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Our earlier article on late payment ("It's
Pay Back Time") raised some eyebrows, particularly with reference
to payment delay being a breach of contract. So it is; but not all breaches
of contract entitle the injured party to the same remedy. As discussed,
the seller who is paid late may recover interest if that is provided for
in the contract, if the court gives judgement for the debt or payment
is made by the debtor after proceedings have commenced.
But many contracts do not provide for interest on late payment and many
debtors pay at the last minute before legal action is started. In either
event the creditor, unless he or she can prove special loss, will lose
out and the debtor enjoys an interest-free period of credit.
Delays in delivery
The situation is very different when there is a firm delivery date in
the contract and the supplier is late. Then the buyer has the implied
right in an ordinary commercial contract, however short the period of
delay, to refuse to accept delivery, terminate and claim damages for breach
of contract. By being late the seller is regarded as in breach of a fundamental
obligation under the contract.
But why should the supplier not give itself the same right which it could
do easily by ensuring that the contract contains a firm time or date for
payment and includes a clause to the effect that "time of payment
shall be of the essence of the contract"? In the event, the supplier
may not wish to exercise the right to terminate but it is a strong hand
to play in any subsequent negotiations since it is always open to the
injured party to limit itself to a claim in damages.
One point applies to buyers and sellers alike when they have the right
to terminate. They must be careful in any negotiations or discussions
after the breach not to waive their rights and act in such way as to lead
the other party to believe that they did not intend to complain about
the breach. Nor can they reserve their right to terminate intact. If they
have a right to terminate, they must decide whether to exercise it or
to continue with the contract and claim damages.
Pay-when-paid clauses
Allied to the seller's problem of late payment is that of not being paid
at all because the buyer has not been paid by the person higher up the
contractual chain. This can happen when the seller's contract contains
a "pay-when-paid" clause. Such clauses appear in most sub-contract
packages issued by main contractors in the construction industry as amendments
to the standard form made by the main or management contractor. They are
also widely applied by suppliers in other industries when purchasing goods
or services from sub-suppliers. Two types of such clauses can be distinguished:
- a clause which says that the sub-contractor will be paid if the main
contractor is paid by the employer;
- a clause which provides that the sub-contractor will be paid within
x days of the main contractor being paid by the employer.
Some commentators doubt the validity of the "if" type clause,
but the general approach of the English courts seems to be that if the
sub-contract makes it clear that the right of the sub-contractor to be
paid depends on the receipt of payment from the employer, then the clause
will be upheld. So in one case the sub-contract stated that the contractor
was to be under no liability to pay the sub-contractor "until the
payment had been approved and paid for by the employer". It was decided
that, as the main contractor had not received payment, it was not liable
to pay the sub-contractor.
In practice a pay-when-paid clause creates two problems for the sub-contractor.
First, payment may be delayed by the main contractor, causing cash flow
difficulties. This can happen because the main contractor and the employer
are in dispute, as a result of which the employer withholds payment. It
was pressure exerted by sub-contractors on the government over this issue
which gave rise to the Latham inquiry.
Second, if the employer becomes insolvent then the sub-contractor is not
going to get paid at all. It is left exposed to a double credit risk,
that of the employer as well as the main contractor.
Dealing with the problem overseas
In America and some Commonwealth jurisdictions court decisions have been
more favourable to the sub-contractor. Americans often have the idea that
pay-when-paid clauses are intended to postpone the right to receive payment
for a reasonable period, not to destroy it. So on the owner's insolvency,
unless the main contractor can produce evidence that the sub-contractor
had agreed to take that risk, the main contractor will find itself unprotected.
In Australia the clause has been interpreted strictly against the main
contractor and only given effect to when the main contractor can establish
the sub-contractor's consent to take the employer's insolvency risk.
There is no indication that the UK courts are willing to take this approach.
Further, if the Housing Grants and Construction Regeneration Bill becomes
law in its present form which will make a pay-when-paid clause in construction
contracts ineffective, except in the case of insolvency of the third party
the courts are likely to conclude that Parliament has amended the law
as far as it considers appropriate. So pay-when-paid clauses will continue
to apply in the construction industry, in the one case where they are
likely to be most damaging. In other industries their use will continue
unchecked.
SM
Peter Marsh and Frank Griffiths are associates at project strategy and
contract management consultancy FGA Ltd, tel: 0116 279 3383
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