The common touch

Legal issues in construction contracts frequently conceal deep-rooted policy issues, usually about where risk is to be allocated. Nowhere is this better exemplified than in "pay-when-paid" clauses. Section 113 of the Construction Act, which partially "outlawed" pay-when-paid clauses, was, of course, the result of industry compromise, the effect of which was to render them ineffective unless and until the paying party up the chain (typically the client) was insolvent.

Before the Construction Act, the debate used to concern the circumstances in which such a clause could be defeated by a subcontractor on the basis of common law as opposed to statutory restraints.

In the aftermath of the Construction Act, it seemed unlikely that these issues would ever be aired in front of a UK court, so it is intriguing to see that in Durabella vs Jarvis (19 September 2001), a Technology and Construction Court judge, Judge Humphrey Lloyd QC, was asked to consider them, probably for the first time.

In this case, Jarvis had built 36 flats for Galliard, engaging Durabella as a subcontractor for the floors. Galliard had terminated its relationship with Jarvis, which was governed by a letter of intent. This letter of intent entitled Jarvis to payment upon a quantum meruit (a reasonable sum) and in due course, a settlement was reached under which Jarvis accepted £550,000 in full and final settlement of all its claims. Durabella then sued for the balance of its entitlement under the flooring subcontract and Jarvis defended, claiming that the work was defective. Clause 4 of the subcontract provided that: "Our liability for payment to you is limited to such amounts as we ourselves actually receive from the employer in respect of your works under this order."

Jarvis' argument was that the settlement agreement had clearly stated that no payment was made by Galliard in respect of Durabella's works. Accordingly, the pay-when-paid clause precluded any claim by Durabella. The Construction Act was not in force when the subcontract was made so Judge Lloyd was faced with the difficulty of interpreting the pay-when-paid clause in the light of common law principles and the Unfair Contract Terms Act. The contractor could not rely on a pay-when-paid clause, said the judge, if the reason for non-payment "is its own breach of contract or default. It is trite law that one cannot take an advantage from one's own breach of contract".

The contractor was obliged to pursue for the benefit of the subcontractor remedies on its behalf against the employer

So if Jarvis' employment had been lawfully terminated for a default to which Durabella had not contributed, then Jarvis could not rely on the clause. It would have deprived the subcontractor of the opportunity to complete the subcontracted works in breach of contract. Clause 4 would be inoperable both under the common law and under the Unfair Contract Terms Act.

In addition, the contractor would be under an obligation (implied into the contract) to pursue for the benefit of the subcontractor remedies on its behalf against the employer. In other words, if the contractor had not done everything it reasonably should have done to pursue the subcontractor's rights, it would be in breach of contract and so not in a position to invoke the pay-when-paid clause.

Counsel for the subcontractor had another argument. In considering whether or not clause 4 was reasonable under the Unfair Contract Terms Act, there should be regard to the fact that parliament had outlawed the clause under the Construction Act. It must therefore be unreasonable. The judge observed that this was not a reliable indicator of industry practice, particularly when large sections of the construction industry had been excluded from the act. The insolvency exception further indicated that pay-when-paid clauses were still acceptable in some circumstances.

Courts often read implied terms into contracts in order to avoid what they see as an unjust situation, and this case is a very good example.