Paying for materials in order to reserve them is common practice when they are in short supply. Just make sure you follow a few guidelines when doing so to avoid trouble
When lead times are long, clients take bigger risks to secure materials. It can never be absolutely safe to pay for materials and goods that are not stored on site, even less so for unfabricated materials and goods, but that does not mean clients should never do it. In my opinion, the industry focuses on the wrong questions when it looks at this issue.
Project managers are fixated on sticking to the programme. They see it as essential to reserve the materials, and this leads them to conclude that a payment must be made, even if not delivered to the site.
The way of protecting the client, in their view, is to ask the contractor to sign a piece of paper called a “vesting certificate” to confirm that the materials will pass to the client, that they are separately stored and marked as the client’s property, that they are insured and so on. Once the vesting certificate has been issued, they tell the client to write out the cheque.
However, even in the case of fabricated goods and even if the goods are separately stored, marked and checked as the client’s property, if a contractor becomes insolvent or there are rumours of insolvency, the goods may simply disappear, and even the most indelible marking of the client’s name may be removed.
Besides, the unfabricated materials that are earmarked for the client are unlikely to become its property anyway, whatever the vesting certificate says. In the contractor’s yard they will be mixed with materials from other suppliers as they cannot be separately stored and marked if they are then to be worked with. In this situation, again, if the contractor is rumoured to be on the verge of insolvency, the materials can disappear.
If the materials or goods, whether fabricated or not, are located abroad, who knows what local laws say about the passing of property? Do we know whether the laws in, say, Taiwan, demand that property passes to those that made the payment or require those that receive goods marked as someone else’s property to return them to the owner?
Furthermore, what value is a vesting certificate signed by a contractor that has gone bust? Suing an insolvent contractor for breach of a vesting certificate is not likely to be fruitful.
If a contractor becomes insolvent, the goods may simply disappear, and even the most indelible marking of the client’s name may be removed
So what question should clients ask in these circumstances?
First, it is important to look at the overall financial standing of the contractor. Does it have a sound balance sheet? If it is part of a bigger group, should an ultimate guarantee be requested from the holding company? Is there a performance bond that might make some contribution to the client’s loss if the goods and materials disappear?
In addition, if the payment is for securing materials that are then to be worked on in the contractor’s yard, is the payment really an advance payment to the contractor? If it is, should it then be secured by an on-demand bank guarantee?
Might it be better if the client entered into a supply contract with the materials supplier, with this being passed across to the contractor when it is appointed? In those circumstances if the client fails to agree the commercial terms with the contractor, it has at least still secured its materials.
Alternatively, is the commercial arrangement really just an undertaking by the client to pay a specific cancellation charge if, for some reason, the contractor does not proceed, so that the supplier is compensated for the lost sale?
Clients need to look more flexibly at how they buy from the construction industry in periods of lack of capacity. Ultimately, the judgment as to whether, how much and when to pay is a commercial one. Instead, when buying materials, the industry tends to stack up a legal pack of cards that collapses as soon as there is an insolvency.
Ann Minogue is a partner in solicitor Linklaters