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Pay-when paid clause defeated due to lack of pursuit


In a recent arbitration, BSA’s team succeeded in defeating the operation of a pay when paid clause, triggered by a MEP subcontractor against BSA’s client, a security package subcontractor, by arguing the MEP subcontractor’s lack of pursuit of the security package subcontractor’s claim and in breach of good faith.

The security package subcontractor (“SP-Sub”) was subject to a strict back-to back arrangement, in terms of payment of its dues, under the SP subcontract it had entered into with the MEP subcontractor (“MEP – Sub”).

Under the pay-when paid clause, no payments would be made to the SP-Sub until the MEP-Sub had first received these from the main contractor, under its own subcontract, which was in turn back-to-back with the main contract.

The additional complexity in this matter, was that the dispute resolution clause under the SP subcontract allowed the MEP-Sub to suspend any proceedings that the SP-Sub commenced against it, pending resolution of any corresponding dispute the MEP-Sub had with the main contractor.

After completion of its scope of work and handover of the building, the SP-Sub issued many reminders for payment of outstanding invoices to the MEP-Sub, none of which resulted in payment.

The MEP-Sub’s position was always that any amounts claimed by the SP-Sub were never due before they were actually received by the MEP-Sub from the main contractor.

The SP-Sub refused to accept this as a valid justification for delay in payment and issued arbitral proceedings against the MEP-Sub for all amounts due to it under the SP subcontract.



The SP-Sub’s case

In seeking to defeat the pay-when-paid clause, the SP-Sub argued that the MEP-Sub cannot evade payment simply because it has not received corresponding payment from the main contractor.

The SP-Sub’s position was that it is irrelevant whether payment from the main contractor has been received by the MEP-Sub to the extent that:
  1. a. the project was complete,
  1. b. the MEP-Sub demonstrated no attempt to legally pursue and obtain from the main contractor payment of the SP-Sub’s dues.
The SP-Sub also argued that the pay-when-paid clause simply served to bridge the gap of a lack of privity of contract between it and the main contractor.

The said clause amounted to an undertaking by the SP-Sub to bear the risk of a delay in payment but not the risk of non-payment.

Therefore, given the lack of privity of contract, the consideration that the SP-Sub must enjoy, by agreeing to the pay-when-paid clause, was that:
  1. the MEP-Sub must adopt the SP-Sub’s claims for payment as if they were its own and,
  2. the MEP-Sub must then pursue them with the main contractor, again as if they were its own.
Any failure to do so, BSA argued on behalf of the SP-Sub, must prohibit the MEP-Sub from relying on the pay-when-paid clause, thus rendering it directly accountable to the SP-Sub for the amounts it claimed in the arbitration.

The MEP Sub’s case

Upon submitting its defence and later its rejoinder in the arbitral proceedings, the MEP-Sub argued that the express terms of the SP subcontract stated that any payment to the SP-Sub was conditional upon its receipt by the MEP-Sub.

The MEP-Sub stated that it had not received the claimed payments, hence the SP-Sub’s resorting to arbitration was premature and was in circumvention of the clear and express payment terms of the SP subcontract.

The MEP-Sub further argued that the SP-Sub was always aware of the risk it agreed to in respect of payments and that, by doing so, it also accepted to bear the risk of non-payment.

The MEP-Sub also claimed that it did pursue and continued to pursue the SP-Sub’s dues (together with its own claims) as against the main contractor, promising, at the same time, to forward to the SP-Sub any payment it did receive.

Furthermore, the MEP-Sub argued that, contrary to what the SP-Sub sated, the pay-when-paid clause did not act as an agreement to accommodate only a delay in payment but that it was in fact a strict condition to payment.

Finally, the MEP-Sub stated that, if the SP-Sub were successful in this arbitration, this would lead to a situation whereby it would receive payment for amounts that are not due in accordance with the express terms of the SP subcontract.

First suspension of the arbitration

After the first round of submissions, the MEP-Sub decided to trigger the option, afforded to it under the SP subcontract to suspend proceedings, pending resolution of the dispute with the main contractor.

The Tribunal accepted this and suspended proceedings, subject to a time limit of three months, following which, it would review the position.

