Clash points

The most controversial aspect of the Construction Act is the insolvency exemption in section 113. This section makes ineffective the traditional pay-when-paid arrangement. But, there is an exception. If a third party payer upstream becomes insolvent, the payer is entitled to have –as the act terms it – a conditional payment provision. I have always found this an extraordinary provision.

Because of the failure of clients and the industry to agree on statutory trust funds, the removal of pay-when-paid would leave many contractors exposed in the event of insolvency of clients. In other words, once a client goes bust, contractors will not have funds to pay subcontractors and suppliers.

Nonetheless, this remains a wholly unjustifiable exemption. Why? It legitimises contractually reserved rights not to make payment for work properly carried out or for materials supplied, in circumstances where – otherwise – the payee would have legal entitlement to the payment. I am not aware of any provision in UK legislation that favours a certain class of payers in this way.

It is, therefore, no accident that this exemption has now been incorporated in both standard and non-standard forms of contract. In fact, the justification often used is that the inclusion of this exemption is necessary for compliance with the legislation.

We all know that the risk of non-payment arising from the insolvency of a payer higher up the contractual chain will be passed on to those further down. It will finally rest on the shoulders of those whose businesses are unable to bear such risk. They will have to pay their suppliers, their employees and, indeed, everybody else with whom they deal. Firms are then put out of business, work is further disrupted and there is misery all round. This is inefficient and wasteful.

At this stage, I can almost anticipate Clare’s argument. Contractors do not benefit from the work supplied or performed by their subcontractors and suppliers. Such benefit directly accrues to the client. They cannot take away the work that has been carried out and use it elsewhere. But, so what? This applies to all firms in the payment chain. All the work done and materials supplied are, ultimately, for the benefit of the client.

Section 113 goes further; it defines the situations in which a company becomes insolvent. The list is far too wide. It includes, for example, the making of administration orders under the 1986 Insolvency Act. The very intention of administration, however, is to keep the show on the road. The aim is to keep the contract going in the hope that the company subject to the administration order will be able to trade its way out of difficulty. Why should pay-when-paid apply in this situation? It is enough to cope with the risk of insolvency of one’s payer. To have to bear the risk of insolvency of the payer of one’s payer is commercially nonsensical. Unfortunately, this is what the act is legitimising and, therefore, this exemption must go.