Pay when paid clause ineffective to protect main contractor:
“In an attempt to protect it from the client’s potential insolvency, Shepherd Construction’s solicitors drafted a pay-when-paid clause, which provided that Shepherd would not be liable to pay its subcontractors in the event that the employer went into administration. However, the clause was not correctly drafted as it failed to take into account all the possible routes to insolvency, particularly self-certifying administration. This had been introduced by amendment into the Insolvency Act 1996 by the Enterprise Act 2002. The employer, Trinity Wakefield, went into self-certifying administration, and the court found that the clause was ineffective. It also rejected arguments that the clause should be construed to include self-certifying administration.”
Coulson, J. had held that Shepherd Construction could not rely upon “pay-when-paid” clause to refuse to pay Hare £996,683.35 following the administration of the employer Trinity Wakefield. Ltd. The issue also affected a number of other subcontractors on the project. The “pay-when-paid” clause had been drafted by Shepherd’s solicitors for insertion in a standard form of subcontract. The clause had stated that Shepherd would not be liable to make further payments to the subcontractor in the event that the employer or anyone else responsible for paying Shepherd became insolvent or went into administration, or was the subject of a winding-up order. The clause defined the different methods of becoming insolvent:
“32.2(sic) For the purposes of clause 32.1 a company becomes insolvent:
“32.2.1 On the making of an administration order against it under Part II of the Insolvency Act 1986;
“32.2.2 On the appointment of an administrative receiver or a receiver or manager of its property under Chapter 1 of Part III of that Act or the appointment of a receiver under Chapter 2 of that Part;
“32.2.3 On the passing of a resolution for voluntary winding up without a declaration of solvency under section 89 of that Act; or:
“32.2.4 On the making of a winding-up order under Part IV or V of that Act.”
Trinity had used the same clause in their subcontracts with Hare and C. R. Reynolds.
Trinity went into self-certifying administration, and Shepherd had sought to rely upon the clause to avoid paying the subcontractors. The judge had ruled that the clause could not apply because Trinity had not become insolvent within the meaning of the clause because there had been no order of the court. Shepherd argued that because the drafting of the clause had not taken into account the subsequent amendments to the Insolvency Act brought about by the Enterprise Act which had introduced the self-certifying method of administration, the clause should be construed as covering all the routes to administration.
Shepherd sought to show that the judge’s assumptions had been unrealistic, and argued that any reasonable person would have known about s.113 of the Housing Grants Construction and Regeneration Act 1996 and its amendment and would have appreciated that something had gone wrong with the drafting of the clause. Shepherd produced statistics to show that the majority of administrations were “self certified” to support its argument that any reasonable person would have realised that the drafting of the clause was not correct.
The court found that “pay-when-paid” clauses were made ineffective unless the third party was insolvent, and “insolvency” was defined by reference to the ways in which a company could become insolvent. For a main contractor to have an effective “pay-when-paid” clause, he would have to identify the way in which the third party employer became insolvent by reference to the definition in the legislation. If the main contractor chose a way which was not in accordance with the legislation because the provision had been wrongly drafted, the court saw no reason why, no matter how obvious it was, that the principles in Investors Compensation Scheme Ltd. v West Bromwich Building Society,  1 All ER 98, would help him out. There was no evidence that it had been realised that an error had been made in the clause. As it stood, the clause did work as it stood, it was just that the number of court orders made was tiny compared with the number of self-certifying administrations. The clause did not share the risk of insolvency, it was simply relieving Shepherd of any liability to pay. If Shepherd wished to rely upon such a clause, it was up to them to get it right. If a party wishes to relieve itself of a legal liability, clear words are needed to do so.