Pay when paid clauses in Construction contracts – the payment critical path

Authored by: Alexander Wagg

In brief:

• Pay when paid clauses can impact the cash flow of those expecting to receive payment pursuant to a contract downstream in the contractual chain.
• Pay when paid clauses are ultimately a type of exclusion clause: Contractual wording seeking to exclude liability for payment to those downstream in the event that payment has not been made to, and money has not been received by, those upstream of a Contractor, Subcontractor or Supplier.
• In the UAE there is no statutory provision making pay when paid (or any conditional payment) clauses ineffective. Contractors, Subcontractors, and Suppliers therefore need to review their conditions of contract carefully to establish whether there is a possibility for those above them in the contractual chain to rely on pay when paid clauses in delaying payments to them.

Why pay when paid clauses matter

Pay when paid clauses can impact the cash flow of payees (those expecting to receive payment pursuant to a contract) downstream in the contractual chain. A crunch on cash flow from upstream payors (those contractually bound to make payment) has the potential to impact Contractors’ relationships with their own supply chain (i.e. their ability to pay for and therefore receive goods and a subsequent effect on any goodwill in the future, e.g. goods on account); increase delays; and ultimately  impact a Contractor’s profit.

Every stage of a Project can be affected by the balance of power between the parties involved in the Project; whether it be an Employer and a Contractor, or a Contractor and a Subcontractor, or indeed a Subcontractor and its Suppliers. Over the lifecycle of any Project, there is potential for the balance of power to shift from overtly in a Subcontractor’s favour at the commencement of the Project, to the Employer’s favour as the Project nears completion and handover. Whilst a Subcontractor will need a positive cash flow in order to commence work on a Project, it can be assumed that an Employer’s cash flow is ripe to meet their outgoings at the start of a Project. However, as a Project progresses, an Employer may face their own unplanned crunch on general cash flow and become less willing and able to pay out to their Contractors as the Project continues. This commercial risk, together with the potential for a Contractor to be burdened with variations and disputed claims throughout the Project means that it can be a near inevitability for Contractors and Subcontractors to face delayed, and even non-payments.

Recent research by PwC, as part of their 2018 Middle East Capital Projects and Infrastructure Survey, suggests that Contractors face the problem of delayed payments more than three times as much as developers.

What are pay when paid clauses?

Pay when paid clauses are ultimately a type of exclusion clause: Contractual wording seeking to exclude liability for payment to those downstream in the event that payment has not been made to, and money has not been received by, those upstream of a Contractor or Supplier.

Under the laws of England & Wales, generally any contractual clause seeking to absolve a party of liability must be accurately and carefully drafted with the onus on the party seeking to rely on it to draft it accurately.

Pay when paid clauses benefit those higher in the contractual chain as they can function as a contractual excuse for non-payment of a downstream Contractor or Supplier where an upstream Contractor has not received payment. These clauses serve to pass down the risk of non-payment by an Employer to Contractors downstream who have not directly contracted with the Employer.

Pay when paid clauses serve to make payment of those downstream conditional upon receipt of payment by those upstream. This works to the advantage of a payer in turning the obligation to pay the downstream payee conditional upon having in the first instance received payment from those above them in the chain. This can serve to preserve, for example, a Main Contractor’s cash flow, however ultimately it passes any cash flow problems all the way downstream.

In order to understand what a conditional payment clause in a contract does, it is of assistance to consider the scenario where a contract does not contain a pay when paid clause. In such cases, a Subcontractor will be entitled to be paid for works completed even where the upstream Contractor in the chain above them has not received payment from the Employer.

Pay when paid clauses in the UAE

In the UAE, generally payment is due on delivery of the works unless agreed otherwise. Article Art 885 of the UAE Civil Code states:

“The employer shall be obliged to pay the countervalue upon delivery of the thing contracted for in the absence of an agreement or custom to the contrary.”

