CONTRACTOR'S

LEGAL GUIDANCE NOTE

F
WINTER 2010 EDITION

THE NON-PAYMENT DILEMMA

I.

Introduction

Evidently one of the biggest problems facing construction and engineering

contractors in the current economic conditions is payment default. In many
markets, cash is in short supply and under the surface, the problem is not
limited to any single market.
This all-too-common situation leaves decision makers within the
contractors organisation confronting the following set of weighty questions:

Will the chances of being paid an acceptable sum improve if

matters are allowed to proceed without our taking some measures
to promote due payment?

How robust and viable is our security for payment?

What effect will measures to stem the shortfall, by our causing work to slow or
suspending all activities, have on any wider business relationship with the developer?
What liability would we risk from doing this?

What damage would our corporate reputation, market position, credit rating etc., suffer if
our developer encashes the performance securities and/or terminates the contract?

Is the developer insolvent on the relevant legal test? If so, how should the answer to
this question affect the usual options for recovering the debt?

Although, clearly, these concerns involve considerations beyond the narrow inquiry into legal
rights and obligations; the legal merits of ones actions often lie at the heart of a robust decision
making process. Third parties (e.g. other developers) will obviously take a dim view of a
contractors actions, albeit in the face of alleged non-payment, if it is ultimately found that those
actions were not legally justified. In such matters, robust legal advice will lie at the heart of
effective measures.

II.

Legislative reform is for a privileged few

In the broader area of contractors security for payment, several common law jurisdictions have
enacted legislation aimed at reforming this area of commercial law. Very little attention has
been paid to the effect of this legislation (if any) on the existing case law principles. This may
be so for two reasons. First, the statutory rights and remedies often extend to a wide class of
contractors; and, secondly, typically those contractors who can bring themselves within the
legislation will do so without resort to concurrent common law rights. Given the adequacy of the
statutory rights, why invoke the rather limited common law protections? For those jurisdictions
that have yet to see material legislative intervention which by number represent the majority of
common law jurisdictions case law principles remain vitally important.

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III.

The Temptation to Suspend

As indicated above, in a situation of payment default, one of a contractors options might be to

suspend (or at least slow down) the execution of work and the provision of plant and materials.
This is not a step that is risk free. The developer may in response to the inevitable slowing of
progress, seek pre-emptive remedies, such as to encash on the performance security; and if the
project runs late, then the developer may claim damages for breach of contract. The developer
may even feel justified in terminating the contract for a breach of the obligation to proceed
regularly and diligently and/or for a repudiation of the contract. A termination will usually be
followed by a repossession of the site, a taking over of control of the plant and machinery on
site, and a claim for damages for the cost of completing the works by an alternative contractor.
Often it will also mark the onset of litigation.
Even where the suspension is wrongful, leading to a breach of an obligation to proceed
regularly and diligently, it and the consequent breach will not necessarily amount to repudiatory
conduct. Whether or not there has been a repudiatory breach will depend, in each case, on the
terms of the contract, the nature of the breach and the facts and circumstances of the case.
It is no surprise that in the context of self-help countermeasures for non-payment, attention will
soon turn to arguments addressing the legal grounds for the contractors suspension or slow
down of work. In common law jurisdictions typically there are three such arguments, namely:

the common law right to suspend

the doctrine of prevention

the doctrine of dependant obligations

Let us now consider each of these in turn.

A.

The Right to Suspend

From time to time, one sees the argument made that the suspension or slowing of the execution
of works etc. is justified by a common law right of suspension. This is a proposition that rests on
questionable authority. It has been by remarked by the English Court of Appeal (in 1902) that a
man who contracts to do a long costly piece of work is entitled to suspend work if he is not paid
reasonable sums in part payment as work proceeds, unless he has agreed to do all the work,
standing out of pocket, until he is paid at the end. Although these remarks are technically
authoritative within English law, it is unclear whether they apply to a modern
construction/engineering contract. The existence of such a right in that context in English law,
or other common law jurisdictions outside the United States of America, appears to be very
much an open question.
B.

The Doctrine of Prevention

A contractor who has suspended or slowed his work might say with some force that the
developers failure to pay due sums on time has deprived the contractor of necessary working
capital. The potential for this argument is confirmed by two cases, one from Canada (in 1879)
and a more recent (somewhat controversial) decision of the English Technology and
Construction Court (from 2003). It is an argument that rests on the general common law
doctrine of prevention. This well established doctrine finds expression in various forms,
including by the proposition that he who prevents a thing being done shall not avail himself of
the non-performance which he has himself occasioned. Notwithstanding such pedigree, in
practice, it is often challenged by difficulties of pleading and proving an actual inability to
proceed (given the fungible nature of working capital) combined with a difficult task of proving a
causal connection between any such inability and the developers breach of contract. That is
not to say however that facts can never be proved to the requisite standard observed by the
tribunal of fact and that budgeting for specific projects cannot be arranged in a manner that
improves the chances of establishing those requisite elements.

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C.

Conditioned Performance

A lesser-known argument of conditioned performance, invokes the ancient doctrine of

dependent covenants. Dependent covenants are those in which the performance, of one
depends on the performance of the other; there may be conditions which must be performed
before the other party is liable to an action on his covenant. Here, the argument tends to go
along these lines: the contractors obligation to execute the works continuously and diligently
(or however the parties defined that fundamental obligation) was conditioned on the developer
making timely payments on an interim basis; such that in circumstances of a default in making
interim payment, the contractors conditional obligation to proceed never arose. The validity of
this argument in the particular case will in principle depend on questions such as (i) whether the
execution of the work does in sense and reason depend upon the making of due interim
payments, or (ii) whether the making of due interim payments goes to the whole of the
consideration (i.e. represents the main commercial return) for due execution of the works by
the contractor.
As such, the focus in this context will invariably fall onto the relationship
between the developers obligation to make due interim payments and the contractors
obligation to proceed with the execution of the works, as reflected by the terms of the parties
contract. The nature of that relationship will be imputed by reference to the techniques of
contractual interpretation.
D.

