Carillion’s entry in to liquidation is likely to have ramifications for all the actors in the construction industry for some time to come. The most immediate impact will concern payments. The aim of the Housing Grants, Construction and Regeneration Act 1996 (amended by the Local Democracy Economic Development and Construction Act 2009 - generically, ‘the Act’) is to ensure that cash keeps moving in the construction industry, but what happens when a main contractor becomes insolvent?
The Act is emphatic: Any payment mechanism in a qualifying contract must provide for interim and final payments, and stipulate a due date for payment and a final date for payment. Crucially, in the absence of a Pay Less Notice, the payer must pay the sum previously notified in a Payment Notice not later than the final date for payment. Moreover, section 113 of the Act did away with the formerly common proviso that a payer need not pay if the payer had not been paid themselves (‘pay when paid’ provisions). However, there was a qualification:
“A provision making payment under a construction contract conditional on the payer receiving payment from a third person is ineffective unless that third person, or any other third person payment by whom is under the contract (directly or indirectly) a condition of payment by that third person, is insolvent.”
The underlined section is not a sparkling example of good drafting, but its import is clear: if the payer has not been paid because of third party insolvency, and the contract says that alleviates the payer from its obligation to pay, then the payer need not pay; this is the only situation where ‘pay when paid’ remains an effective defence to a claim for payment.
As such, most standard forms of main contract provide that where a contractor goes ‘pop’, the employer may terminate the contract ‘at any time’ (see for example the JCT Standard Building Contract 2016, clause 8.5.1) and even if the employer does not terminate, no further sums become due under the conventional interim payment mechanism (126.96.36.199) and the contractor’s obligation to perform the works is suspended (188.8.131.52). A final account reckoning then applies regardless of whether the employer has terminated the contract or not. In its down-chain counterpart, the JCT Standard Building Subcontract, termination of the main contract automatically ends the subcontract (clause 7.1). Insolvency of the contractor permits the subcontractor to terminate the subcontract on 3 weeks’ notice (184.108.40.206) and if it does not elect to terminate, its obligations to perform the works are automatically suspended and that is deemed to be a contractor default (220.127.116.11). If termination occurs, whether immediately or following a failure to agree how the contractor’s default is to end then, again, no further sums become due under the conventional interim payment mechanism (7.11) and a final account reckoning then applies. That takes time, which is often short when insolvency looms.
Controversially, contract clauses which assist payers in the event of payee insolvency have been upheld. In Melville Dundas Ltd (In Receivership) & Ors V George Wimpey UK Ltd & Ors  UKHL 18, the House of Lords examined the relationship between insolvency, the words " …the provisions of this contract which require any further payment … to the contractor shall not apply … [except in relation to sums which were due to be paid more than 28 days before determination]" in clause 27 of JCT Standard Building Contract with Contractor's Design 1998, and the predecessor to the Pay Less Notice, the Withholding Notice. The issue was, essentially, “If a contract is terminated because a payee goes insolvent, can a payer who has failed to serve a Withholding Notice be compelled to pay an interim payment”? You can see the controversy: on the one hand, why should a payee be permitted to withhold an interim payment when it has not served a notice of its intention to do so in accordance with s.111(1) of the Act, and on the other, how can a payer serve a Withholding Notice within the prescribed time for doing so if it only becomes aware of the payee’s insolvency, and the cessation of its obligation to pay, after the end of the prescribed period?
By 3 judges vs. 2 judges dissenting, the House of Lords held that the payer was not obliged to pay because insolvency changes the normal position; the obligation to pay the notified sum falls away, regardless of the absence of the notice. When, in 2009, the Act was amended, this position was enshrined in section 111(10), so the Act now provides:
“111(1) Subject as follows, where a payment is provided for by a construction contract, the payer must pay the notified sum (to the extent not already paid on or before the final date for payment”
“111(10) Subsection 1 does not apply in relation to a payment prvided for by a construction contract where:-
(a) The contract provides that, if the payee becomes insolvent the payer need not pay any sum due in respect of the payment, and
(b) The payee has become insolvent after the prescribed period...[for serving a Pay Less Notice]” .
Where insolvency occurs before the final date for payment, the payee need not pay even if it has not served a Pay Less Notice.
What does this mean for you or your business?
Below subcontractor level, parties commonly adopt similar mechanisms in their bespoke standard conditions of subcontract, purchase order terms etc. The effect at best is to lock up money until the contractor is replaced, or at worst it brings the chain of contracts, and the relevant project, to an end. Due to its size and reach, Carillion’s insolvency is likely to paralyse many subcontractors, render them unable to fulfil their obligations to other contractors on other projects, and be disastrous for many small sub-subcontractors over the coming months.
What do you need to be doing now?
If you are a payee, and sums are already overdue their final date for payment, consider resorting to your right to suspend performance of your obligations under a construction contract for non-payment, which is permitted under s.112 of the Act. Properly suspending performance, then seeking payment in adjudication, could stem your expenditure of overheads while allowing you to recover interim payments due to you.
Payers are in a more secure position; ending a contract is a very powerful way of protecting your company against downstream insolvency. As will be noted from the above, most contracts and the Act specifically prevent further sums falling due and even permit non-payment of sums which are otherwise due and payable. We recommend that if you have notice of payee insolvency, then deploy a Pay Less Notice, but should you fail to do so, remember that if your payee’s insolvency occurs before the final date for payment, then all is not lost because payment can still be lawfully resisted.
The other advantage to payers is that where there is an entitlement to set-off sums due from the payee (such as the additional cost to complete with an alternative contractor) against a sum otherwise due, the courts have held that construction contracts are no different to other contracts where payee insolvency occurs, so the balancing act about who is owed what is best done by liquidators, and courts have refused to enforce adjudicators’ awards in favour of payees because of that.
These notes have been prepared for the purpose of articles only. They should not be regarded as a substitute for taking legal advice.