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KEYWORDS: Payment - Pay-when-Paid Clauses, Smith and Smith Glass Ltd -v-
Winstone Architectural Cladding Systems Ltd (1991), Thomas Dyer & Co -v-
Bishop International Engineering Co [1968], Durabella Limited -v- J. Jarvis
& Sons Limited (September 2001), pay-when-paid clauses, Housing Grants
Construction and Regeneration Act 1996,
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SUMMARY
In
Durabella Limited -v- J. Jarvis & Sons Limited (September 2001) it
was held that the 1996 Act clearly envisaged that pay-when-paid clauses which
shared the risk of insolvency were not unreasonable.
A contractor cannot rely on a pay-when-paid clause if the reason for
non-payment is its own breach of contract or default. A party cannot
take an advantage from its own breach of contract.
A pay-when-paid could only be effective so long as the main contract
machinery of payment was capable of being operated. For the clause to
be effective the contractor impliedly undertakes that it will pursue all means
available to obtain payment, or it will not be able to rely on the clause to
defeat the subcontractors claim for payment.
One interesting observation in Durabella was that Section 113(1) of the 1996
Act did not affect payment conditional on certificates under the main
contract, the parties freedom to make such arrangements was stated to be
legitimate and not unreasonable.
Contractors and subcontractors in the construction industry know the real
meaning of the famous phrase cashflow is the lifeblood of the industry. A
contractor who pays a sub-contractor before being paid by the Employer, is
effectively funding the project. Add to this the cost of pursuing the
Employer for non-payment and the precarious nature of construction becomes
obvious. Insolvency of the Employer in that situation can threaten the
continued existence of the contractor.
A pay-when-paid Clause means that a subcontractor may have completed the
SubContract Works in accordance with the SubContract, but is not paid because
of matters not connected with the SubContract. The Employer may for instance
withhold payment because of default by the contractor or other
subcontractors.
Not surprisingly, contractors argue that pay-when-paid clauses are a valid
and legitimate protection against these risks, which are more marked in the
present lurch of the economy to recession.
The subcontractor on the other hand has an equally valid argument against
pay-when-paid clauses. If he has properly carried out the work, he
argues, he should be entitled to be paid, otherwise he will run the risk of
continued existence instead of the contractor. He should not become
embroiled in disputes between the Employer and contractor, which may have
nothing at all to do with his work. That situation would be unreasonable
says the subcontractor and the Housing Grants Construction and Regeneration
Act 1996 is an indication that cashflow of subcontractors should be
protected.
Courts appear to dislike pay-when-paid clauses and have adopted an
interpretation to reduce their impact. In the New Zealand decision in Smith
and Smith Glass Ltd -v- Winstone Architectural Cladding Systems Ltd (1991)
a distinction was made between an 'if' clause and a 'when' clause. An
'if' clause requires the contractor to pay the subcontractor only when he has
received payment from the Employer. The 'when' clause indicates the time
for payment only, so that the time for payment to the subcontractor is
calculated from the date when payment should have been made by the Employer,
whether or not payment has in fact been made. It was held that unless
the clause spells out in clear and precise terms that payment will not be
made until payment is received, the clause does no more than indicate the
time for payment.
The US Courts have taken a much more robust approach in reducing the
effect of pay-when-paid clauses. In Thomas Dyer & Co -v- Bishop
International Engineering Co [1968] a pay-when-paid clause was held only
to postpone payment for a reasonable time, to allow the contractor to obtain
funds to pay, following the Employers failure to pay.
The English courts have not followed either approach, but have taken the
lead from the enactment of the Housing Grants Construction and Regeneration
Act 1996.
Section 113 of the 1996 Act makes unenforceable pay-when-paid clauses of
the if type, in construction contracts to which the Act applies, except in
the case where non-payment is due to insolvency of the Employer.
Section 113 deals also with the situation where the main contract includes a
pay-when-paid clause which is dependant on another person making
payment. If that other person becomes insolvent, and the Employer does
not make payment, then the contractor is not under an obligation to make a
related payment, provided the SubContract pay-when-paid clause is in suitable
terms.
The recent decision in Durabella Limited -v- J. Jarvis & Sons
Limited (September 2001) now establishes the position in English
Law. It was held that the 1996 Act clearly envisaged that pay-when-paid
clauses which shared the risk of insolvency were not unreasonable. Such
clauses would therefore be enforced. In my view, unless a contract falls
under the 1996 Act, it will be difficult now to argue against enforcement of
any pay-when-paid clauses on grounds of unreasonableness.
The decision does not open the floodgates for pay-when-paid clauses. There
are a number of sensible legal safeguards identified in the decision.
First, it was held that a contractor cannot rely on a pay-when-paid clause if
the reason for non-payment is its own breach of contract or default. A
party cannot take an advantage from its own breach of contract. Second,
it was held that a pay-when-paid could only be effective so long as the main
contract machinery of payment was capable of being operated. It was an
implied condition for the operation of such a clause. If the machinery
breaks down as for instance where certificates are not or cannot be issued as
they should be, then the contractor was best placed to remedy the
situation. For the clause to be effective the contractor impliedly
undertakes that it will pursue all means available to obtain payment, or it
will not be able to rely on the clause to defeat the subcontractors claim for
payment.
The second safeguard was applied to the particular facts of the case in Durabella.
Termination of the contractors employment with the Employer prevented further
payment. The contractor had failed to pursue its remedies promptly and
effectually. It was held that the contractor could not rely on the
pay-when-paid clause.
One interesting observation in Durabella was that Section 113(1) of
the 1996 Act did not affect payment conditional on certificates under the
main contract, whether by Architect or Engineer under the contract.
This confirms the view generally taken by legal commentators. The
parties freedom to make such arrangements was stated to be legitimate and not
unreasonable.
The approach
to be taken by a subcontractor faced with non-payment and a pay-when-paid
clause can be stated in summary as follows:
1. Establish by legal advice whether the clause is an if clause i.e.
conditional on payment, or a when clause i.e. setting the time for payment
only;
2. If the clause is an if clause, then establish
(a) whether the non-payment is due to the
contractors default if so he may not be able to enforce the clause; or
(b) whether the non-payment is due to the breakdown
of the main contract administration if so the contractor may not be able to
enforce the clause if he has not take steps to enforce his right to payment.
3. If the clause is an if clause, then establish whether your
contract is caught by the Housing Grants Construction and Regeneration Act
1996 if so if clauses are unenforceable except in situations of insolvency.
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