Updating construction contracts is unexciting. But not keeping them fully up to date can be disastrous, as a contractor discovered in William Hare Limited v Shepherd Construction Limited, when it found itself unable to rely on a “pay when paid” clause. “Pay when paid” clauses were, of course, prohibited by section 113(1) of the Housing Grants (Construction and Regeneration) Act 1996, unless, however, it can be shown that the ultimate employer is insolvent. Which is where our case begins.

The main contractor, Shepherd, had entered into a subcontract with Hare for fabrication and erection of steelwork. When the employer (Trinity) became insolvent, Shepherd withheld sums due to Hare, relying on a “pay when paid” clause in the subcontract. Clause 32 entitled Shepherd to withhold amounts where the employer went insolvent by reference to four specified routes, including an administration order made by the court under the Insolvency Act 1986.

Clause 32 did not, however, take account of amendments to the Insolvency Act 1986 (introduced by the Enterprise Act 2002) which had brought in a form of out of court administration. Trinity appointed administrators using this out of court route rather than any of the four options specified in clause 32. Hare argued that Shepherd’s withholding notices were invalid as Trinity had not become insolvent pursuant to clause 32.

The court agreed and said that, on a true construction of clause 32, Hare was entitled to payment of the withheld sum of approximately £997,000 plus VAT and interest. The court was not willing to “rewrite” the clause to allow for the amendments to the legislation and one of the reasons cited for the decision was that it was not prepared to pass on to Hare the risk of the employer’s insolvency.

Another factor in the court’s decision was that the subcontract had been entered into a number of years after the changes to the legislation and the court thought that a diligent party would have included the amended provisions. In fact, elsewhere in the subcontract, a clause referred to “the Insolvency Act 1986 or any amendment or re-enactment thereof ” and so it seemed evident, in contrast, that clause 32 was for specific instances of insolvency. The burden of Trinity’s insolvency therefore fell on Shepherd, rather than being passed on.

The case provides a simple, but important, lesson not to use out-of-date definitions in contracts (or to refer to legislation “as amended from time to time”) and a reminder to look closely at the wording of “pay when paid” clauses to check what degree of protection from employer insolvency they provide. In the current economic climate it could be crucial.