One of the most daunting prospects for an MEP sub-contractor – or, indeed, any sub-contractor – is the possibility of being held ransom to a pay-when-paid clause.
Quite commonly included in MEP sub-contracts, this clause effectively dictates that the MEP sub-contractor will receive payment only within a given period of time, usually around 14 days, after such payment has been actually received by the main contractor. This type of provision is usually interpreted by main contractors as a carte blanche to simply avoid making payments due to the MEP sub-contractor, unless and until the corresponding payment has been received from the employer.
Under normal circumstances, this type of provision is nothing more than administrative in nature and should not cause any problems. However, in instances where there is an underlying dispute between the main contractor and the employer, delays in payment may ensue, which could indirectly affect the MEP sub-contractor. In those instances, it is understandably a source of significant frustration for the MEP sub-contractor to not receive payment for work carried out and to also not have a clear and transparent line of vision on the negotiations between the main contractor and the employer.
The good news for MEP sub-contractors is that pay-when-paid clauses are not as undefeatable as they appear to be. In legal proceedings, it has been possible to argue on behalf of an MEP sub-contractor that the main contractor’s lack of pursuit of the MEP sub-contractor’s claim was in breach of the sub-contract, as well as in breach of the principle of good faith. This is so even in instances of additional complexities being present, where, for example, the dispute resolution clause, under the MEP sub-contract, allowed the main contractor to suspend any proceedings that the MEP sub-contractor commenced against it, pending resolution of any corresponding dispute that the main contractor had with the employer.
It is predictable that the main contractor’s position is almost always likely to be that any amounts claimed by the MEP sub-contractor would never become due before they are actually received by the main contractor from the employer. Thanks to many MEP sub-contractors’ reluctance to accept this as a valid justification for an indefinite delay in payment, it became possible to test the legal basis of the lack-of-pursuit argument.
Specifically, in seeking to defeat the pay-when-paid clause, it has been possible to argue that a main contractor cannot avoid nor delay payment simply because it has not received corresponding payment from the employer.
The reason argued for this was that it is irrelevant whether payment from the employer has been received by the main contractor, to the extent that:
- The project was complete or has been terminated, and;
- The main contractor demonstrated no attempt to legally pursue and obtain from the employer payment of the MEP sub-contractor’s dues.
It has also been possible to argue on behalf of an MEP sub-contractor that the pay-when-paid clause simply served to bridge the gap of a lack of privity of contract between it and the employer. In other words, the pay-when-paid clause normally amounts to an undertaking by the MEP sub-contractor 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 MEP sub-contractor must enjoy, by agreeing to the rather unenviable pay-when-paid clause, is that:
- The main contractor must adopt the MEP sub-contractor’s claims for payment, as if they were its own and,
- The main contractor must then pursue them with the employer, again as if they were its own.
Any failure to do so, it has been argued on behalf of the MEP sub-contractor, must prohibit the main contractor from relying on the pay-when-paid clause, thus rendering it directly accountable to the MEP sub-contractor for the amounts it claimed.
It is predictable that when faced with this line of argument, a main contractor may seek to submit in its defense that:
- The express terms of the MEP sub-contract state that any payment to the MEP sub-contractor was conditional upon its receipt by the main contractor;
- That such payments have not been received, hence the MEP sub-contractor’s resorting to legal proceedings would be premature and in circumvention of the clear and express payment terms of the MEP sub-contract;
- The MEP sub-contractor would normally be fully 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 and, finally, that;
- If an MEP sub-contractor were successful, 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 MEP sub-contract.
These defences have been proven to be unconvincing in practice, thus prompting main contractors to demonstrate some semblance of an actual effort to pursue payment from the employer, which may, in turn, lead to a possible suspension of any legal proceedings, pending developments of such pursuit.
Even this approach, however, may only buy some time for the main contractor and serve as a dilatory tactic. It is unlikely, however, to constitute an absolute defence, unless formal legal proceedings are proven to have been commenced by the main contractor against the employer, properly pursuing the MEP sub-contractor’s claims.
Even in that instance, the main contractor would ordinarily be requested to substantiate how the MEP sub-contractor’s claims are being pursued, in terms of the arguments raised and the technical evidence submitted.
Therefore, by adopting the lack-of-pursuit defence, an MEP sub-contractor is likely to achieve one of two objectives:
- Either to defeat the pay-when-paid clause on the basis that the main contractor failed to pursue the MEP sub-contractor’s claim and, in this way, obtain an award, judgment or – as is most likely – a settlement in its favour. or,
- Force the main contractor to be forced to commence proceedings against the employer and, in this way, pursue the MEP sub-contractor’s claim.
In reality, if a main contractor is inclined to pursue its claim legally against an employer, it would do so in any event, and it would be unlikely that it would wait to be faced with legal proceedings against it by the MEP sub-contractor
Hence, the first possible objective of an award, judgment or settlement is the most likely one to be achieved in practice. To conclude, it is critical to consider the operation of a pay-when-paid clause from the perspective of the parties’ actions.
These clauses are certainly not undefeatable and may very well result in a successful outcome for MEP sub-contractors, as long as a strategic approach is adopted. If the only condition to an MEP sub-contractor’s payment is time-dependent, it may not be sufficient for a main contactor to simply plead non-payment by a party further up the contractual chain, usually the employer. This is because an implied obligation exists on the part of a main contractor to pursue the rights and entitlements of any sub-contractor.
This implied obligation is that a main contractor must carry out with every means that the sub-contractor would, if it could enjoy a direct contractual relationship with the employer.
It is also significant to note that a sub-contractor 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 main contractor to pursue the sub-contractor’s claims, coupled with a continued pressure on the main contractor that it demonstrates that such pursuit is purposefully made.
This article was originally published for BSA in Climate Control ME.
Partner and Head of Arbitration