Barrister, Professor Rudi Klein, examines the  extent to which sub-contractors can recover  payments directly from the client.

The headline ‘John Lewis to pay its sub-contractors directly’  appeared in the trade press
last year.  John Lewis Partnership, the retail chain, announced that it would be paying its sub-contractors directly – without the monies going to the main contractor.  Some years ago Tesco did the same.  But in the absence of such arrangement a sub-contractor does not have a right to be paid directly by the client.

This issue arose last year in the case of A.J. Building and Plastering Ltd v Turner Munday and Dalling.  A.J. Building had the misfortune to be sub-contracted to Rok which had gone into insolvency.  Rok had been engaged by Zurich, the insurance company, to carry out repairs on a number of houses that were insured under its policy.  A.J. Building had carried out the works as sub-contractors for the three defendants who were the householders.  Rok went in to administration without paying A.J. Building which then sought to claim payment from each householder.  A.J. Building had argued that the householders were liable to pay them since they had signed a “Work Authority Mandate”.

Not surprisingly the court threw out the claim from A.J. Building.  All parties understood that the work was to be paid for by Zurich. The householders had dealt directly with their insurer and had no say over the cost of the works to be carried out.  A.J. Building’s contract was with Rok and, consequently, they took the risk of Rok’s insolvency.

The risk to clients historically standard contracts enabled clients to make direct payments. This usually occurred in the case of nominated sub-contracts where the architect would also certify the value of works carried out by a sub-contractor nominated by the client.  In the event of the lead contractor failing to discharge the certified amount, the architect would advise the client to make payment of that amount directly to the relevant sub-contractor and deduct it from sums becoming due to the lead contractor.

One of the major difficulties with contractual provisions allowing for direct payment is that they could fall foul of insolvency legislation. Insolvency law requires that all creditors be treated equally. Where a lead contractor has failed to make payment because he has gone into insolvency, direct payment could be regarded as treating the sub-contractor as a preferred creditor.  For clients, therefore, there is a risk that in making a direct payment to a sub-contractor, they may have to pay that amount again to the main contractor’s insolvency practitioner.

This concern was prompted by a decision of the [then] House of Lords in the British Eagle case in 1975.  This was not a construction case but it has always been assumed to be applicable to construction.  In a 1994 report for both government and industry Sir Michael Latham recommended that there should be legislation making clear that the British Eagle decision did not apply to construction.  This recommendation was never actioned.

Direct payments legislation in other countries The French 1975 Law of Sub-Contracting introduced an obligation upon both public and private sector clients to make direct payments to sub-contractors.  Article 12 of the 1975 Law states:

“Where the main contractor fails to pay the subcontractor within one month after formal notification, the subcontractor may request payment of all amounts due under the
sub-contract directly from
the employer.”

The 1975 law places a limit on the extent of the employer’s obligation:

“The obligations of the employer are limited to the amount he still owes to the main contractor at the date of receipt of a copy of the form
of notification.”

It is slightly different where the contracts involved are in connection with public sector procurement. Here the direct payment obligation allows the employer to pay the sub-contractor directly and in the process exempt the main contractor from his payment obligations.

Legislation enabling direct payments from clients to sub-contractors is also to be found elsewhere.  For example, legislation in the US state of Massachusetts enables sub-contractors on public works to demand payment directly from the public authority.

Liens legislation in North America also has provisions for direct payments. For example, section 14(1) of the Ontario [Canada] Construction Lien Act 1990 enables firms in the supply chain to place a charge on the property being improved. Therefore a plastering and dry lining sub-contractor working for a main contractor has the right to register a charge on the client’s property in the event of non-payment.  This means that, in practice, clients make direct payments to ensure that they do not end up with numerous charges on their properties.  Moreover the Ontario legislation expressly enables direct payments to take place between the client and a sub-contractor having a lien.

Opportunity in UK for direct payments legislation article 71(3) of the recently revised Public Procurement Directive gives member states the option to provide in national law that public sector bodies and the utilities pay sub-contractors directly where the sub-contractor requests this.  Furthermore article 71(7) gives member states the option to introduce more stringent rules relating to direct payment, for example, requiring contracting authorities to pay sub-contractors directly without them having to request this.

As I write the government is now consulting on this issue.  This seems to be the best opportunity, yet, for having direct payments in this country.  SpecFinish will, no doubt, report on future developments.

Rudi Klein
Barrister and chief executive, SEC Group