Company Pays Price When Contract Terms Do Not Reflect Current Law

Pay when paid' clauses in construction contracts came under the microscope in a recent case, with unfortunate results for a company that did not keep its contract terms up to date.

The case involved a contractor which was carrying out work for a firm that went into administration, owing the contractor for the work it had done. Some of that work had been subcontracted to two other firms. The sums involved were substantial, with one of the subcontractors owed nearly £1 million.

The contractor relied on a pay when paid clause, which meant its liability to the subcontractors was limited if the firm to which it was contracted (the ‘employer’) did not pay it the sums due to it. The operation of such clauses is prohibited by the Housing Grants (Construction and Regeneration) Act 1996 (HGCRA) unless it can be shown that the employer is insolvent. The precise wording of the relevant part of the Act has changed over the years, following an amendment in the Enterprise Act 2002 that changed the meaning of the section which relates to insolvent companies. The new wording means that where a company ‘self-certifies’ its need to enter administration, that suffices for the purposes of the relevant section of the HGCRA. Prior to that change, only an administration which resulted from a court order would qualify. Standard contract documentation now usually incorporates appropriate wording to allow for this change.

Unfortunately for the contractor, when it made its contracts with the subcontractors, it failed to change the relevant clause, with the result that the pay when paid clause was not triggered when the employer entered administration unless the administration was the result of a formal process.

In this case, the employer's administration was by the informal, self-certifying route. Accordingly, the contractor could not rely on the pay when paid clause and was liable to its subcontractors whether or not it received payment.

'The judgment does not dwell on how it was that a contract of this size could fail to take account of changes in the law that are well known in the construction industry,' says Bill Duncan, “and a trip to the Court of Appeal in pursuit of a lost cause magnified the loss.'

Involving us at an early stage in the negotiations in all contractual matters will help control your legal risks and avoid potential pitfalls.

For advice and more information please contact Bill Duncan