A contractor has withheld £250k from a flooring firm and told it the contract states it has to arbitrate directly with the client. How can it best recover the money it is owed?

My flooring firm entered into a formal bespoke subcontract agreement some time ago. The work was broken down into two categories: direct and domestic.

The contract conditions state that for domestic work, we should apply to the main contractor for payment in the normal way.

For direct work, we have to make a separate application, which the main contractor passes to the ultimate client’s project QS who values it. Payment goes from the client through the main contractor down to us.

The conditions contain a procedure for resolving any dispute over direct works whereby we are able to borrow the main contractor’s name to arbitrate direct against the client. This is described as an “exclusive remedy”.

We are about £250,000 short in respect of direct works. Having told the main contractor that we intend to use its name in an arbitration against the client to recover the outstanding £250,000, it has informed us that no formal agreement was ever struck with the client reflecting the procedures in the subcontract. It appears the main contractor has carried out the project on the basis of a letter of intent.

It says the reason the formal main contract was not signed was because we would not agree the scope of the direct work.

What can we do to recover the outstanding £250,000? If there are steps that we can take, should we be taking them against the main contractor or the ultimate client?

The client is not obliged to pay you

From the client’s perspective, the answer is pretty simple. The client’s contractual obligations are owed to the main contractor. It seems that in fact there was no formal main contract, but a letter of intent. While we do not know the terms of the letter of intent, it appears that there is no dispute between the client and the main contractor and so, presumably, both are satisfied that proper payment has been made for the works. Of course, the client cannot be bound to make payments to a subcontractor when it is not a party to the subcontract and may well have no knowledge at all of the arrangements made between the main contractor and the subcontractor.

Surely you should look to the main contractor for payment? It seems rather naive to accept a contract that provides that the client will make payment to you directly without satisfying yourself that the client knows about the arrangements and has committed in writing to comply with them.

Ann Minogue, partner at Linklaters

Take the contractor to adjudication

The mechanisms spelled out in the contract for channelling money from the client back through the contractor are irrelevant. You have a contract with the contractor and this probably falls under the Construction Act.

So you have two advantages. First, “pay when paid” provisions are banned, so the contractor cannot use the fact that the client has not paid for the direct work as a reason for not paying you. Second, you are not bound by any arbitration clause as you are entitled to go to adjudication against the contractor.

You should point this out forcefully to the contractor, assemble your paperwork and if it doesn’t pay, go for a quick adjudication.

Andrew Hemsley, regional operations director at Cyril Sweett in London

(l-r)Ann Minogue, Julian Holloway, Rachel Barnes, Rudi Klein, Andrew Hemsley
(l-r)Ann Minogue, Julian Holloway, Rachel Barnes, Rudi Klein, Andrew Hemsley

My immediate reaction was to advise you to report the contractor to the police. On the face of it, it should be prosecuted for obtaining services by deception

Report the contractor to the police

After reading your query, my immediate reaction was to advise you to report the contractor to the police. On the face of it, it should be prosecuted for obtaining services by deception under section 1 Theft Act 1978. From the information provided, it appears to have procured £250k worth of work without any intention of paying for it. However, this will not immediately help your plight although it remains an option.

By virtue of section 110 of the Construction Act, your subcontract should have an adequate mechanism for determining how much and when you are to be paid. Insofar as the direct payments are concerned, your subcontract is likely to be deficient in this respect. Furthermore, if your entitlement to payment is dependent upon the contractor receiving payment from the client this is, in effect, a pay when paid arrangement, which has no effect under the act.

Since your subcontract does not contain an adequate mechanism for payment, you can rely on the scheme for construction contracts. Under the scheme, progress payments are to be made in respect of a “relevant period”. In the absence of any period in the subcontract, this is 28 days from the start of the contract and payment is due on the expiry of seven days from the end of the 28-day period or on the making of a claim for payment.

You can refer the matter to an adjudicator or you can issue legal proceedings to obtain a judgment for the £250k.

Rudi Klein, chief executive of the Specialist Engineering Contractors Group

Arbitration could prove tricky

Although the conditions provide that your right to borrow the main contractor’s name to arbitrate direct against the client is an “exclusive remedy”, your statutory right to adjudicate against the main contractor cannot be excluded.

Alternatively, if you choose to arbitrate direct against the client, your claim will have to be expressed as the main contractor’s claim and the employer will be able to use any defences that are available to it under the main contract. These may not be applicable under the subcontract. Furthermore, no formal main contract was signed and the employer and main contractor are still working under the letter of intent. Only if that letter of intent incorporated the conditions of contract to be comprised within the formal contract, and those conditions contained an arbitration clause, would any arbitration be possible at all.

For all these reasons, the quickest and best method for you is to adjudicate direct.

Julian Holloway, partner at Berwin Leighton Paisner

You’re entitled to a fair sum

On the face of it, it does not look as though it was the intention for you to contract with the ultimate client in relation to the direct works – why otherwise would you have to borrow the main contractor’s name in order to arbitrate with the client? The assumption must be that the main contractor would have contracted with the ultimate client for the carrying out of these works, in order for this procedure for resolving disputes to be effective.

As for this procedure for resolving disputes, if there is in fact no agreement between the main contractor and the ultimate client that would make it workable, this part of your agreement would appear to be nugatory and can be disregarded. This would leave you with the usual remedies against the contractor for unpaid work.

I am concerned that it is being alleged that the scope of the work was not agreed. This might call into question whether there was a concluded contract for these particular works. However, you seem fairly sure that you are owed a specific sum for the work that you have carried out and I assume this is based on the terms of the subcontract.

You would normally be entitled to be paid a fair and reasonable sum for work that you were requested to carry out, if there was no contract for that work.

Rachel Barnes, partner at Beale & Company