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F

THE NON-PAYMENT DILEMMA

I. Introduction

Evidently one of the biggest problems facing construction and engineering contractors in the current economic conditions is payment default. In many markets, cash is in short supply and under the surface, the problem is not limited to any single market. This all-too-common situation leaves decision makers within the contractor’s organisation confronting the following set of weighty questions:-

• Will the chances of being paid an acceptable sum improve if

matters are allowed to proceed without our taking some measures

to promote due payment?

• How robust and viable is our security for payment?

• What effect will measures to stem the shortfall, by our causing work to slow or

suspending all activities, have on any wider business relationship with the developer?

What liability would we risk from doing this?

• What damage would our corporate reputation, market position, credit rating etc., suffer if

our developer encashes the performance securities and/or terminates the contract?

• Is the developer insolvent on the relevant legal test? If so, how should the answer to

this question affect the usual options for recovering the debt?

Although, clearly, these concerns involve considerations beyond the narrow inquiry into legal rights and obligations; the legal merits of one’s actions often lie at the heart of a robust decision making process. Third parties (e.g. other developers) will obviously take a dim view of a contractor’s actions, albeit in the face of alleged non-payment, if it is ultimately found that those actions were not legally justified. In such matters, robust legal advice will lie at the heart of effective measures.

II. Legislative reform is for a privileged few

In the broader area of contractor’s security for payment, several common law jurisdictions have enacted legislation aimed at reforming this area of commercial law. Very little attention has been paid to the effect of this legislation (if any) on the existing case law principles. This may be so for two reasons. First, the statutory rights and remedies often extend to a wide class of contractors; and, secondly, typically those contractors who can bring themselves within the legislation will do so without resort to concurrent common law rights. Given the adequacy of the statutory rights, why invoke the rather limited common law protections? For those jurisdictions that have yet to see material legislative intervention – which by number represent the majority of common law jurisdictions – case law principles remain vitally important.

CONTRACTOR'S LEGAL GUIDANCE NOTE WINTER 2010 EDITION

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III. The Temptation to Suspend

As indicated above, in a situation of payment default, one of a contractor’s options might be to suspend (or at least slow down) the execution of work and the provision of plant and materials. This is not a step that is risk free. The developer may in response to the inevitable slowing of progress, seek pre-emptive remedies, such as to encash on the performance security; and if the project runs late, then the developer may claim damages for breach of contract. The developer may even feel justified in terminating the contract for a breach of the obligation to proceed regularly and diligently and/or for a repudiation of the contract. A termination will usually be followed by a repossession of the site, a taking over of control of the plant and machinery on site, and a claim for damages for the cost of completing the works by an alternative contractor. Often it will also mark the onset of litigation. Even where the suspension is wrongful, leading to a breach of an obligation to proceed regularly and diligently, it and the consequent breach will not necessarily amount to repudiatory conduct. Whether or not there has been a repudiatory breach will depend, in each case, on the terms of the contract, the nature of the breach and the facts and circumstances of the case. It is no surprise that in the context of “self-help” countermeasures for non-payment, attention will soon turn to arguments addressing the legal grounds for the contractor’s suspension or slow down of work. In common law jurisdictions typically there are three such arguments, namely:-

• the common law right to suspend

• the “doctrine of prevention”

• the doctrine of dependant obligations

Let us now consider each of these in turn.

A. The Right to Suspend

From time to time, one sees the argument made that the suspension or slowing of the execution of works etc. is justified by a common law right of suspension. This is a proposition that rests on questionable authority. It has been by remarked by the English Court of Appeal (in 1902) that a man who contracts to do a long costly piece of work is entitled to suspend work if he is not paid reasonable sums in part payment as work proceeds, unless he has agreed to do all the work, standing out of pocket, until he is paid at the end. Although these remarks are technically authoritative within English law, it is unclear whether they apply to a modern construction/engineering contract. The existence of such a right in that context in English law, or other common law jurisdictions outside the United States of America, appears to be very much an open question.

B. The Doctrine of Prevention

A contractor who has suspended or slowed his work might say with some force that the developer’s failure to pay due sums on time has deprived the contractor of necessary working capital. The potential for this argument is confirmed by two cases, one from Canada (in 1879) and a more recent (somewhat controversial) decision of the English Technology and Construction Court (from 2003). It is an argument that rests on the general common law doctrine of prevention. This well established doctrine finds expression in various forms, including by the proposition that “he who prevents a thing being done shall not avail himself of the non-performance which he has himself occasioned”. Notwithstanding such pedigree, in practice, it is often challenged by difficulties of pleading and proving an actual inability to proceed (given the fungible nature of working capital) combined with a difficult task of proving a causal connection between any such inability and the developer’s breach of contract. That is not to say however that facts can never be proved to the requisite standard observed by the tribunal of fact and that budgeting for specific projects cannot be arranged in a manner that improves the chances of establishing those requisite elements.

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C. Conditioned Performance

A lesser-known argument of “conditioned performance”, invokes the ancient doctrine of “dependent covenants”. Dependent covenants are those in which the performance, of one depends on the performance of the other; there may be conditions which must be performed before the other party is liable to an action on his covenant. Here, the argument tends to go along these lines: the contractor’s obligation to execute the works continuously and diligently (or however the parties defined that fundamental obligation) was conditioned on the developer making timely payments on an interim basis; such that in circumstances of a default in making interim payment, the contractor’s conditional obligation to proceed never arose. The validity of this argument in the particular case will in principle depend on questions such as (i) whether the execution of the work does “in sense and reason” depend upon the making of due interim payments, or (ii) whether the making of due interim payments “goes to the whole of the consideration” (i.e. represents the main commercial return) for due execution of the works by the contractor. As such, the focus in this context will invariably fall onto the relationship between the developer’s obligation to make due interim payments and the contractor’s obligation to proceed with the execution of the works, as reflected by the terms of the parties’ contract. The nature of that relationship will be imputed by reference to the techniques of contractual interpretation.

