Slipping the choke chain

Cash flow is the life blood of the building industry, said Lord Denning in a series of Court of Appeal decisions starting with Dawnays vs Minter (1971) and finishing with Modern Engineering vs Gilbert Ash (1973). The subcontractor needed the money so as to get on with the rest of its work, he said. Therefore, once a certificate had been issued for payment to the subcontractor, it was to be honoured without withholding any money on account of cross-claims, whether good or bad.

As everyone knows, the House of Lords overruled the Court of Appeal in Gilbert Ash. Not only did their Lordships reject Lord Denning’s approach to meeting subcontractor’s needs, they also firmly rejected his view that there was anything unique about building contracts that justified such special indulgence.

Main contractors sometimes withhold payment from subcontractors to improve their own cash flow but, on occasion, their objective can be management control: the purse strings are used as a financial choke chain to obtain compliance with instructions or wishes.

Two questions arise in this situation:

• What can the subcontractor do to obtain the prompt payment that it believes is rightfully due?

• Is the subcontractor entitled to stop work and walk away if it has not been paid in accordance with the subcontract?

Claiming payment

The first question has been partly addressed by the Construction Act. The Dawnays line of cases involved applications by subcontractors for summary judgment under RSC Order 14 (now replaced by CPR Part 24) to obtain payment on certificates, where the main contractor had withheld payment on the grounds of set-off.

Some 25 years on, Sir Michael Latham recognised that Lord Denning had a good point about the special cash flow needs in the construction industry, and the Construction Act has imposed a special legal regime on construction contracts to cure the problem. This modifies Lord Denning’s approach to the extent that withholding “good” cross-claims must be allowed. The Construction Act’s construction-specific cure involves ritual notices and possible visits to an adjudicator, who is supposedly able to divine rightful entitlements and deductions within a lunar month. The courts have been left to fill in the gaps in the act as to enforcement.

Several other important legal potions to promote the circulation of the life blood have been invented during the 25 years since Gilbert Ash, mostly based on charging interest for late payment, and including the recent Late Payment of Commercial Debts (Interest) Act 1998.

However, with respect to the second question, the subcontractor’s need is sometimes to stem the loss of blood rather than promote its circulation. Here, a recent employment law case throws some fresh light on the subcontractor’s right to walk off the job.

Latham provided statutory aid for struggling subcontractors, but courts have revived a natural remedy. Withholding payment with intent may be a repudiatory breach of contract

Walking out

The subcontractor’s dilemma is that if it walks off the job because it has not been paid, its stopping work can amount to a repudiatory breach, entitling the main contractor to claim damages. It is entitled to terminate performance only if the withholding of money constitutes a breach of condition or a repudiatory breach.

The Construction Act has sought to overcome the dilemma by a new right to suspend performance after due notice in the event of non-payment. This may prove a useful threat, but the implications of actually suspending performance remain to be worked out. Complete termination may still be preferable in practice, so long it does not constitute wrongful repudiation.

Construction contracts are generally on terms laid down by the paying party and rarely make time of payment an express condition. In Decro-wall International vs Practitioners in Marketing (1971), the Court of Appeal held that, in the absence of an express term, persistent late payment did not constitute a repudiatory breach where the receiving party could reasonably anticipate that it would be paid in full eventually.

To constitute a repudiatory breach, the cases suggest that payment delay must amount to an unjustified refusal to pay or manifest an intention never to pay. A refusal to pay may be justified by a right of set-off. Where a right of set-off is relied on as grounds to resist repudiation, it is not necessary that the amount of the set-off should be accurate, but it must be a “reasonable assessment in good faith”: Santiren Shipping vs Unimarine SA (1981).

A recent employment case, Cantor Fitzgerald International vs Callaghan (1999), has added an important qualification. The case involved a team of bond brokers who had left the plaintiff company. They argued that the conduct of the company in deliberately refusing to deal with problems over their remuneration effectively amounted to a withholding of payment, and that this entitled them to treat the contract as repudiated.

The Court of Appeal found that contracts of employment do not constitute a special type of contract (rather like the House of Lords in Gilbert Ash). Lord Justice Judge quoted an observation by Lord Denning that repudiation required “conduct which is a significant breach of the contract of employment or which shows that the employer no longer intends to be bound by one or more of the essential terms of the contract.” He continued in a passage which caught my eye: “The refusal to pay was deliberate and determined, motivated by a desire improperly to pressurise the defendants into harder work. The decision wholly undermined the contract of employment and constituted a repudiatory breach.”

Main contractors whose management style inclines to sustained tugging on the choke chain should take note.