Seng Hansen Master Student of Construction Contract Management UTM Email: Hansen_zinck@yahoo.co.id
Introduction: What is Pay When Paid? Construction industry has played an important role in the development of the countries. It provides building and infrastructure works for the sake of peoples welfare and benefits. It also provides many job opportunities for both professionals (engineers, architects, surveyors, etc) and non professionals (skilled and unskilled workers). Due to this nature, construction industry has a high potential of disputes. One of the common disputes is about payment related disputes. Delayed payment, non- payment, and conditional payment have become challenges in construction world and if these challenges cannot be settled, they may cause to the failure of construction works.
Moreover, these problems seem to have a domino effect that will affect all players in the construction industry. Projects especially mega projects may delayed for a long periods of time and suffers huge impact from the failure to prevent these problems. It will certainly affect to not only the employers, contractors and subcontractors or suppliers, but also to the other third parties who indirectly involve in the construction works such as the stakeholders, the financing institutions, and the government.
For years, throughout the country up-stream contractors, such as general contractors, have often included a contractual provision in their subcontracts providing that payment to the subcontractor is conditioned 2 | P a g e S e n g H a n s e n 2 / 2 0 1 2 upon the general contractors actual receipt of payment from the owner 1 . If drafted correctly, these clauses require the subcontractor to wait for payment on their completed work until the general contractor receives payment from the owner 2 . This essentially passes on the owners solvency risk to the downstream subcontractor. No payment from the owner means no payment is due to the subcontractor. This clause, depending on their language, is commonly known as pay when paid clauses 3 .
The definition of pay when paid can be found in the case of DEC Elec., Inc. v Raphael Const. Corp 558 So. 2d 427 (Fla. 1990). There, it was interpreted as establishing a condition precedent in which payment must first be received from the employer before it can be paid out to the service provider, or, on the other hand, as simply fixing a reasonable time frame for when payment is to be made. It is normally used to express the relationship between the main contractors to the subcontractors and supplier in their subcontract and supply agreements.
We can also see this clause as a transfer of risk from the main contractor to his subcontractors or suppliers in case he does not receive payments from his employer. Therefore, many main contractors drafted domestic subcontracts or supply agreements which contain pay when paid provisions. This is of course an unfair practice in construction industry.
In UK, a pay when paid arrangement is illegitimate. Hence, all contractors need to pay subcontractors despite they may not receive interim payment from the employers, unless the employer is insolvent. It is quite different in Australia, where the main contractors would be required to pay the subcontractors even if the employers went into liquidation (see the case of Lezzi Construction Pty Ltd v Watkins Pacific (Queensland) Pty Ltd
1 Perlmuter, G.E. (2007). Michigans Winning Economy Wallops Construction Contractors. Has the Sting of a Pay-When-Paid Clause Gotten Your Attention?. Foster, Swift, Collins & Smith Construction Law Newsletter, November 2007. 2 Ibid. 3 Sklar, A.J. & Sternlieb, M. (2007). The Pay-If-Paid Clause-A Suspect Subcontract Provision. Cole Schotz Docket, Fall 2007. 3 | P a g e S e n g H a n s e n 2 / 2 0 1 2 (1995) 2QdR350 4 . And now, how about the position of this provision in Malaysia?
This paper is talking about the probable position of pay when paid clauses in Malaysias Construction Industry. Below are four case analyses, two from international cases and the other two from Malaysia cases.
Schindler Lifts (Hong Kong) Ltd v Shui On Construction Co. [1985] HKLR 118 (CA) In this case, the Subcontractor (Schindler Lifts) was claiming judgment for sums of money which were alleged to be owing upon two certificates issued under a building contract. The main contractor (Shui On) relied on a clause which provided that payment was to be made by the main contractor to the subcontractor upon Shui On having received the payment from the developer of the project. The developer had earlier exercised its right of set- off for liquidated damages under the main contract between the developer and the main contractor. In setting aside the High Courts decision 5 allowing an application by Schindler for summary judgment, the Court of Appeal effectively recognized the validity of the pay when paid provision in te subcontract.