Termination

Occasionally a contractor will see fit to terminate his contract on the ground of non-payment of
an interim payment certificate. Whether or not this is justified will of course depend on several
factors, including:

The particular terms of the contract

The sums involved

The persistence of the developer in failing to make due payments

Any other wrongful actions of the developer, such as improper deductions for liquidated
damages from payments due and any improper encashment of a performance security

If the contractor has responded to non-payment of interim payment claims by purporting to

terminate the contract then in the legal skirmish that inevitably follows actions of this kind, the
contractors grounds for termination will come under close scrutiny. In this context, it is settled
law that a mere breach of a payment obligation does not justify termination at common law.
What has to be considered is whether the circumstances of the non-payment show an intention
by the developer not to be bound by the contract. The central question is: does the occurrence
of the event (having regard to its practical results) deprive the party who has further
undertakings still to perform of substantially the whole intended benefit of his performing those
undertakings?

IV.

The importance of contractual provisions no hard and fast rules

It is a well recognised principle of common law systems that contracting parties are free to
define for themselves what events and circumstances may trigger a right to suspend or
terminate performance of the contract. This freedom is manifested in modern standard form
construction contracts, which afford contractors valuable rights to protect themselves from
financial embarrassment during the course of the project by means of a right of suspension and,
ultimately, termination. Of common interest to the contracting parties, the conditions of contract
in a modern construction contract play a useful role in setting out in printed words the scope and
procedural aspects of these self-help remedies. Both those advantages will not be felt however
where the termination provisions are not drafted with clarity.

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Sub-Clause 16.1 of the FIDIC Conditions of Contract for Plant Design-Build provides a right to
suspend or terminate for non-payment. In substance, it provides that where (a) the Engineer
fails to issue an interim payment certificate to the Employer within 28 days after receipt of the
Contractors (valid) statement of costs, or (b) the Employer fails to honour a (valid) interim
payment certificate within 56 days of its issue, the contractor may reduce the rate of progress or
suspend the works. The Contractor must give to the Employer at least 21 days notice (in due
manner and form) before exercising this right, for instance, if the Contractor is subsequently
paid then he is entitled to an extension of time and to payment of any reasonable costs plus a
reasonable profit for the period of suspension. But he must resume work again as soon as is
reasonably practicable. If however the Contractor does not receive the amount due under an
interim payment certificate issued by the Engineer within 98 days of the issue of the interim
payment certificate [comprising the 56 day payment period under Sub-Clause 14.7 and a further
42 days grace provided in Sub-Clause 16.2(c)] then, by force of Sub-Clause 16.2(c), the
Contractor may terminate the Contract. To do this, the Contractor must issue a notice to the
Employer no later than 14 days prior to the termination. If he believes that the Employer's
failure to pay is sufficiently serious to merit termination under Sub-Clause 16.2(c), for a number
of reasons, a prudent Contractor will still take legal advice before giving the notice of
termination, not least because a notice of termination that does not conform strictly with all
applicable legal requirements will be ineffective and may even, in extreme circumstances, be
viewed in law as repudiatory conduct entitling the Employer to cross-terminate.

V.

Does the existence of contractual rights to suspend and/or terminate for nonpayment affect the common law self-help remedies?

The point has been made already above that the terms of the parties contract are a relevant
factor in the correct evaluation of the nature of the relationship between the contractors legal
justification for suspending work based on the doctrine of dependant covenants and the
resulting conditioned performance defence. By the same token, parties can agree to confine
the scope of any argument based on the doctrine of prevention by various drafting techniques.
As regards the common law right of termination, every once in a while, one encounters
arguments that by establishing a complete "code" for contractual termination and the ancillary
monetary remedies, the parties may be taken to have deliberately exhausted what would
otherwise have been a concurrent common law right to terminate. Such an argument was
raised in a recent shipping case brought to the English Court of Appeal, without success on the
particular facts of the case. This case demonstrates the difficulty of complete code arguments,
and underscores the basic contract drafting point that parties wishing to exclude the right to
common law termination need to be meticulously clear about it in the wording of their contracts.
Equally, from a tactical perspective, the aggrieved party wishing to terminate might wish to take
legal advice on the viability of common law termination where an express contractual right does
not give a sufficient remedy. In principle, the courts will not exclude the common law right to
terminate without express words.

VI.

Conclusion and Recommendations

There is a widespread, broadly, mistaken view that many common law jurisdictions that have
yet to see legislative reform offer no relief for construction/engineering contractors whose
customers are not honouring his payment obligations. The solution to this will always depend
on the particulars facts and circumstances, including the terms of their contract, however the
common law has developed doctrines which will offer relief to some. Whilst measures can be
taken at the outset of a project to bring oneself within the ambit of those doctrines as a
precautionary measure, whatever deliberate forward planning has been done early on, it is
always worth investigating and evaluating the available options when this increasingly common
problem arises on a particular project.

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This bulletin does not constitute legal advice. Specific legal advice should be taken before acting on any
of the topics covered.

Pinsent Masons 2010

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