Following Carillion’s liquidation, many employer and developers are keen to establish stronger relationships with sub-contractors on site. But what are the legal risks and how can they be avoided?
There is generally no obligation or entitlement for a developer to pay a sub-contractor directly. However, clients have on occasion asked lawyers to include direct payment clauses to enable developers to by-pass the main contractor, and maintain progress of the project and cashflow downstream to sub-contractors. Sub-contractors may suspend the works for non-payment and the developer may feel obliged to make a direct payment to keep the project afloat.
In summary, whilst the commercial and practical reasons for making direct sub-contractor payments are appealing, the law does not give developers much freedom. The legal risks may not be immediately apparent, but if operated wrongly could lead to a breach of contract.
These risks include:
- In the event of contractor insolvency, the liquidator could seek to recover the direct payments made to the sub-contractor under the insolvency rules. The payment may be viewed as part of the contractor’s insolvent estate and that the sub-contractor was granted a preference incorrectly;
- Payment disputes between the contractor and sub-contractor may be disadvantaged by the direct payment from a developer;
- The contractor may not recognise any attempt by the developer to set-off the sum against payments due to the contractor. The contractor may seek payment from the developer under the building contract, and the developer may have to pay twice for the same work;
- Commercially, the relationship and trust between developer and contractor is often dwindled if a direct payment is made to the contractor’s sub-contractor. This can affect progress and may cause delays and further issues on site.
Careful thought needs to be given to how a project is procured at the outset. Alternatives include:
- A construction management route may be preferable to an experienced developer wishing to have more control over its trade contractors, for example.
- A project bank account may also provide some comfort to ringfence project funds for payment to sub-contractors (although this can be expensive to set up and administer).
- Parent company guarantees should also be considered to protect against non-performance by the main contractor.
- The developer should also seek collateral warranties from the key design sub-contractors and ensure they have step-in rights available, as well as the ability to novate sub-contractors to the developer if required.
For more information on this issue, please contact Natalia Sokolov.