Another Hong Kong High Courts case of Hong Kong Teakwood Works Ltd v Shui On Construction Co Ltd [1984] HKLR 235 (HC) gave the similar judgment. The payment provision in Hong Kong Teakwood reads as follows: Within 14 days of the receipt by the main contractor of payment from the employer against any certificate from the architect, the main contractor shall notify and pay to the subcontractor. 6
4 Nasyira Bt Ibrahim. (2009). The Application of Pay When Paid Provisions in Construction Sub-contract. M.Sc. UTM. 5 [1984] HKLR 340 (HC) 6 Oon Chee Kheng. (2005). Pay When Paid Clauses in Sub-contracts. Presented at International Forum on Construction Industry Payment Act and Adjudication. KL Convention Centre. 4 | P a g e S e n g H a n s e n 2 / 2 0 1 2 From two cases above, we can see that the Hong Kong authorities seem to agree and give literal construction of a pay when paid clause in subcontract agreements.
Brightside Mechanical & Electrical Services Group Ltd v Hyundai Engineering (1988) 41 BLR110 (HC) The Singapore High Court seems to follow the Hong Kong courts decision on this matter. In the case of Brightside Mechanical and Electrical Services Group Ltd v Hyundai Engineering and Construction Co Ltd (1988), the plaintiff was the mechanical subcontractor for Marina Centre. The defendant was the main contractor. Payments were to be made by the plaintiff under certificates of payment issued by the architect. The architect certified a sum of some s$1.6 million as being due to the plaintiff which, after the allowable deduction, came to S$924,711. Owing to delays in the completion of the project, the employer declined to make any payment to the defendant (the main contractor), holding the money due to be set off against liquidated damages to be paid for the delay. The defendant in turn declined to pay the sum of S$924,711 certified as payable to the plaintiff. The plaintiff sued the defendant for this sum and applied for summary judgment. The defendant applied for a stay of proceedings and also relied upon clause 11(b) of the subcontract, reads as follows: Within five days of the receipt by the contractor of the sum included in any certificate of the architect the contractor shall notify and pay to the subcontractor .
It was the defendants contention that as they had not received any money from the employer, he was not liable to pay anything to the subcontractor. In construing the wordings of this provision which Thean J said clear and unambiguous and effect must be given to them, His Lordship concluded that the words contemplate actual receipt by the main contractor of the sum included in the certificate. So construed, the effect of the clause is that until the defendants receive the sum claimed by the plaintiffs, the defendants are not obliged to pay it to the plaintiffs. 5 | P a g e S e n g H a n s e n 2 / 2 0 1 2
A similar pay when paid clause was included as cl 7(ii) of the subcontract in Interpo Engineering Pte Ltd v Sin Heng Construction Co Pte Ltd [1998] 1 SLR 694. Choo Han Teck JC (of the Singapore HC) held that the pay when paid clause was reasonably straightforward and unambiguous, and that the plaintiff (subcontractor) was not entitled to any progress payment unless the same was received by the defendant (main contractor) from the employer.
Pernas Otis Elevator v Syarikat Pembinaan Yeoh Tiong Lay [2004] 5 CLJ 34 The defendants were the main contractors in a joint venture project involving the construction of a proposed hotel known as Hotel Istana. The plaintiff was a subcontractor to the defendants by virtue of a written subcontract dated 15.6.1990 for the supply, delivery, commissioning and maintenance during defects liability period of lifts and escalators including all accessories and incident works. The employer of the project was one Pernas One (KL). One of the terms of the subcontract reads as follows: Payment in respect of any work, material or goods comprised in the subcontract shall be made within seven (7) days after receipt by the main contractor from the employer.
There was no dispute that the plaintiff has completed the works as stipulated under the subcontract. However, due to complaint from the consultant, the employer through his architect deducted the said sum of RM 300,000 from the amount to be paid to the plaintiff. Consequently, the defendants did not pay the said sum to the plaintiff. The plaintiff denied the allegation made by the consultant and claimed to the court.
