Shepherd Construction tried to rely on a pay-when-paid clause to not pay its subcontractor, William Hare. Problem was, it wasn’t well drafted – so would the courts help it out?

In 2009 it was ruled that the insolvency of Trinity Walk Wakefield was not sufficient to trigger a pay-when-paid clause in a subcontract between the main contractor, Shepherd Construction, and its subcontractor, William Hare. The Court of Appeal has given resounding support for that decision.

William Hare was employed by Shepherd on the Trinity Walk shopping centre in Wakefield, west Yorkshire. Trinity was the developer and the contract between Shepherd and William Hare contained a pay-when-paid clause designed to allow Shepherd not to pay William Hare if Trinity became insolvent.

The clause set out Trinity’s insolvency by reference to four possible events, the key one being by order of the court under part II of the Insolvency Act 1986.

In March 2009, Trinity’s directors placed the company in administration using the “self-certifying” route brought in under the Enterprise Act 2002. The terms of the subcontract did not refer to this route into administration. Had the clause read “under the Insolvency Act or any amendment or re-enactment thereof has an administrator appointed”, Shepherd would not have had to pay the subcontractors.

William Hare argued that the pay-when-paid clause did not apply because no “administration order” had been made.

Shepherd argued that it would be absurd if the self-certifying routes were excluded from the pay-when-paid clause. William Hare’s interpretation was accepted. The words as drafted gave rise to a commercially sensible result and William Hare had interpreted the plain meaning of the words. The clause was a form of exclusion clause as it attempted to pass to William Hare the risk that Shepherd may not be paid under the main contract and the circumstances in which the subcontractor may not be paid should not be expanded. As the contract had been entered into more than five years after the amendments to the Insolvency Act 1986, the failure to amend the clause was deemed a deliberate choice to restrict its scope.

It was not open to Shepherd to argue that there was a lack of clarity in the clause and ask the court to give it another meaning

Shepherd appealed, but it was dismissed. The Court of Appeal was clear that there must be a strong case for the court to conclude that something was wrong with the language used by the parties in a contract. It was not readily accepted that people make linguistic mistakes, particularly in formal documents. The test is what a reasonable person, having all the background knowledge that would have been available to the parties, would have understood the language in the contract to mean.

However, in a case involving an exclusion clause, the court was doubtful that these usual principles would apply at all. The pay-when-paid clause had such financial significance that if the party seeking to rely on it had mis-drafted the provision, the court could see no reason why these usual principles should come to its rescue, however obvious the error.

The case serves as a warning that a party will only be able to limit its liability if it uses clear words. This will take precedence over the rarely applied principle that the courts may modify contract wording where a reasonable person would conclude from the background that something must have gone wrong with the drafting.

It was not open to Shepherd to argue that there was a lack of clarity in the clause and ask the court to give it another meaning. The clause was drafted for the benefit of Shepherd and it excluded a liability to pay the subcontractor. It was for the party relying on the clause to make sure it was correct.

The decision isn’t the end of pay-when-paid clauses. A properly drafted one in a construction contract that covers upstream insolvency is legal and enforceable. However, any party seeking to rely, not just on a pay-when-paid clause, but on any clause that seeks to relieve it from liability (of which there are many in commercial contracts) must take notice of this decision to make sure contract terms are clear. If they are not, the courts will not readily come to the rescue.