Stormy waters: Issues when paying subcontractors directly

Employers can sometimes find themselves wishing to make direct payments to subcontractors engaged by their contractor. This could be, for instance, if a payment dispute arises at subcontract level or if the main contractor suffers cash flow difficulties. Subcontractors may threaten to terminate or suspend work and the employer may feel that direct payments are necessary to keep the project afloat. 

Although the commercial rationale is clear, a number of legal issues can arise. For example, the employer will usually wish to recover such payments from the contractor but, with little knowledge of the claims, may struggle to prove that the contractor was liable to pay such sums to the subcontractor. 

Cases dealing with these issues are rare. However, a recent arbitration appeal heard by the Commercial Court provides a good illustration of the legal difficulties faced by employers in such circumstances and potential routes to overcome them. 

Nobiskrug vs Valla Yachts

In Nobiskrug GmbH vs Valla Yachts Ltd, Valla engaged Nobiskrug, a German shipyard, to build a superyacht. The contract did not contain direct payment provisions, but during the course of the project Valla made numerous payments to certain specialist subcontractors that had brought claims against Nobiskrug. 

Nobiskrug contested most of the claims and the subcontractors threatened to cease work. Valla wished to avoid this and expressly reserved its right to recover the payments from Nobiskrug. 

Valla subsequently commenced arbitration proceedings against Nobiskrug to recover the payments. Among other things, it claimed that Nobiskrug had breached certain project management obligations in the contract which required Nobiskrug to manage and investigate claims made by the specialist subcontractors. 

The arbitral tribunal emphasised the reservation of rights made by Valla, but its award was unclear as to whether the payments could be recovered without proving that Nobiskrug was obliged to make those payments to the subcontractors. Valla had not been able to prove such an obligation to the tribunal. The tribunal nevertheless accepted Valla’s case as to project management failings but considered that it would only be entitled to damages for such breaches if they “were an effective cause” of the costs claimed by the subcontractors. The tribunal did not go on to determine that issue, but nonetheless ordered Nobiskrug to reimburse some of the payments made by Valla on grounds that were unclear from the award. 

Nobiskrug appealed against the decision, asserting that the tribunal had made an error as there had been no finding that Nobiskrug was under a legal liability to the subcontractors in respect of the payments. Nobiskrug accepted there was a reservation of rights but argued that this did not create a right or a cause of action against it for the recovery of the sums paid. It asserted that payments made by Valla were voluntary and the reservation of rights simply meant that Valla had not waived its right to recover the money by pursuing its counterclaims. 

Valla argued that the tribunal’s award could be supported on restitutionary grounds, on the basis that: (i) Nobiskrug breached its project management obligations, which placed Valla in an extremely difficult position, compelling it to make the payments if the yacht was to be completed; and (ii) making such payments was to the benefit of Nobiskrug, allowing the project to continue and Nobiskrug to earn the contract price. Therefore Nobiskrug was unjustly enriched and Valla had a valid restitutionary claim.

Somewhat inevitably, the Commercial Court remitted the matter to the tribunal for further consideration. The court did not think the tribunal could be said to have ordered the reimbursement of payments made by Valla “simply on the basis that it made them subject to a reservation of rights”. On the other hand, it was unclear on what basis the tribunal had ordered reimbursement and Valla’s restitutionary analysis was “not spelt out completely on the face of the award”. Of note, however, the court considered that the restitutionary claim had “considerable force”. 

Conclusions

It is unsurprising that a mere reservation of rights was insufficient to entitle the employer to the reimbursement of direct payments. Of much greater interest, however, is the court’s encouragement of a restitutionary claim based on the contractor’s failure to adequately manage subcontractor claims. If successful, such an argument would appear to avoid the need for the employer to prove that (i) the contractor had a liability to the subcontractors in respect of the amounts paid by the employer; or (ii) the contractor’s project management failings had caused or contributed to the amounts claimed by the subcontractors. The ability to make such claims would be of considerable assistance to employers in a similar position to Valla. 

The restitutionary argument is not without difficulty, however. Such claims are usually unavailable where contractual remedies already exist. If a restitutionary claim did succeed, it might prove difficult for the contractor to recover those amounts from its subcontractors.

Sarah Leaver is an associate in the construction and engineering team at CMS