There are no statutory provisions for interim payments, however the courts will uphold agreements made for payments on an interim basis. Additionally of note are provisions on an emirate by emirate basis expressly limited to contracts with government bodies and government companies. For example, Abu Dhabi Executive Council Circular 1 of 2019 Concerning the Payment of Entitlements of Contractors and Suppliers recognises the issue of cash flow in construction projects and, “…in light of the constant concern to encourage the Private Sector and pay its financial entitlements…” enacts a statutory basis for payments to Contractors and Suppliers within 30 days of receipt of relevant invoices. The Executive Council Circular applies to construction projects with Abu Dhabi “Government Bodies and Companies” and provides that Contractors contracting with those entities must include a clause in their contracts “…to pay the dues of subcontractors and sub-suppliers within 30 days of the date of receiving their entitlements from the Government Bodies and Companies.”

The Executive Council Circular also includes a positive provision to amend all existing contracts to take effect of this Executive Council Circular. The Executive Council Circular is afforded statutory footing as an executive subsidiary legislation under the UAE Constitution, however it makes no provision for a penalty for non-conformance.

A Subcontractor has no right to claim payment directly from an Employer, unless the Subcontractor has been expressly assigned the right to do so (as is common in the case of Subcontractors ‘nominated’ by the Employer). This statutory restriction on a Subcontractor making a claim directly against the Employer only serves to exacerbate any potential cash flow problem, and as such, there are limited remedies for a Subcontractor where payment is being withheld by a Contractor based on a pay when paid clause.

As an important regional distinction from the legal landscape in England & Wales, in the UAE there is no statutory provision making pay when paid (or any conditional payment) clauses ineffective. Indeed Art 425 of the UAE Civil Code allows for parties to agree conditional clauses within contracts:

“A disposition dependent upon a Condition not incompatible with the contract

shall be ineffective, unless the Condition materialises.”

Interpretation of pay when paid clauses by UAE Courts

In the overwhelming majority of cases, the UAE Courts have upheld the validity of a pay when paid clause. In all of these cases the Courts found the Subcontractor’s claim for payment to be made prematurely as it had been made before crystallisation of the condition that payment had been received by the contracting party upstream.

In 2013, in the Dubai Court of Appeal a Main Contractor successfully resisted a claim for payment by a Subcontractor for glass and aluminium works. The Main Contractor had not been paid by the Employer, and the Court dismissed the action by the Subcontractor as premature. The Court of Appeal cited the Dubai Court of Cassation, which had previously held that holding that in cases of conditional payment the obligation of the Contractor to pay the Subcontractor is subject to a condition precedent that payment has been received by the Contractor. However, in a 1995 Dubai Court of Cassation case, the Subcontractor prevailed even though there was a pay when paid clause in the Subcontract. In that case, the Main Contractor had not been paid by the Employer and relied on a pay when paid clause to not pay the Subcontractor for 5 years after the Project had been handed over. The Subcontractor sought the remaining balance of the contract price. The Court held that given the meaning, intention, and common interest of the parties (and not the mere words) to the contract, a Subcontractor should not have to wait for payment beyond handover of the Project.

Conclusion

Contractors, Subcontractors and Suppliers all need to be aware of the effect of contracting on a ‘back to back’ basis, and at the tendering stage of any Project need to consider the effect of contractual clauses affecting payment obligations. Certain practical and contractual steps can be taken to ensure that Contractors, Subcontractors and Suppliers both limit the risks they are exposed to, and plan for the risks associated with non-payment throughout the Project lifecycle.

This article, together with any commentary, does not constitute legal advice. It is provided solely for information purposes on a complimentary basis, without consideration of any specific objectives, circumstances or facts. It reflects then current views of the writer which may modify in time and based on differing objectives, circumstances or facts. A writer's view may differ from views of colleagues and/or the firm. You should seek legal advice on each specific matter. Access to this article does not form an attorney-client relationship.