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Insolvency and pay when paid clauses

The Construction Act 1996, with one exception, delivered a death blow to pay when paid clauses in construction subcontracts. That exception is when the employer becomes insolvent by the time the clause is sought to be invoked. By Mark Roach

In June Coulson J in William Hare v Shepherd Construction, had to grapple with the changes to the definition of insolvency brought about by the Enterprise Act 2002.

The subcontract in this case was drafted for the main contractor in 1998. It precisely reflected the wording of the Construction Act. It stated that its pay when paid clause came into play when one of the employer insolvency events was a court made administration order under the Insolvency Act.

The subcontract was entered into in 2008 with the wording as originally drafted ten years before. The problem was that the contractor had not amended the subcontract to take into account the changes brought about by the Enterprise Act in the meantime.

The Enterprise Act amends the Insolvency Act by adding two further routes to administration. One is the appointment of an administrator by the company itself. The employer in William Hare went down this route. The subcontractor brought claims against the contractor which it accepted as being legitimate. The contractor therefore sought to invoke the pay when paid clause on the ground of the employer’s “self-certified” administration. It served a withholding notice based on this ground.

The subcontractor at this point cried “technical foul”. It sought a declaration from the court that the insolvency event in the sub-contract of a court made administration order under the Insolvency Act did not include the employer’s “self-certified” administration. The contractor’s case was that it would be absurd if the sub-contract provision for what in 1998 was the only type of administration under the Insolvency Act should not now be read as including these further routes to administration.

Unfortunately for the contractor, Coulson J disagreed. The first reason was that the subcontract only referred to the making of an administration order by the court (and not to the further routes).

The second reason was that Coulson J was of the view that such a clause is a type of exclusion clause. It seeks to exclude the contractor’s liability to the subcontractor where there is a financial failure up the contractual chain. As such it needs to have clear wording to be effective. The subcontract provision in question did not have the clear wording it needed by referring expressly to a “self certified” administration.

The third reason was that the subcontract was entered into some six years after the Enterprise Act was passed. If the sub-contract had been entered into before the Act was passed, the contractor’s case might have been stronger. As it was, the contractor had ample opportunity to take the changes made by the Act into account by changing the wording of the sub-contract, which it failed to do.

Some might be surprised by the decision. After all, the employer’s “self-certification” of its insolvency did constitute an administration under the Insolvency Act, albeit not by court order. Furthermore the contractor’s (if not the subcontractor’s) intention was undoubtedly to include all acts of insolvency provided for by the Insolvency Act as amended by the Enterprise Act.

However, the message from the decision is clear for main contractors and for those who draft subcontracts on their behalf. Make sure that the subcontract’s definition of employer insolvency expressly includes the further routes to administration introduced by the Enterprise Act. The validity of the pay when paid clause might just depend on it.

Mark Roach is a senior solicitor at Davies Arnold Cooper