For subcontractors the day when crippling paid-if-paid clauses are outlawed cannot come too soon, but in the meantime here’s how to launch an effective counter-attack

There is nothing that gets my goat more than section 113 of the Construction Act, which legitimises pay-if-paid provisions when a third-party payer has gone into insolvency. It is an extraordinary provision. It encourages businesses to deny payment to suppliers even though there is no complaint about the work provided.

The DTI’s consultation document was lukewarm about getting rid of section 113 because of the lack of evidence to suggest that it was unfair. What would be the reaction of most of British firms if the DTI were to announce that people would no longer have to pay their bills if a third-party payer went into insolvency? I should imagine that there would be an outcry.

The DTI, presumably, subscribes to the belief that risk should be allocated to parties in the best position to manage it. In the case, the risk of employer insolvency is, of course, best managed by the main contractor. The subcontractor has no rights against the client in respect of its payment entitlement. Furthermore, it is unlikely to obtain insurance in respect of bad debts accruing from the operation of pay-if-paid provisions. The client is not indebted to it and, furthermore, a pay-if-paid provision prevents a debt from arising in the first place; it only arises where the main contractor has received the cash.

As a result, it is not surprising that 99.9% of subcontracts contain a pay-if-paid provision. So, if subcontractors are out of pocket because of a pay-if-paid provision, is there anything they can do? Answer: quite a lot …

Sometimes the payer will state that no monies will be forthcoming in the event of the third party going into insolvency. Ignore this and take your debtor to court

  • The first thing is to read the relevant clause carefully. Sometimes the payer will state that no money will be forthcoming in the event of the third party becoming insolvent. Ignore this and take your debtor to court to recover the outstanding amount. The Construction Act only legitimises pay-if-paid provisions (not non-payment provisions). Keep looking at the wording. Does the pay-if-paid provision relate to progress payments only and not final payment?
  • What happens if you learn that your payer has received money after the insolvency of the third-party payer? You will have to make inquiries as to whether any of this was allocated to your work. This could be difficult because your prices would have been different from the prices used by your payer upstream. In these circumstances some payment is often made to ensure that the work continues without any express allocation being made. All this is simply evidence of the impracticality of pay-if-paid.
  • An unanswered question – in England at least – is whether a quantum meruit claim (that is, payment for work done outside the contract “for what it’s worth”) can be made in the event that your contract comes to an end after an upstream insolvency. This issue came before the Court of Appeal in Queensland, Australia, in 1994. The case was Iezzi Constructions Ltd vs Currumbin Crest Development Ltd.
The client had gone into insolvency. Iezzi had entered into two subcontracts – for carpentry work and roof truss work. Most of the work on the two subcontracts had been completed and a substantial amount of money was owing. Iezzi claimed that its subcontracts had come to an end either because of a breach by the builder (in closing the site) or, alternatively, because the builder had exercised a contractual right of termination. Both subcontracts contained a pay-if-paid clause. The subcontractor had no right to payment until the builder had actually received payment from the client.

The Queensland Court of Appeal held that such clause only related to payments due under the contract. They did not apply to a quantum meruit claim, which was a claim allowed by the law. Such an issue is likely to be argued in court in England rather than in an adjudication.

  • There remains, however, a more effective means of attack. Section 113 permits the use of pay-if-paid where the third party is insolvent. Section 113(2) defines insolvency. as administration, administrative receivership and compulsory winding-up under the 1996 Insolvency Act. The provisions governing these regimes have now been overtaken by the Enterprise Act 2002, and administration is now the primary insolvency regime. This means that section 113 could prove useless in underwriting pay-if-paid provisions if the third party is not in administration. In fact, the insolvency exception in section 113 may no longer qualify as an exception.

Hopefully, the whole matter will be put beyond doubt when the Construction Act is amended to outlaw all conditional payment provisions.