Chapter 2 Introduction to Contract and Tort

This section is to enable accountants to understand what their potential liabilities are and the standard of
care which they are required to reach when performing their duties.

A. Brief Introduction of Contract and Tort Law

1. Contract Law

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A contract is an agreement between two or more parties which is enforceable at law. If a party to the contract
does not perform its contractual obligations, the other party can go to the court and either seek damages or
specific performance or apply for other appropriate relief. A contact may be made in writing, by word of
mouth or by conduct.

Offer & acceptance When a definite offer made by one party is unconditionally accepted by another party,
an agreement comes into existence.

Consideration is a necessary ingredient of a contract. A person who does not give consideration for a contract
cannot enforce it. Consideration can be said to be something of value in the eyes of law. It may consist of
money, or something which has economic value or is measurable in monetary terms. For instance, in a sale
contract, the buyer’s price is the buyer’s consideration and the seller’s goods are the seller’s consideration.

Legal intent An agreement is a contract only if both parties intend to have legal consequences, this is, if one
party breaches the agreement, the innocent party may ask the court to enforce the contract. The courts apply an
objective test to determine whether such an intention exists. In applying the objective test, the courts look at
whether a reasonable person would regard the parties as intending their agreement to have legal effects. The
courts presume that the parties intend legal consequences to arise from commercial agreements. The
presumption that commercial agreements are intended to be binding, however, can be rebutted where there is
evidence that the parties do not intend to enforce their agreement. This may happen, for example, where the
agreement is made ‘subject to contract’. The words ‘subject to contract’ negate contractual intention and the
parties are not bound until formal contracts are exchanged. There is only an agreement to agree, but no
contract.

Capacity Only a person who is over 18 of age and has a clear mind has the capacity to form contracts. A
company may come into being by incorporation or registration under the CO and it has the capacity to form
contracts.

Representations & contract terms Before the parties enter into a contract, they usually negotiate with each
other. During the negotiation, some statements and promises may be intended by the parties to be terms of the
contract while others may induce the making of the contract, but may not be terms of the contract. Such terms
are called mere representations. Whether a statement is a contractual term or a mere representation depends on
whether or not the parties intend that ‘there should be contractual liability in respect of the accuracy of the
statement’. Statements made at or near the time the contract is being concluded are likely to have contractual
effect.

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Express & implied terms Express terms are terms which have been expressly agreed to by the parties,
whether in writing or by word of mouth. Some other terms not expressly agreed to by the parties may be
implied into the contract. Implied terms are regarded as resting on the presumed intention of the parties.
However, in some situations, terms are implied by the courts basing on customs and usages of a particular
trade. Some terms are implied by legislation.

Contractual terms are classified into ‘conditions’ and ‘warranties’. If a term has been classified as a
condition, even a minor breach of that term will allow the innocent party to terminate the contract and/or sue
for damages. The innocent party may waive the right to terminate the contract and only sue for damages. On
the other hand, if a term breached is a warranty, the breach of it does not amount to repudiation of the contract
by the guilty party and does not entitle the innocent party to terminate the contract. He can only claim damages.
Whether a term is a condition or warranty depends on the intention of the parties. Where a term is described as
a ‘condition’ in the contract, it is a strong indication that the parties would like to treat it as an important term
of the contract. These labels, however, are not conclusive.

The traditional theory is that the nature of contractual terms is fixed at the time of the contract is made.
However, in practice, it seems that the courts are often influenced by the effects of the breach. This gave rise to
a new category of terms, called ‘innominate terms’. The courts look at the effects of the breach to determine
whether the innocent party has the right to terminate the contract or claim damages for the breach.

In HK Fir Shipping v Kawasaki Kisen Kaisha Ltd [1962] 2 QB 26, the plaintiff shipowners chartered a ship to
the defendant charterers for 24 months. The shipowners promised that the ship was seaworthy. However, the
charterers discovered that the engines were old and the engine room staff were incompetent. The ship was at
sea for eight weeks but then had to undergo repairs for five weeks. The ship had to undergo further repairs
which would have taken 15 weeks. The charterers terminated the contract and the shipowners sued them for
wrongful termination of the contract.

It was held that the promise of seaworthiness was neither a condition nor a warranty but an innominate term.
Since the ship being available for 17 out of the original 24 months, the charterers were not entitled to terminate
the contract because the ship-owners’ breach of the seaworthiness clause did not make further performance of
the contract impossible. The charterers were only entitled to claim damages.

A contract is discharged or comes to an end where both parties fully perform their contractual obligations. An
existing contract may be mutually cancelled by the parties. One party to the contract may breach its
obligations under the contract giving the right to the innocent party to treat the contract as having been
discharged. A contract may be discharged due to frustration because of the happening of an event not
foreseen by the parties at the time of making their contract. Finally, a contract may come to an end because of
the operation of law.

