As the court accepted in the following case, pay-when-paid clauses in construction contracts have been “a relatively rare sight in the construction industry for the last fifteen years”. This is largely due to section 113 of the Housing Grants, Construction and Regeneration Act 1996 (Construction Act) which outlawed pay-when-paid clauses except in cases where the employer had become insolvent in one of the ways provided for in section 113.

Section 113 was under the spotlight in the following case.

William Hare v Shepherd Construction Limited and others [2009] EWHC 1603 (TCC)

The sub-contractor was engaged by the contractor to fabricate and erect steelwork at a large development in Wakefield.

The sub-contract contained an express pay-when-paid clause (clause 32) which had been drafted by the contractor and entitled the contractor to withhold sums of money otherwise due to the sub-contractor in the event of the employer’s insolvency. The sub-contract defined the employer’s insolvency by reference to four alternative situations:

  • an administrative order made by the court
  • the appointment of an administrative receiver
  • insolvent liquidation
  • the making of a winding-up order by the court

In effect the sub-contract pay-when paid clause 32 mirrored the wording of section 113 of the Construction Act.

Section 113 of the Construction Act

Section 113 provides:

“(1) A provision making payment under a construction contract conditional on the payer receiving payment from a third person is ineffective, unless that third person, … is insolvent.

(2) For the purposes of this section a company becomes insolvent:

(a) on the making of an administrative order against it under Part II of the Insolvency Act 1996;

(b) on the appointment of an administrative receiver … under that Act;

(c) on the passing of a resolution for voluntary winding up…;

(d ) on the making of a winding-up order.

The relevant provision in clause 32 was “the making of an administrative order against it under Part II of the Insolvency Act 1996”. The parties agreed that the other insolvency situations were not relevant.

Withholding notices

The contractor issued withholding notices on the grounds of the employer’s insolvency and withheld approximately £1 million from payments due to the sub-contractor pursuant to the pay-when-paid clause in the sub-contract.

The sub-contractor commenced proceedings seeking declarations that as the employer did not become insolvent by a route which was expressly identified in clause 32, the employer was therefore not insolvent on the dates that the contractor issued its withholding notices. As a result the sub-contractor was entitled to recover the certified amounts.

The problem for the contractor was that the employer’s insolvency arose through what has been described as a “self-certifying” administration (without the need for a court order) introduced by virtue of the Enterprise Act 2002, as an amendment to the Insolvency Act 1996. The amendment was made a number of years before the sub-contract was entered into. Self-certifying administrations were not referred to in clause 32.

Were the withholding notices valid? The arguments

The contractor argued that the withholding notices were valid because it would be absurd if clause 32 of the sub-contract (which referred to what was originally the only type of administration, namely by court order), was read so as to exclude the other kinds of administration introduced to the Insolvency Act by virtue of section 248 of the Enterprise Act 2002.

The sub-contractor argued that as a matter of construction the words of clause 32 meant what they said. The words referred only to insolvency events as set out in the Insolvency Act 1986. The scope of clause 32 could not be widened to include administrations which did not require a court order. Clause 32 did not refer to any amendment or re-enactment of the Insolvency Act (in contrast to other provisions of the sub-contract). The parties had therefore chosen not to refer to the alternative routes to administration introduced by the Enterprise Act 2002.

Were the withholding notices valid? The court’s view

The starting point in any dispute about the meaning and effect of a particular contractual provision was the actual words used and the natural and ordinary meaning of those words. Applying those principles, the judge found in favour of the sub-contractor for the following reasons:

  • The plain meaning of the words in clause 32 produced a coherent result. There was no reason to believe that the parties had not intended to use the words they had used in their sub-contract. The making of an administrative order under Part II of the Insolvency Act had not been made redundant by the amendments introduced by the Enterprise Act 2002.
  • A pay-when-paid provision amounted to a form of exclusion clause since it attempted to identify circumstances in which the sub-contractor could carry out a considerable amount of work for the contractor and then not be paid for that work. It should be construed narrowly. The court

“… is required to ensure that [the contractor is] kept to the four corners of [its] bargain with [the sub-contractor] and that a clause of this nature is not rewritten to expand the circumstances in which the sub-contractor might find themselves (through no fault of their own) significantly out of pocket because of a financial failure up the contractual chain.”

  • The sub-contract was entered into five years after the amendments to the Insolvency Act 1986 came into force. Both parties were deemed to have known about the amendments to the Insolvency Act 1986 and in those circumstances the failure to amend clause 32 was to be regarded as a deliberate decision. Had the amendments occurred after the sub-contract had been entered into then that might have altered the judge’s construction.

The judge went on to say that if he was wrong on the above, he would still find against the contractor using the contra proferentem rule on the basis that where there was doubt as to the meaning of a contract term, the words should be construed against the person who put them forward.

Editors’ comments

The case is a timely reminder of the importance to check bespoke amendments made to standard form contracts particularly when there has been a change in legislation. It would also be sensible to put in place a contract review process to ensure that account can be taken of any changes in legislation or judicial interpretation of contractual provisions.

View: William Hare v Shepherd Construction Limited and others [2009] EWHC 1603 (TCC)