997] 2 Lloyd’s Rep 547.
[9] Consider, for example, a conspiracy to offer an advantage to an agent in the context of bid-rigging in building repair works: 香港特別行政區 訴 丘瑞田(unreported, DCCC 552/2015, 29 September 2016); Hong Dau Construction Company Limited v Incorporated Owners of Garden Vista (unreported, HCA 2290/2016, 8 September 2017).
[10] For example, “Renovation company proprietor charged with bribing property management company staff” ICAC, 17 August 2021, accessed at https://www.icac.org.hk/en/press/index_id_1161.html
[11] See Derry v Peek (1889) 14 App Cas 337.
[12] See for example, in the context of trustee vs beneficiary, Armitage v Nurse [1998] Ch. 241
| Isabel Tam
Isabel acted as junior counsel for the first and second Applicants in Kwok Cheuk Kin v Director of Lands and Others v Heung Yee Kuk (Interested Party) [2021] HKCFA 38 at the Court of First Instance, Court of Appeal, and Court of Final Appeal. This landmark decision has broad implications for land transactions involving small houses, land supply, the scope of rights for indigenous villagers in the New Territories. Recently, she was invited to deliver a cross-disciplinary webinar to the Hong Kong Institute of Surveyors on the ramifications of the CFA’s judgment. In the sphere of land law, Isabel has represented Incorporated Owners at trials and hearings in the Lands Tribunal, District Court and the High Court. She is also experienced in conducted trials and applications on trust, adverse possession, building management fees, disputes as to common parts, meeting procedures, contentious charging orders, harassment remedies, unauthorized building works, and more. Visit Isabel’s profile for more details on her experience. |
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Emily Ting
Emily was called to the Bar in 2019 and joined Denis Chang’s Chambers in September 2020. She is developing a broad civil practice and has advised or represented clients in various areas including building management, land compulsory sale, adverse possession, landlord and tenant, building planning, as well as civil fraud, competition, insolvency, and tax law. In the realm of land law, Emily has handled a number of Cap. 545 compulsory sale for redevelopment cases. Most recently, she acted for the respondent minority owner of Zung Fu Industrial Building, Quarry Bay in Lead Harvest Group Ltd & others v Cheong Wing Electric Ltd & another [2022] HKLdT 8 (led by Mr. Denis Chang SC and with Mr. Ross M.Y. Yuen). She is co-author of the article Summary possession of land under Order 113: Practical tips. Emily served as a Judicial Assistant at the Court of Final Appeal between 2019 and 2020, where she assisted judges in appeals, leave applications and other research and publications. Find out more from Emily’s profile. |
This article was first published on 11 April 2022.
Disclaimer: This article does not constitute legal advice and seeks to set out the general principles of the law. Detailed advice should therefore be sought from a legal professional relating to the individual merits and facts of a particular case. The photograph (by Som yeah on Unsplash) which appears in this article is included for decorative purposes only and should not be taken as a depiction of any matter to which the case is related.