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Scots case sets a bad precedent

LAW

Expecting an employer to pay an insolvent contractor goes beyond the aims of the Construction Act, writes Jeremy Winter

BEFORE the 1996 Construction Act came into force, English lawyers had little knowledge or exposure to Scottish court decisions. Scots law was a quite different system (or so we were told by Scots lawyers) and anyway we had quite enough case law of our own, thank you.

But since the Act (which applies equally in Scotland as it does in England and Wales), we have had a good deal of exposure to Scottish court decisions and Scots law is now regarded as no different from English law.

But in terms of precedent, decisions of the Scottish courts are not binding upon English courts, although they are 'persuasive'. So if a Scottish decision is simply wrong, an English court need not follow it.

That is fortunate, because I believe that one recent and important Scottish decision is wrong. The case is Melville Dundas (in receivership) v George Wimpey UK, a decision of the Extra Division of the Inner House of the Court of Session (the Scots version of the English Court of Appeal) in December 2005.

My fellow contributor and Scots lawyer, Lindy Patterson, wrote about the case in February. Here is a reminder of what the case was about.

Melville Dundas (as contractor) had a JCT contract with Wimpey (as employer) to build some f lats in Glasgow. Melville Dundas went into administrative receivership. Wimpey applied the provisions of the contract, which said that if the contractor became insolvent, its employment under the contract could be terminated and the employer would not have to make further payments until the work had been finished and an account drawn up of who owed what to whom.

Accordingly, Wimpey did not pay the certificate that was due for payment just before the receivership. The Scots appeal court held that it could not do this because it had not given a withholding notice under Section 111 of the Construction Act. So Wimpey would have had to pay out what was due to Melville Dundas, pay another contractor to finish the project, and then stand in line with Melville Dundas's other unsecured creditors. Press reports quote the receiver as saying Melville Dundas had debts of £36 million and nearly 2,000 unsecured creditors, with no prospect of the unsecured creditors getting anything.

The Construction Act was the product of the Sir Michael Latham's Constructing the Team report, which kick-started the movement to modernise construction practices. One of the problems it identif ied was that 'main contractors are abusing their position to wrongfully withhold payment from subcontractors who were in no position to make any effective protest'. The requirement to give a withholding notice under section 111 of the Act was aimed at preventing that abuse.

It is a rule of the interpretation of statutes that a judge can refer back to the 'mischief' that a statute was introduced to deal with. In the Melville Dundas case, the Scots court cited that passage from Latham. It also repeated the well-worn mantra about the intention of the legislation being to secure cash flow (it often seems to get overlooked that cash f low is as important to employers as it is to contractors, and to main contractors as it is to subcontractors). And thus, supposedly following the objectives of the Act, the court concluded that Wimpey could not stop the payment because it had not given a withholding notice.

But the provisions that one finds in most standard form contracts to deal with what happens when a contractor becomes insolvent have nothing to do with contractors 'abusing their position to wrongfully withhold payment'. Nor is the insolvent contractor's cash flow the most important consideration at that stage - few insolvent companies survive as going concerns. If the court was trying to meet the intention of the legislation, it patently failed to do so because Wimpey's cash f low was irretrievably harmed.

The provision that is fair to both parties to a construction contract where the contractor becomes insolvent is the one that most contracts contain: the insolvent contractor gets paid only what remains of the sum due after deduction of the amount that its failure to complete the contract has cost the employer The Construction Act deliberately interferes with the freedom of parties in the construction industry to contract as they think fit. That is a strange thing in itself, given that freedom of contract is one of the most basic tenets of English law and business. Surely there is no reason to extend its effect beyond what it was specifically intended to deal with.

The Melville Dundas decision will affect other forms of contract. JCT 2005 clause 8.5 contains simpler language to deal with contractor insolvency than clause 27 of the old JCT form, but it still operates in the same way: the contract purports to stop any right to further payment from the date the contractor becomes insolvent.

Following the Melville Dundas reasoning, that would amount to an attempt to block the effect of the Construction Act and so would not be binding.

This decision is unlikely to apply when the contractor is put into liquidation, as opposed to administration, because Rule 4.90 of the Insolvency Rules allows set-off of mutual debts and credits.

It cannot be necessary to give a withholding notice for this rule to apply.

I have no idea how many English judges read Construction News or if, on reading this, they would take my views on board. But I would urge an English company caught in this situation not to regard the Melville Dundas decision as representing the final word on the subject under English law.

KEY POINTS

A recent Scottish appeal court decision has held that, where a contractor becomes insolvent, the employer cannot stop payment for the work unless he has given a withholding notice.

It is suggested that th is decision is incor rect, in that it goes well beyond what the Construction Act was designed to achieve.

Law Report is a weekly column covering legal issues of all kinds - including contractual, employment and industrial relations. To h e lp us provide a steady f low of quality, readable legal articles, we have created a panel of expert advisers. They are: ¦ Daniel Atkinson, executive director of Atkinson Law; ¦ James Bell, partner with London law firm Christian Khan; ¦ Guy Cottam, a conciliator, arbitrator and former chairman of the arbitration advisory panel of the Institution of Civil Engineers; ¦ Catriona Dodsworth, a partner with law firm Pinsent Masons; ¦ Rudi Klein, visiting professor of construction law at the University of Wolverhampton and chief executive of the Specialist Engineering Contractors' Group; ¦ Lindy Patterson, partner and head of construction group with Dundas & Wilson; and ¦ Jeremy Winter, a partner with law firm Baker & McKenzie.