Contract clauses permitting a contractor to pay a subcontractor only when payment has already been received from the employer are very divisive in an industry dependent on cashflow. Whilst prohibited in some jurisdictions such provisions are not only permitted, but almost encouraged in others.
Pay-when-paid clauses give greater power to the contractor in paying subcontractors and managing their own cashflow. However, a lack of certainty for parties further down the supply chain causes great financial pressure and results in higher rates of subcontractor insolvency.
As a result of years of lobbying by specialist subcontractors, pay-when-paid clauses have been outlawed in many jurisdictions such as the UK, Singapore and Australia. However, many subcontractors moving from these jurisdictions to work around the world are surprised to find that “pay-when-paid” is alive and well elsewhere.
Whilst onerous, clear wording placing the contractor and subcontractor on a back-to-back basis will be regarded as enforceable in most of the Middle East. The legal systems of the Gulf states will look primarily to the principles of freedom of contract to conclude that terms signed up to by commercial parties should be upheld. This will only be prevented where the terms agreed to are either unlawful or in contravention of public morals1.
It is unlikely that an aggrieved unpaid subcontractor would be able to claim that such provisions fail under local laws for a lack of good faith where they are both express in the contract and common in the industry.
It is also not certain that the failure of a contractor to make payment would give rise to an entitlement to suspend performance by the subcontractor under local laws. Article 247 of the UAE Civil Code will only give such a right where the obligation to perform is regarded as reciprocal to the obligation to pay and the suspension is regarded by the courts as proportionate. A pay-when-paid clause would almost certainly render statutory suspension impossible, since as an expressly agreed term any attempt to exclude it would be regarded as disproportionate.
Similarly, termination is also not commonly available in the Gulf states without court consent and it is unlikely that unilateral termination provisions would be made available to the subcontractor in the event of non-payment, let alone where a pay-when-paid provision had been inserted.
Where a subcontractor is forced to accept a pay-when-paid clause in a subcontract, the manner in which the contractor applies such a clause may still give some chance for relief to the subcontractor.
It is very common for contractors to bundle together claims prior to their submission upstream to an employer. Even more prejudicial to a subcontractor would be the situation where a claim is effectively blocked upstream due to some default of the contractor or other subcontractors. This means that the contractor will never be able to recover the sums due in respect of the innocent subcontractor’s work.
In either of these situations the contractor may arrange for a commercial settlement of his upstream claims which the contractor will then wish to apportion onto various subcontractors. Such an approach by a contractor is likely to fall foul of middle eastern Civil Codes which state that a party shall not do harm to another. As a result of the contractor entering into a global settlement upstream in respect of works which have been fully and adequately performed, the subcontractor would otherwise be placed in an onerous position.
Where a subcontractor has fully completed and handed over his works without complaint or dispute, the contractor will no longer be entitled to rely on the pay-when-paid clause to continue to withhold. To get around this principle it is not uncommon for an impoverished contractor to try and withhold completion of the subcontractor’s part of the works for as long as possible.
When faced with a pay-when-paid clause a subcontractor would always be well advised to push for obligations on the contractor to pursue prompt payment upstream.