Section 113 of the Housing Grants, Construction & Regeneration Act 1996 (the 1996 Act) outlaws pay when paid provisions, with one exception. It is permissible for a Contractor to use a pay when paid provision to deny payment of outstanding amounts due to its Sub-contractor where the Client at the top of the supply chain has gone bust. The general consensus is of course that this exception is unfair. It is essentially asking the Sub-contractors to act as insurers of both the main Contractor and Client insolvency. One of the biggest drawbacks of the exception is that, even if the main Contractor does receive money from the Administrator of an insolvent Client, there is no mechanism for the main Contractor to distribute that money amongst its Sub-contractors. There is similarly no obligation on the main Contractor to inform his Sub-contractors of any funds he has received from the Administrator.

The decline in the construction industry has seen many Sub-contractors hang up their spades and call it a day. Could this be as a result of Contractors invoking pay when paid provisions when it’s Client has also been forced to call it a day? And is this avoidable? The recent Court of Appeal decision in William Hare v Shepherd Construction ([2010] EWCA Civ 283) considers when it is competent for a Contractor to exercise the exception to section 113 of the 1996 Act.

Hare was one of many sub-contractors of Shepherd. Shepherd’s Client went into administration. The Sub-contract contained a pay when paid clause to apply if Shepherd’s Client went into administration. You will recall that the original section 113 of the 1996 Act defined an Administration Order as one made by the Court only. This definition of Administration was repeated in Hare’s Sub-Contract, which was drafted in 1998. The Enterprise Act 2002 (Insolvency) Order 2003 (the 2003 Order) subsequently amended section 113 to include out of Court appointments also. This extended this provision to creditors of an insolvent company for example. The 2003 Order only applied to contracts made after 15 September 2003 however.

Hare’s Sub-contract with Shepherd was entered into in December 2008. Shepherd did not amend its pay when paid provision following the bringing into force of the 2003 Order.

During the course of the works, Hare issued 2 applications for payment to Shepherd for just under £1 million each. Shepherd issued withholding notices on the basis that it had not received payment from its Client. The Client had appointed an Administrator. Shepherd argued the terms of its Sub-contract with Hare ought to be read so as to include a situation where an Administrator is appointed out of Court.

The Court interpreted the terms of Hare’s Sub-contract strictly. It ruled that the pay when paid clause of the Sub-contract could only operate in the event of the Court appointing an Administrator. The Court reminded us that ignorance of the law is no excuse and as such, the parties were deemed to be aware that the 2003 Order had amended the 1996 Act. It was for Shepherd to amend the pay when paid provision of its Sub-contracts to bring them into line with the amendment introduced by the 2003 Order. It failed to do so and as such, the sub-contractor could not be held to these new provisions.

Shepherd appealed the Court’s decision, but the Court of Appeal upheld this ruling. Shepherd could not rely on its pay when paid provisions and was required to pay Hare. Hare escaped the plight of so many Sub-contractors nowadays and this case acts as a word of warning: make sure your contracts are up to date for if they are not, you could be hit with a bill you hoped you would never have to pay.