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Pay When Paid Clauses

in Malaysia Construction Industry

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
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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.
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(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.
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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.
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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.
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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.
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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
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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.
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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
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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.