D. Termination

Occasionally a contractor will see fit to terminate his contract on the ground of non-payment of an interim payment certificate. Whether or not this is justified will of course depend on several factors, including:-

• The particular terms of the contract

• The sums involved

• The persistence of the developer in failing to make due payments

• Any other wrongful actions of the developer, such as improper deductions for liquidated

damages from payments due and any improper encashment of a performance security

If the contractor has responded to non-payment of interim payment claims by purporting to terminate the contract then in the legal skirmish that inevitably follows actions of this kind, the contractor’s grounds for termination will come under close scrutiny. In this context, it is settled law that a mere breach of a payment obligation does not justify termination at common law. What has to be considered is whether the circumstances of the non-payment show an intention by the developer not to be bound by the contract. The central question is: does the occurrence of the event (having regard to its practical results) deprive the party who has further undertakings still to perform of substantially the whole intended benefit of his performing those undertakings?

IV. The importance of contractual provisions – no hard and fast rules

It is a well recognised principle of common law systems that contracting parties are free to define for themselves what events and circumstances may trigger a right to suspend or terminate performance of the contract. This freedom is manifested in modern standard form construction contracts, which afford contractors valuable rights to protect themselves from financial embarrassment during the course of the project by means of a right of suspension and, ultimately, termination. Of common interest to the contracting parties, the conditions of contract in a modern construction contract play a useful role in setting out in printed words the scope and procedural aspects of these self-help remedies. Both those advantages will not be felt however where the termination provisions are not drafted with clarity.

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Sub-Clause 16.1 of the FIDIC Conditions of Contract for Plant Design-Build provides a right to suspend or terminate for non-payment. In substance, it provides that where (a) the Engineer fails to issue an interim payment certificate to the Employer within 28 days after receipt of the Contractor’s (valid) statement of costs, or (b) the Employer fails to honour a (valid) interim payment certificate within 56 days of its issue, the contractor may reduce the rate of progress or suspend the works. The Contractor must give to the Employer at least 21 days’ notice (in due manner and form) before exercising this right, for instance, if the Contractor is subsequently paid then he is entitled to an extension of time and to payment of any reasonable costs plus a reasonable profit for the period of suspension. But he must resume work again as soon as is reasonably practicable. If however the Contractor does not receive the amount due under an interim payment certificate issued by the Engineer within 98 days of the issue of the interim payment certificate [comprising the 56 day payment period under Sub-Clause 14.7 and a further 42 days’ grace provided in Sub-Clause 16.2(c)] then, by force of Sub-Clause 16.2(c), the Contractor may terminate the Contract. To do this, the Contractor must issue a notice to the Employer no later than 14 days prior to the termination. If he believes that the Employer's failure to pay is sufficiently serious to merit termination under Sub-Clause 16.2(c), for a number of reasons, a prudent Contractor will still take legal advice before giving the notice of termination, not least because a notice of termination that does not conform strictly with all applicable legal requirements will be ineffective and may even, in extreme circumstances, be viewed in law as repudiatory conduct entitling the Employer to cross-terminate.

V. Does the existence of contractual rights to suspend and/or terminate for non-

payment affect the common law self-help remedies?

The point has been made already above that the terms of the parties’ contract are a relevant factor in the correct evaluation of the nature of the relationship between the contractor’s legal justification for suspending work based on the doctrine of dependant covenants and the resulting conditioned performance defence. By the same token, parties can agree to confine the scope of any argument based on the doctrine of prevention by various drafting techniques. As regards the common law right of termination, every once in a while, one encounters arguments that by establishing a complete "code" for contractual termination and the ancillary monetary remedies, the parties may be taken to have deliberately “exhausted” what would otherwise have been a concurrent common law right to terminate. Such an argument was raised in a recent shipping case brought to the English Court of Appeal, without success on the particular facts of the case. This case demonstrates the difficulty of “complete code” arguments, and underscores the basic contract drafting point that parties wishing to exclude the right to common law termination need to be meticulously clear about it in the wording of their contracts. Equally, from a tactical perspective, the aggrieved party wishing to terminate might wish to take legal advice on the viability of common law termination where an express contractual right does not give a sufficient remedy. In principle, the courts will not exclude the common law right to terminate without express words.

VI. Conclusion and Recommendations

There is a widespread, broadly, mistaken view that many common law jurisdictions that have yet to see legislative reform offer no relief for construction/engineering contractors whose customers are not honouring his payment obligations. The solution to this will always depend on the particulars facts and circumstances, including the terms of their contract, however the common law has developed doctrines which will offer relief to some. Whilst measures can be taken at the outset of a project to bring oneself within the ambit of those doctrines as a precautionary measure, whatever deliberate forward planning has been done early on, it is always worth investigating and evaluating the available options when this increasingly common problem arises on a particular project.

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This bulletin does not constitute legal advice. Specific legal advice should be taken before acting on any

of the topics covered.

© Pinsent Masons 2010