Where the innocent party sues the guilty party for breach of contract, the main remedy which the courts grant
is damages. The principle of damages is that the innocent party must be placed in the same position in which
it would have been if the contract had been performed.

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Remoteness of damage Not all losses flowing from the breach of a contract are compensated. First, the
losses must have been caused by the defendant’s breach of contract. If the losses would have occurred anyway
notwithstanding the breach, the plaintiff cannot claim damages for them. Secondly, the party must have
foreseen the losses at the time of making the contract. Otherwise, the losses are considered too remote and not
recoverable.

Although the innocent party can recover all foreseeable losses, this rule is subject to the innocent party’s duty
to mitigate. It means that the innocent party must take reasonable steps to reduce its losses flowing from the
breach.

2. Tort Law

The word tort refers to a civil wrong. In a civilized society, people must be able to live on the assumption that
others will respect their person and possessions and if they fail to do so, they will pay for their unwarranted
interference, aggressions, or for failure to observe norms of expected behaviour.

There are three main types of tortious liability, namely, liability for intentional torts, liability for negligence
and strict liability. The liability for the first two categories is based on fault. It is concerned with a person’s
failure to live up to a certain standard. Strict liability arises independently of any fault. A person is liable for
strict liability whether or not the harm is caused intentionally or negligently.

In a tort claim, the successful plaintiff is awarded damages. The objective of awarding damages is, as far as
practicable, to return the victim to the same position in which he or she was before the tort was committed.

B. Negligence

A person who suffers injury or damage caused by a careless act or omission of the defendant may have a claim
against the defendant in negligence. To succeed, the plaintiff must establish the following:

(1) The defendant owes a duty of care to the plaintiff;

(2) The defendant has breached that duty; and
(3) The plaintiff’s injury or damage is a consequence of the defendant’s breach of duty.

(1) Duty of Care

In the case of Donoghue v Stevenson (1932), the court explained that everyone owes a duty of care to his
neighbor. The duty of care is a duty ‘to take reasonable care to avoid acts or omissions which you can
reasonably foresee would be likely to injure your neighbour’. In other words, everyone owes a duty of care to
persons they ought to foresee being affected by their activities. There should be sufficient proximity between
the parties such that one owes a duty of care to the other. For example, X drives his car carelessly and causes
an accident which injuries a pedestrian. X should have foreseen that both fellow road users and pedestrians
could be affected by his carelessness.

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In Yuen Kun-yeu v Attorney-General (1987) PC, YKY lost money deposited with a registered deposit-taking
company which went into liquidation. YKY claimed damages in negligence from the Commissioner of
Deposit-taking Companies, arguing that the Commissioner owed him a duty of care and that the duty had been
breached because the Commissioner knew or ought to have known that the affairs of the deposit-taking
company were being conducted fraudulently and to the detriment of depositors.

It was held that the commissioner did not owe YKY a duty of care in negligence because there was not a
sufficiently close and direct relationship between the Commissioner and would-be depositors.

In Caparo Industries plc v Dickman (1990) HL, CI bought shares in a company whose accounts had been
audited by D. CI relied on the company’s published accounts and eventually bought so many shares that it was
required to make a takeover bid for the company. CI then discovered that the accounts did not reflect the
company’s financial position and sued D (the auditor). The question to be decided by the court was whether D
owed a duty of care to CI.

It was held that D was not liable to CI because there was insufficient proximity between them. D only owed a
duty of care to the company whose accounts he was auditing. He did not owe a duty to the company’s
shareholders or potential investors. The court emphasized the need to establish the three elements—
foreseeable damage, proximity and reasonableness—in deciding whether to impose a duty of care.

Standard of Care of Auditors:

For professionals, the test is ‘what a reasonably competent practitioner would do having regard to the
standards normally adopted in his profession’. Keep Point Development Ltd v Chan Chi Yim [2000] 3 HKLRD
166. The court may refer to the codes of practice and industry standards of the profession in deciding the
proper standard. Thomsen v Johnson Burglar Alarms Co Ltd [2001] 3 HKLRD 571. In preparing the financial
statements of a company the auditor has to abide by the Statements of Standard Accounting Practice (SSAPs)
issued by the Hong Kong Society of Accountants. The court in Peter PF Chan v Hong Kong Society of
Accountants [2001] 1 HKLRD 687 emphasized that the SSAPs were required to be followed (though they do
not have the status of law) and any deviation from them should only be made in exceptional circumstances and
had to be justified.

