| Date | 7 November 2001 |
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| Judgment | Durabella Limited -v- J Jarvis & Sons Limited, TCC 19 September 2001 |
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| The Issue | The operation of "pay when paid" clauses under the general law. |
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| Implication |
Even where a "pay when paid" clause is authorised by the terms of the Construction Act, a main contractor will still be required to demonstrate its reasonableness in all the circumstances. |
printIn January 1996, Durabella entered into a sub-contract with Jarvis for the installation of hardwood flooring in 36 flats, which Jarvis was constructing for Galliard Homes at Old Sun Wharf, Limehouse in London. The sub-contract was based upon Jarvis's standard conditions, which at Clause 4 contained a "pay when paid" provision: "Our liability for payment to you is limited to such amounts as we ourselves actually receive from the employer in respect of your works under this order". Such clauses have for many years been controversial, but it would be another two years before the Housing Grants, Construction & Regeneration Act would make "pay when paid" provisions unlawful, at least in certain circumstances. Although it was known in 1996 that the Construction Act would likely take steps to outlaw the practice of "pay when paid" clauses, there had been no clear guidance from the courts upon the effectiveness of such provisions. However, a pointer was perhaps given in the standard text book "Keating on Building Contracts", where it was stated that: "There is no reason in principle why the English courts should not give effect to a properly drafted clause according to its true construction". Despite this fairly positive statement in support of "pay when paid" clauses, Keating went on to warn that clauses excluding liability in this manner might, in certain circumstances, fail the test of reasonableness as set down in the 1977 Unfair Contract Terms Act. Whether or not "pay when paid" provisions are to be viewed as unreasonable depends on where the observer sits in the contractual supply chain. Sub-contractors will of course always argue that it is unreasonable not to pay for work that has been carried out properly. Main contractors, on the other hand, will say there are two principal reasons for a "pay when paid" or "pay if paid" clause. Firstly, work has to be financed until payment is received. A "pay when paid" clause extends the period for financing until payment is received, and relieves the main contractor of the risk of financing itself. Of course, such safeguards can be achieved within the terms of the main and sub-contract payment provisions, without resorting to "pay when paid". Indeed, to an extent the Construction Act now makes it easier for main contractors to protect themselves in this way, by making it mandatory to fix the final dates for payment in main and sub-contracts. Secondly, main contractors will argue that "pay when paid" clauses allow the risk of the client's insolvency to be shared proportionately. Opinions remain divided over whether or not this is a valid justification for "pay when paid" clauses. Nevertheless, it is a justification which was accepted by the legislature and became enshrined into the Construction Act. Clause 113 of the Act now provides that a "pay when paid" provision is perfectly lawful when it is operated in the event of the insolvency of a third party payer (normally the client). Of course, the Construction Act did not affect Durabella, whose sub-contract was entered into before the Act came into force. Durabella found that almost the entirety of its payments under the sub-contract were being resisted by Jarvis on the basis of the "pay when paid" provision in the sub-contract. The matter ended up before His Honour Judge Humphrey Lloyd QC. It was necessary first to examine why it was being said that the Employer, Galliard, was refusing to pay Jarvis. It was shown that Galliard had become dissatisfied with the performance of Jarvis for a number of reasons, quite apart from problems with Durabella's flooring, and had terminated its employment. That had precipitated lengthy legal proceedings, which had gone as far as applications for leave to appeal to the House of Lords. Eventually, matters between Galliard and Jarvis were settled. Mindful of the concurrent dispute that it had with Durabella, Jarvis had ensured that the settlement agreement with Galliard stated that nothing was included in the settlement in respect of Durabella's flooring works. Jarvis now relied on this agreement to show that they had not been paid by their client for Durabella's work. Judge Lloyd dismissed this as contrived. In his opinion, settlement agreement of this type had no evidential value in respect of whether or not Jarvis had received payment for Durabella's work. Jarvis had accordingly failed to establish that it had not been paid. That ruling would be sufficient to deny Jarvis the right to rely upon the "pay when paid" provision. However, Judge Lloyd looked further into the operation of the clause in the circumstances of the case. He confirmed that both by reference to the common law and to the Unfair Contract Terms Act, a contractor cannot rely on a "pay when paid" clause if the reason for non-payment is its own breach of contract or default. Moreover, if the "pay when paid" clause is to be effective, Judge Lloyd held that the main contractor impliedly undertakes that it will pursue all means available to obtain payment. On the facts of this case Jarvis could not demonstrate it had done so and therefore could not rely on the "pay when paid" clause in its sub-contract.
CJ-0144
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