There are various types of clauses in a contract. One of the most important clauses in service agreement pertain to delays in payments and are endemic in construction industry all over the world. European Commission report on payment behaviour in Business to Business transactions, published in 2018, mentions that construction industry is most affected by delays with 65% stakeholders having experienced delayed payments. Extensive research all over the world and in India has shown that delayed payments in construction industry has four major outcomes:
• Cash flow problems.
• Increase in disputes.
• Insolvency and Bankruptcy.
• Delays and cost overrun in projects.
One of the major reasons of delayed payments in construction industry is the “Pay if Paid and Pay when Paid” clauses included or implied in construction contracts. These important clauses in a contract broadly imply that the main contractor will be liable to pay the subcontractor if and when he is paid by the Employer. On the face it, this may seem reasonable- How can an Upper Tier contractor pay a lower tier unless he himself is paid for the work? But a closer look at this clause shows how it is unfair and unreasonable to the lower tiers in the contracting chain, blocks their cash flows and may even lead to bankruptcy.
Contract clauses explained
Let us take small, simplified example of a project done by me- conversion of a hall in a hospital in a remote area of Indian into a makeshift operation theatre. The contract was lump sum fixed price contract with 10 percent advance payment and remaining payment on completion. The main contractor gave two subcontracts- one for building renovation and one for HVAC and for specific medical requirements such as shadowless lights. While the building contractor completed his work in time, the project completion was delayed by six months due to the other subcontractor. The Employer refused to make the payment till completion. The civil works subcontractor, who had completed his job in time, still could not get his payment which seriously affected his business and cash flow.
To prevent such unfair delays on subcontractors , many countries have banned “pay if paid and pay when paid” clauses by enacting laws or including them as part of Construction Law/Construction Contract Act. Housing Grant , Construction and Regeneration Act (HGCRA) 1996 of UK has expressly barred such provisions in construction contracts. Similarly, Construction Contract Acts enacted by various provinces of Australia, New Zealand, Ireland , Building and Construction Industry Security of Payment of Singapore, Construction Industry Payment and Adjudication Act of Malaysia, have also made inclusions of these clauses illegal.
Contract clause examples - difference Between Pay if Paid and Pay When paid
Some states in USA such as California, have barred “pay if paid” clauses but allow “pay when paid” clauses.
What is the difference between the two?
Pay if paid clauses dictate that the main contractor will pay the subcontractor for the completed work only if he is paid by the project owner. If he is never paid by the owner (due to insolvency of owner, dispute or any other reason), he is not obliged to pay the subcontractor at all. “Pay when paid” clause establish the timing by which the main contractor will pay the subcontractor after receiving payment from the owner, as per construction contract terms. This sometimes seems contradictory in that the main contractor still has to be pay the subcontractor for his competed work (since pay if paid is illegal) but can time the payment as per receipt from the owner! Recent judgment in California Supreme court in the case of Crosno Construction Inc v Travellers Casualty and Surety company of America, finally gave clear meaning of pay when paid principle as implying that the main contractor may delay the payment to a subcontractor for some time if not paid by the owner, but still has to pay the lower tier within a reasonable time irrespective of whether he is paid or not paid by the owner, under the conditions of contract in construction.
Pay if paid and pay when paid clauses are applicable in Indian construction contracts. Due to this, delays in payment to subcontractors are rampant in India. These subcontractors often do not have requisite finances to take legal recourse. Even if legal recourse is taken, it may take many years to finalize. Many subcontractors in India have been taken to bankruptcy and number of projects have faced cost and time overrun due to ineffective remedies for delayed payments. Perhaps it is time for India to enact a Construction Law incorporating such provisions, implementing it under common contract clauses.
In the upcoming RICS Emerging Leaders Programme on Construction Contract and Dispute Management, we will discuss many such provisions relating to construction contracts in India and abroad.
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