(2) Breach of Duty

The defendant is judged not by what he did, but by what a reasonable man would have done in the same
situation (reasonable man test). If the defendant has professional qualifications, he is judged by the standard of
a reasonable man with such qualifications. If a defendant does not act as the reasonable man would have been
acted, he will be ‘at fault’. The courts will consider a range of factors to decide whether the defendant was at
fault, including:

• Whether such a loss has been suffered before

• Whether reasonable and practical precautions had been taken
• The practices of the relevant industry or profession

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(3) Consequential Damage

The damage must be caused by the breach of duty. This is described as a ‘causal link’ between the damage or
loss and the breach of duty. The court applies the ‘but-for’ test to determine this question, that is, ‘but-for’ the
negligence of the defendant, the plaintiff’s injury or damage would not have occurred.

In Barnett v Chelsea & Kensington Hospital Management Committee [1969] 1 QB 428, at 5 am, the plaintiff’s
husband, a watchman, shared some tea with two other watchmen. After that, all three men started to vomit and
that persisted until 8 am. They went to the casualty department of St Steven Hospital, but they were not seen
by any doctor. The doctor on duty was himself sick. They were advised to go home and call in their own
doctors. The plaintiff’s husband died by 2 pm from arsenic poisoning.

It was held that the defendant’s casualty officers were negligent. However, the plaintiff had failed to establish
her claim, on the balance of probability, that the death of the deceased resulted from the defendant’s
negligence. Even if care had been taken, the deceased would have died anyway.

Even if the plaintiff can establish that the damage was caused by the breach of duty, the damage must not be
too remote. The defendant is liable only for loss or damage which is reasonably foreseeable.

Pure Economic Loss: A pure economic loss caused by to a person by a negligent act of the defendant cannot
be recovered in tort. It is well settled that when a defendant by his negligent act causes physical injury to the
person or damage to property of another, economic losses including loss of business or loss of profit or loss of
earnings are recoverable. On the other hand, when such losses are not consequent upon any personal injury or
damage to property, they are not recoverable. Where a ship negligently collides with another ship and the
other ship is sunk, the owner of the ship can recover damages for the loss or damage to the ship and business
profits. However, the workers on the ship who lose their jobs cannot recover their economic losses. They do
not arise from physical injury to workers or damage to their property. Financial losses resulting from losing a
job are purely economic.

Pure economic loss caused by a negligent statement will not be allowed.

For example: John would like to invest his savings in stocks. He comes across an article. ‘All-Well
Construction—A Must-buy HK Stock’ in a newspaper. The article is written by Wally, a famous financial
analyst. Wally advises the readers to purchase shares in this company. He says that All-Well has been doing
quite well and expects that soon the value of its shares will increase 10 times. Relying on Wally’s advice, John
invests heavily in All-Well’s shares. In fact, All-Well is not doing well at all and collapses two months later. If
Wally had done research on All-Well, he would have found out its true position. Can John recover his
financial losses form Wally?

John cannot do this. His loss is a pure economic loss. In order to recover this loss, he has to establish proximity
between him and Wally. If he had paid for the advice, the requirement would have been satisfied. Moreover,
Wally’s article is in a newspaper. It is an academic piece. In the circumstances, it will be unfair, unreasonable

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and unjust to impose a duty of care on Wally. To allow John to claim would make Wally liable to all and
sundry, to any reader who acts upon his advice.

(4) Defences
(a) Contributory Negligence

Contributory of negligence refers to a situation where the plaintiff’s injury has been caused partly by the
defendant’s fault and partly by his own.

In Hsu Li Yun v Incorporated Owners of Yuen Fat Building [2000] 1 HKLRD 900, the plaintiff’s estate only
received 25% of the total claim because the plaintiff was 75% to blame for his own death. There, the deceased
electrician and plumber, had negligently designed and installed a plumbing system. Owing to the defective
design, he was electrocuted while working with the system and died as a result of it.

(b) Exclusion of Liability

At common law, a defendant could limit or exclude his liability in negligence by an express contract term or
by giving reasonable notice. Now, a person’s right to exclude and limit liability by contractual terms, notices
or disclaimers is subject to the Control of Exemption Clauses Ordinance (Cap 71) (CECO).

The controls are in twofold. First, a contract term or a notice which exempts a person from liability for death
or personal injuries resulting from negligence is of no effect whatsoever (s 7(1) of the CECO). Second, a
contractual term or a notice which exempts a person from liability for any other loss resulting from negligence
is effective only if the term is reasonable (s 7(2)). What is reasonable will always depend on the circumstances
of a particular case.

(c) Limitation Period

A claim in tort must be brought within the statutory period of limitation. The Limitation Ordinance (Cap 347)
(LO) deals with limitation periods for claims in tort. The basic limitation period for claims in tort is six years
from the date on which the cause of action arises (s 4).

In the case of an action for negligence, nuisance or breach of statutory duty where the damages claimed by the
plaintiff consist of or include damages in respect of personal injuries, the limitation period is three years from
the date of the injury or within three years from the date of having knowledge of the injury (s 27 .

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