The Act provides that a payment clause will be invalid if it makes payment conditional on:
- performance of obligations under another contract; or
- a decision by any person as to whether obligations under another contract have been performed.
This is to prevent a party up the line from relying on circumstances relating to its own contract to delay payment under a separate contract - for example, the fact that an employer has not complied with its certification obligations to a main contractor cannot be used by the main contractor to deny payment to a subcontractor.
Any 'pay when paid' clause will also be rendered ineffective by the Act. The only exception to this is if the third party making the payment is insolvent. Insolvent is defined in the Act, with reference to insolvency legislation as:
- A company entering administration, having a receiver appointed, passing a resolution to voluntarily wind-up without also declaring they are solvent, or the court making a winding -up order under the Insolvency Act;
- A partnership granting a trust deed to its creditors, its estate being sequestrated or a winding-up order being made under the Insolvency Act;
- An individual being sequestrated, granting a trust deed or having a bankruptcy order made against them.
The Act has not been updated to reflect changes made by the Corporate Insolvency and Governance Act 2020, which introduced two new insolvency procedures
When preparing your contract, any 'pay when paid' clause should be carefully drafted to be unambiguous. It should also refer to the current legislation and the possibility that the legislation may change. This is particularly important as failure to refer to the up to date insolvency provisions can render an effective 'pay when paid' clause ineffective, especially as the courts will generally interpret such clauses as narrowly as possible.
This was seen in the English case of William Hare Ltd v Shepherd Construction Ltd, the main contractor, Shepherd, sub-contracted work to William Hare. The sub-contract was entered into after the insolvency legislation had changed but the contract didn’t reflect the current terms of the legislation. The contract referred to an administration order being made against the employer. The employer went into administration under a self-certification procedure. This wasn’t included in the definition of insolvency under the contract, which referred to the old legislation. The English Court of Appeal held that the exception didn’t extend to the administration of the employer and therefore Shepherd required to pay William Hare nearly £1million, notwithstanding that Shepherd hadn’t been paid by the employer.
Where such a clause is ineffective, parties can agree other terms for payment, failing which the Scheme provisions will apply.
We hope you have enjoyed this payment blog series and it has answered some of the common queries which arise in respect of payment under a construction contract. If you haven’t read our previous payment blogs they can be found here.
Should you require assistance with any aspect of a construction contract, we have a large and experienced construction team who would be happy to discuss this with you.