| Date | 4 July 2007 |
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| Judgment | Sydenhams (Timber Engineering) Ltd v CHG Holdings Ltd, TCC 3 May 2007 |
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| The Issue | The direct payment of subcontractors by the employer in the event of the insolvency of the main contractor. |
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| Implication |
Direct payments to subcontractors remain contrary to insolvency law as they contravene the rights of other creditors. Direct payment agreements between an employer and an independent specialist contractor, where that specialist contractor is not a subcontractor, will not be caught by the insolvency rules regardless of arrangements for channelling those payments through the main contractor. |
printIn the recent case of Sydenhams v CHG, the Court held that an employer was liable to make direct payments to a specialist contractor following the main contractor’s insolvency, where the employer had entered into a direct agreement with the specialist prior to the insolvency. The facts of this case do however merit close attention. It has long been the case that arrangements by which subcontractors attempt to bypass the main contractor and secure direct payment from the employer are fraught with difficulty. In December 1995, these issues were investigated in the case of B Mullen & Sons v John Ross and Malcolm London. In that case the Court held that it was bound by the decision of the House of Lords in the case of British Eagle v Air France. The effect was that an employer could not pay a subcontractor direct in the event of the insolvency of the main contractor, at the same time withholding corresponding monies from the main contractor, as to do so would be to create an unlawful preference in favour of the subcontractor which ran contrary to insolvency law. Were the employer to pay the subcontractor direct in such circumstances, he ran the very real risk of being forced to pay those monies a second time to the liquidators of the main contractor to allow them to make a proper distribution of those funds to the remaining creditors. This does not mean that an employer will not be bound by any agreement it has made with a subcontractor to pay monies direct. In July 2003, in the case of Brican Fabrications v Merchant City Developments, the Inner House of the Court of Session in Scotland upheld an agreement between an employer and a subcontractor to make direct payments bypassing the main contractor. That agreement between the employer and the subcontractor was not affected by the subsequent liquidation of the main contractor. This did not mean however that the insolvency law could be avoided and indeed having found that it was bound to pay the subcontractor monies due in respect of completed works in accordance with the direct subcontractor agreement, the employer may well have found itself bound to make these payments, once again, to the main contractor under the terms of the main contract. This whole question arises principally because, upon insolvency, subject to provisions as to preferential payments, if the insolvent firm’s liabilities cannot be paid in full due to insufficient assets, the liabilities will abate in equal proportions between creditors. This is often known as the pari passu rule, meaning that payments must be made in equal proportions at the same time. These rules are spelled out in sections 107 and 328 (3) of the 1996 Insolvency Act and in Clause 4.181 of the Insolvency Rules 1986. In the Sydenhams case, CHGwas an employer undertaking the development and construction of a hotel in Bournemouth. A considerable part of the design and construction work, including the timber frame, windows and internal joinery, was carried out by Sydenhams. A main contractor, Rybarn, had been employed but prior to completion of the works had entered into administration. Disputes arose concerning payments to Sydenhams which ended up in court. Sydenhams claimed that it had a direct contract with CHG and that it was entitled to be paid in full by CHG for the work it had carried out.` The insolvency of the main contractor was, they said, of no consequence. CHG responded that there had never been a direct contract with Sydenhams and that instead Sydenhams were subcontractors to the main contractor Rybarn. Since Rybarn was in administration, CHG argued that it was unable to make direct payments to Sydenhams. His Honour Judge Peter Coulson QC carefully examined the history of dealings between the parties and concluded on the evidence that a direct contract had indeed been formed between CHG and Sydenhams prior to any contract being concluded with the main contractor for the main contract works. A few months after that contract had been formed with Sydenhams, a tri-partite agreement had been made between CHG, Rybarn and Sydenhams by which it was agreed that Sydenhams would be paid instalments through Rybarn for certain elements of the works. Judge Coulson concluded that there was nothing in that agreement, or the surrounding discussions, which somehow magically transformed Sydenhams into Rybarn’s subcontractor. Judge Coulson was also quite clear that the guidance contained in the Mullen case simply did not apply here. Sydenhams had a direct contract with CHG from the outset and never became a subcontractor to Rybarn. This case reinforces the guidance that agreements that seek to redirect payments due to insolvent main contractors to their subcontractors will remain contrary to insolvency law as they contravene the rights of other creditors. However, direct payment agreements between an employer and an independent specialist contractor, where that specialist contractor is not a subcontractor, will not be caught by the insolvency rules regardless of arrangements which may be agreed by the three parties for channelling those payments through the main contractor.
CJ-0726
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