Held, the plaintiff has failed to establish its claim against the defendants. Using the literal interpretation of the relevant provision clearly indicates that the parties thereto have agreed that the defendants were only obliged to pay the plaintiff within 7 days of receipt of the same payment from the employer. 6 | P a g e S e n g H a n s e n 2 / 2 0 1 2 The fact that the defendants have not received the money from the employer, clearly point to the fact that the defendants cannot be held liable to pay the plaintiff. Therefore the plaintiffs claim against the defendants is dismissed with costs. Asiapools v IJM Construction [2010] 3 MLJ 7 In this case, the plaintiff was the nominated subcontractor to build a swimming pool for a 161-unit condominium in Seremban. The defendant had earlier entered into a main contract with the developer (the employer) as the main contractor. The plaintiff completed the swimming pool but had not been fully paid by the defendant, as the employer had not paid the defendant. Pursuant to the main contract, the defendant had commenced an action against the employer to recover the agreed sum. Under the subcontract, the plaintiff commenced the present action against the defendant to recover the unpaid sum. The sessions court had allowed the plaintiffs claim with costs. On appeal to the High Court, the defendants appeal was allowed with costs. Aggrieved by the decision of the High Court, the plaintiff appealed to the court. The plaintiff submitted that pursuant to the subcontract, the final payment claimed by the plaintiff was outside the pay when paid provision expressed in cl 13.01 of the subcontract, as it referred to progress payment/interim payment only. The defendant however, contended that the final payment claimed by the plaintiff was only due and payable upon receipt of such payment by the defendant from the employer, because the expression progress payment in cl 13.01 covers final payment.
The Court of Appeal held dismissing the appeal with costs, saying: the effect of a pay when paid clause will be entirely a matter of construction, requiring clear and unambiguous words, and requiring careful consideration of whether, on a true construction, the clause affects the right to payment or only the time for payment. The words generally are to be understood in their plain and literal meaning. This is, of course, always subject to admissible evidence being adduced to show that the words are to be understood in some technical or special sense. 7 | P a g e S e n g H a n s e n 2 / 2 0 1 2
Malaysias Position towards Pay When Paid Clauses Before 2012, it seems that Malaysia authorities tend to follow the other commonwealth jurisdictions towards pay when paid clauses (see Pernas Otis and Asiapools cases as have been described above). In the case of BBR Construction Systems (M) Sdn Bhd v Maxdouble Construction (M) Sdn Bhd [2002] MLJU 104 (HC), Azmel Maamor J upheld that a pay when paid clause was approved according to Brightside case. The relevant pay when paid clause in Maxdouble reads as follows: Progress payment, payment of authorized variations and claims after taking into account the quantities duly checked and certified by the main contractors representative, shall be made to the nominated subcontractor at monthly intervals and within 7 days upon receipt of payment by the sub-contractor from the man contractor.
Therefore, it seems that in Malaysia, a literal construction may also be placed on pay when paid clauses. According to the above cases, there are three points that can be highlighted: 1. For a pay when paid clause to be effective, it must be expressly stated in the subcontract itself and not by merely referring to it in another document, e.g. the provisions in the main contract. This was held in the Malaysian case of Royden (M) Sdn Bhd v Syarikat Pembenaan Yeoh Tiong Lay Sdn Bhd [1992] 1 MLJ 33 (HC). 2. In attempting to ascertain the presumed intention of the contracting parties to a contract, the court will generally adopt an objective approach: that the court will consider what would have been the intention of reasonable persons in the position of the actual parties to 8 | P a g e S e n g H a n s e n 2 / 2 0 1 2 the contract and not the post-event declaration and conduct of the parties themselves 7 . 3. Even though the completion dates for construction contracts are not usually the essence, the time of effecting payment in construction contracts, being commercial contracts, will be of the essence.
However, the position of a pay when paid clause in construction industry should not be literally constructed or interpreted: the reasoning and the conclusion in Schindler, Hong Kong Teakwood, Brightside, Interpro Engineering, Maxdouble and Pernas Otis should not be regarded as correct and final. It is further submitted that this literal approach can and will in many instances lead to injustice and, taken to their logical conclusion, even absurdity 8 .