After the suspension period elapsed, the SP-Sub submitted that no payment was made and that no updates were received by it as to any deliberations or pursuit of claims that the MEP-Sub may have had with the main contractor.

The arbitration then resumed and, shortly before the evidentiary hearing, the MEP-Sub reapplied for a second suspension of the proceedings.

This was again on the basis of the option to do so afforded by the SP subcontract.

However, this time, the MEP-Sub claimed that it intended to imminently file arbitration proceedings against the main contractor in pursuit of, amongst other issues, the SP-Sub’s claims.

Second suspension of the arbitration

After hearing the parties’ submissions as to whether a second suspension of the arbitration should be allowed, the Tribunal decided to again suspend proceedings for another three months, however, this time it ordered that the MEP-Sub must:
  1. commence arbitral proceedings against the main contractor and
  2. provide the SP-Sub and the Tribunal with monthly updates on the progress of its dispute with main contractor.
The Tribunal allowed the SP-Sub to apply for a lifting of the second suspension if circumstances changed.

Furthermore, the Tribunal reminded the parties that the fundamental criterion as to whether a suspension would continue, was that at all times the parties should do everything necessary in good faith for the fair, efficient and expeditious conduct of the arbitration.

In the Tribunal’s view, this included the MEP-Sub taking steps to ensure that the SP-Sub’s dues were pursued expeditiously in an arbitration against the main contractor.

Arbitration against the main contractor

Whilst the MEP-Sub did eventually commence an arbitration against the main contractor, it nevertheless failed to provide monthly updates and it also agreed to have the submission of the main contractor’s defence postponed numerous times without advising or consulting with the SP-Sub.

In its application to lift the second suspension, BSA argued on behalf of the SP-Sub that, with these continued delays, the MEP-Sub had in fact failed to comply with the Tribunal’s directions and failed to act in good faith.

For all practical purposes, it was argued on behalf of the SP-Sub, no meaningful arbitration against the main contractor was commenced and no substantive pursuit of the SP-Sub’s claims was undertaken.



Lifting of the second suspension

In considering the SP-Sub’s application, the Tribunal held that:
  1. The MEP-Sub had not fully complied with its directions and that the SP-Sub was forced to make the current application to lift the suspension, following substantial inactivity on the part of the MEP-Sub.
  2. In the absence of any contrary evidence, the Tribunal held that it appeared to be merely convenient for the MEP-Sub to continuously postpone proceedings against the main contractor.
Crucially, the Tribunal held that this was not a good faith operation of the SP-subcontract and that that the second suspension would be lifted if no settlement of the SP-Sub’s dues was reached within a month’s time, without any further suspension of proceedings being granted thereafter.

Resumption of proceedings and settlement

After the passage of a month, no settlement was reached and the SP-Sub was successful in having the second suspension lifted.

After lifting the suspension, the Tribunal ordered directions on the evidentiary hearing with a view to issuing its final award thereafter.

However, shortly before the hearing took place and without any payments being made by the main contractor to the MEP-Sub, the latter settled the SP-Sub’s dues for the full amount claimed.

A consent award was then issued at the request of the parties, after the SP-Sub had secured full payment of its dues directly by the MEP-Sub, after having successfully bypassed the pay-when- paid clause by demonstrating lack of pursuit and lack of good faith.

Conclusion

This case puts into context the operation of a pay-when-paid clause when looked at from the perspective of the parties’ actions.

These clauses are not undefeatable, as BSA’ approach demonstrated, and may very well result in a successful outcome for subcontractors as long as a strategic approach is adopted.

If the only condition to a subcontractor’s payment is time dependant, it may not be sufficient for a contactor to simply plead non-payment by a party further up the contractual chain.

This is because an implied obligation exists on the part of a contractor to pursue the rights and entitlement of a subcontractor.

This, a contractor must do with every means that the subcontractor would, if it could enjoy privity of contract.

It is also significant to note that a subcontractor must not base its claim simply on a mere lack of payment.

Rather, the subcontractor’s claim should be presented as a failure on the part of the contractor to pursue the subcontractor’s claims, coupled with a continued pressure on the contractor that it demonstrates that such pursuit is purposefully made.
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