Holding on

Consider the following situation. An electrical subcontractor carried out electrical installations for a main contractor. Work was completed in November 2004 and the retention still outstanding is £12 414.

The subcontractor attempts to obtain payment of this retention from the main contractor, only to be informed that the employer will not release it. The subcontractor contacts the employer and explains the situation.

The employer simply states that there is a problem with the roof system and, until it is resolved, no retention monies will be released.

The subcontractor asks the employer if there is a problem with the electrical installations. The employer says no.

In the subcontract, release of retention is linked by express provision to certification under the main contract. The first half of the retention is to be released following issue of the certificate of practical completion.

The second half is then to be released following the issue of the certificate of making good defects or the final certificate. This effectively makes payment of retention conditional on the issue of these certificates, or put another way, it is a ‘pay when paid’ clause. No certificates – no entitlement to retention.

Conditional payments

By virtue of section 113 of the Housing Grants, Construction and Regeneration Act 1996, in simple cases a traditional ‘pay when paid’ clause in a subcontract is ineffective. The main contractor will not be able to delay or avoid payment to the subcontractor on the strength of such a clause, simply because the employer has not paid the main contractor.

Although payment of retention, conditional on the issue of a certificate under the main contract, is not a provision relating to “receiving payment from a third person”, it might be argued it has the same effect.

Dates for payment

Section 110 (1) (ii) of the Act states that every construction contract (as defined by the Act) shall provide for a final date for payment in relation to any sum that becomes due. The main contractor and the subcontractor are free to agree the period between the due date and the final date for payment.

It is critical to bear in mind the important distinction between the two dates. The due date is the moment at which a subcontractor’s entitlement to payment crystallises, but it is not the date at which it is to be paid. That involves the second stage: final date for payment.

This is the date when payment should actually be made. The subcontract should therefore expressly identify the two dates so the subcontractor knows when it will be paid.

Release of retention, conditional on the issue of a certificate under the main contract, does not provide a means of determining these dates. It cannot be ascertained with any certainty when the certificates will be issued.

Remember, both dates have to be clearly spelt out in the subcontract so the subcontractor knows in advance when payment will be made. The subcontractor will simply not know in advance when retention will be paid.

This also applies even when the certificates are finally issued, unless the subcontract contains an express clause stating when payment will be made following their issue. As a result, any subcontract with such provision for the release of retention may not comply with the Act. This would be a breach of subcontract.

Judicial authority

Surprisingly, there is a distinct lack of judicial authority on ‘pay when paid’ clauses, but this issue came before the courts in a recent case, Midland Express Way v Carillion Construction.

The court considered a variation clause in the contract. The judge stated that the main contractor could not be paid any money for variations until the employer had established its own entitlement under its agreement with the transport secretary.

This was held to be a breach of section 113 of the Act, and thus a breach of contract.

The same argument could be used in interpreting retention clauses in subcontracts.

There is a growing concern among subcontractors over ‘pay when paid’ retention clauses, and the pressure is on for these to be prohibited.

With the legislation now available, greater opportunity exists for tackling retention clauses and their abuse.

Arguments purely based on ‘pay when paid’ retention clauses will soon, hopefully, become a thing of the past.