Moreover, if we look at the standard forms of construction contract in Malaysia, actually none of the nominated subcontracts such as PAM 98, PWD 203, IEM and CIDB 2000 contain a pay when paid clause. They all contain pay when certified clauses. In other words, payment to subcontractors must be made by the main contractors upon certification by the certifier whether or not the main contractors get payment in time from the employer as provided in the main contract. However, many of the contractors draft domestic subcontracts or supply agreements which contain pay when paid clauses. Of course they do this in order to transfer their risk of delayed or non-payment from the employer to their subcontractors. Due to many problems from this practice, the government has taken a preventive action by enacting the Construction Industry Payment and Adjudication Act (CIPA Act).
The Enactment of CIPA Act
7 See: Kim Lewison QC, The Interpretation of Contracts 3 rd Edition (2004), para. 1.03 at pp 4-7 and para. 2.05 at pp 26-31. 8 See: Oon Chee Kheng. (2005). Pay When Paid Clauses in Sub-contracts. Presented at International Forum on Construction Industry Payment Act and Adjudication. KL Convention Centre. Pp 14. 9 | P a g e S e n g H a n s e n 2 / 2 0 1 2 In early 2012, the Malaysian government has enacted the Construction Industry Payment and Adjudication Act or often be shortened as CIPAA. This act has three main objectives: 1. To remove the practice of conditional payments (pay if paid and pay when paid) in Malaysia construction industry 2. To establish a cheaper, speedier, binding, statutorily-enabled adjudication mechanism to be used in Malaysia construction industry 3. To reduce payment default
The Malaysia position towards conditional payments such as pay if paid and pay when paid clauses has been established strongly in this act. Therefore, there will be no more valid and enforceable judgment of pay when paid clauses in Malaysia jurisdictions. We can see this prohibition in PART VI section 35 of the Act, reads as follows: Prohibition of conditional payment 35. (1) Any conditional payment provision in a construction contract in relation to payment under the construction contract is void. (2) For the purposes of this section, it is a conditional payment provision when (a) the obligation of one party to make payment is conditional upon that party having received payment from a third party; or (b) the obligation of one party to make payment is conditional upon the availability of funds or drawdown of financing facilities of that party.
Conclusion As a conclusion, pay when paid clauses can be considered as an unfair payment practice in the construction industry. It provides the power for the dominant party (main contractor) to force acceptance of delayed or discounted payment to the inferior party (subcontractor). It also can be considered as a kind of risk transfer of payment when the dominant party still does not receive any payment from his employer. These clauses attempt to exclude the liability of payment to subcontractors until the main 10 | P a g e S e n g H a n s e n 2 / 2 0 1 2 contractor gets payment from the employer. The consequence is that the subcontractor may end up with not being paid for reasons beyond their control.
Before the enactment of CIPA Act, it seems that Malaysia follows the other commonwealth jurisdictions towards pay when paid clauses. We can see this in the case of BBR Construction System [2002], Pernas Otis [2004], and Asiapools [2010].
Some jurisdictions have enacted acts precisely to protect the subcontractors against the widely used of the pay when paid clauses. The New South Wales Building and Construction Industry Security of Payment Act 1999, the New Zealands Construction Contract Act 2002, and the Singapores Building and Construction Industry Security of Payment Act 2004 are some countries who have been implementing this provision for quite a long period and it finds successful. While in 2012, the Malaysia Government has enacted the Construction Industry Payment and Adjudication Act in order to protect the subcontractors from conditional payment provisions. The effectiveness of this Act still needs to be monitored so that hopefully there will be no more conditional payment provisions which contribute to cash flow problems.
References Construction Industry Payment and Adjudication Act. Nasyira Bt Ibrahim. (2009). The Application of Pay When Paid Provisions in Construction Sub-contract. M.Sc. UTM. Oon Chee Kheng. (2005). Pay When Paid Clauses in Sub-contracts. Presented at International Forum on Construction Industry Payment Act and Adjudication. KL Convention Centre.