How subcontractors can get paid

One of the critical but not “headline making” aspects of the downturn in the construction industry is that many subcontractors are having difficulty getting paid on projects and meeting their own debts as they fall due.

The subcontractor is usually dependent on the contractor being paid under the main contract. One often sees a “pay when paid” clause in subcontract which essentially means that the subcontractor will not be paid by the contractor until the contractor has been paid for the subcontractor’s work by the employer. This necessarily involves even in the best case scenario a longer credit period to the contractor than the contractor in turn gives to the employer. The subcontractor generally has little input in to the certification process by the employer’s advisor prior to him or her approving an invoice in favour of the contractor.

The purpose of this paper is not to review the usual contractual rights a subcontractor may have under its subcontract. Most contracts set out clearly the payment application, analysis approval and certification mechanisms. This paper will focus on instances where the subcontractor has had its work certified higher up the contractual chain and has not received payment. Whatever the excuse is the subcontract or will be facing demands from its suppliers and services providers and needs to answer those demands as soon as possible.

Options available to the Subcontractor

In Ireland, the subcontractor has the option under the law of contract to sue the contractor for breach of contract where it has not been paid. The subcontractor would have to be certain that it has fulfilled all its obligations under the contract so as to give rise to a right or an entitlement to be paid. This is usually indicated by a certificate by the employer’s payment application reviewer. The standard forms of subcontract will usually require that any disputes be resolved by “non-Court” methods such as conciliation/mediation and arbitration. A right to sue in Court under such contracts will only arise where there is a clear obligation on the part of the contractor to pay under the subcontract.

In other words, there must be no dispute as to the amount owing and no contractor’s right of set off arises. Otherwise, the subcontract would have to follow the prescribed route of conciliation then arbitration in most instances.

A second common law right may lie in negligence where due to the conduct of a party who owes a duty to the subcontractor the subcontractor is put in a position of loss. For example, the architect or engineer contracted by the employer to administer and certify the contractor’s payment applications may have been negligent in fulfilling its duties either in terms of delay or under certification. Whilst there has not been a case to my knowledge on this point in Ireland, it is reasonable that the administration of the contract by the architect or engineer involves a duty to more than just the employer. In several instances in standard form contracts such as the RIAI or IEI forms, the architect or engineer is put in a position of sitting as an objective decision maker between the employer and the contractor. By extension, they are also sitting as an objective decision maker in relation to the subcontractor whose works they are certifying.

Section 214 of the Companies Act 1963

Where a subcontractor is clearly owed a liquidated debt by a contractor, a subcontractor can bring what is called a Section 214 petition to wind up the contractor. The debt must exceed the euro equivalent of 1,000 Irish punts and notification of the demand must be made. Section 213 of the Companies Act 1963 gives the High Court the power to order the winding up of a company and to appoint a liquidator.

A Section 214 notice is relatively inexpensive to prepare and the mere threat of such an application often receives a favourable response from the debtor. Nonetheless the Courts have exhibited reluctance to use this as a method of debt recovery only.

It is important to understand that such a claim must involve liquidated debt. In the context of a construction contract pyramid, the subcontractor would likely need to rely on the payment certifier higher up the chain to certify that the subcontractor’s work is completed properly. The difficultly subcontractors often face is that they do not receive the information in relation to certification of their particular works.

In the traditional nominated subcontractor scenario, it may be that the payment certifier indicates specifically what payments are due to the nominated subcontractor. The standard forms often allow the employer to pay the nominated subcontractor directly where there has been a previous instance of the contractor failing to pay certified amounts on to the nominated subcontractor after it has been paid by the employer. The domestic subcontractor is not usually put in such a prime position to be paid directly by the employer.

If there is some question as to the right of set off or failure to have actually earned the money, then a Section 214 application is unlikely to succeed and the subcontractor who is facing demands from its creditors may be in a worse off position financially due to legal costs incurred and delays.

Application for Summary Judgement in the High Court

A second method to recover liquidated debts in the High Court may be commenced by way of a Summary Summons. The creditor must serve a sealed summary summons, have it endorsed with service by a summons server and provide an affidavit of debt sworn by a director of the creditor company. The debtor is given a period of 8 days to file a notice of appearance. Where the contractor does not seek to defend the matter, the Court Master will generally order a default judgement be issued against the Defendant pursuant to Order 37 Rule 4 of the Rules of the Supreme Court. As in the case of the Section 214 Companies Act 1963 application, the defendant may show that it has an arguable defence to the debts alleged against it. Often this can be a very low threshold for the defendant to cross. The usual defences would include a lack of entitlement to the particular monies given poor performance, defects and the like. Moreover there may be the right of set off for the contractor where it has incurred costs or losses due to the conduct or inaction by the said subcontractor at some point in the project. Moreover in a construction contract, a monthly application for payment is not necessarily a final decision as to any party’s entitlement to be paid. This can be crafted in the form of a defence by the contractor saying that there is a possibility that the work will be reviewed at some point in the future and that final payment has not been determined due to the subcontractor and that monthly payments are merely a cash flow assistance to the subcontractor until the final determination is made in the course of the project.

The new Government Forms of Contract – a New Remedy for Subcontractors?

In the forms of public works contract issued by the Department of Finance and updated in August 2009, the definition of “Contractor’s Personnel” includes subcontractors and employees of subcontractors. In effect, the contractor is responsible for all other parties below it in the construction pyramid so far as the employer is concerned.

Under Section 5 of the public works contracts the contractor is obliged with each payment application to certify that all of its personnel have been paid in full. If a particular subcontractor has not been paid in full under a previous payment obligation, the contractor would be in breach of its contractual obligations and indeed runs the risk of being found to be fraudulent in issuing certificates for payments that have not actually been made. Where a subcontractor is in dire financial straits and is no longer as concerned about maintaining its relationship with the contractor, it may wish to consider advising the employer that it has not been paid for works properly completed where it can show the contractor has been paid for such works. This would give rise to the right of the employer to withhold payments in the amounts equivalent to the unpaid sums the subcontract can prove it has been paid to the contractor in light of such information. The employer is not entitled to release such payments to the contractor until it has proven that it has paid all its employers (including subcontractors) up-to-date in full.

As with any of the above routes to obtain payment, a subcontractor is well advised to research the financial position of the contractor to maintaining all its work relationships and avoid being burdened with a large unpaid debt with creditors applying pressure to be paid themselves.

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