Construction — Subcontract — Pay-when-paid clause — Clause entitling main contractor to withhold payment in event of employer’s insolvency — Insolvency defined in terms of section 113(1) of Housing Grants, Construction and Regeneration Act 1996 by reference to four routes under Insolvency Act 1986 prior to amendment by Enterprise Act 2002 — Employer going into administration by self-certifying route introduced by 2002 Act — Whether main contractor entitled to withhold payment to subcontractor — Whether pay-when-paid clause to be construed using all routes to administration under legislation as amended
In 2008, the appellant main contractor engaged the first respondent as a subcontractor on a construction project. The subcontract incorporated a standard-form pay-when-paid clause that had originally been drafted in 1998. The clause was limited so as to comply with section 113(1) of the Housing Grants, Construction and Regeneration Act 1996. It enabled the appellant to withhold payments from the first respondent in the event that it had not itself been paid by the employer if it could show that the employer was insolvent. The pay-when-paid clause defined insolvency in terms that mirrored section 113(1) of the 1996 Act, as drafted, by reference to the four principal routes to insolvency under the Insolvency Act 1986: (i) an administration order made by the court under Part II of the 1986 Act; (ii) the appointment of an administrative receiver; (iii) insolvent liquidation; or (iv) the making of a winding-up order by the court. The clause had not been altered to reflect the amendments made to the 1986 and 1996 Acts by the Enterprise Act 2002, which introduced various “self-certifying” routes to administration.
The appellant sought to withhold substantial sums from the first respondent in reliance on the pay-when-paid clause. In proceedings to recover those sums, the first respondent contended that the appellant could not rely on the clause because the employer’s insolvency had not resulted from any of the four routes but by means of self-certifying administration. The appellant contended that the clause should be construed to take account of the 2002 Act amendments, since a literal construction would produce absurd results and the drafting had clearly gone awry. Allowing the claim, the trial judge held that clause 32 should be construed according to the plain meaning of its wording and could not be rewritten to allow for the 2002 Act amendments: see [2009] EWHC 1603 (TCC); [2010] BCC 332. The appellant appealed.
Held: The appeal was dismissed. The principles of construction that allowed the correction of drafting errors in rare cases where a reasonable person would conclude that something had gone awry and the parties could not have meant what the words said were of doubtful application to a pay-when-paid clause. Since the clauses are ineffective unless the employer is “insolvent”, defined by reference to the routes to insolvency, a main contractor that wants an effective pay-when-paid contract inserted into a subcontract must identify a way in which the employer becomes insolvent as defined in the legislation. If it chooses a route that does not accord with the legislation, because it misdrafts the provision, there is no reason why the above principles of construction should come to its aid. That applies with greater force if the pay-when-paid clause is drafted in a way that works, even if a reasonable person would surmise that the party relying on it did not intend it to be so limited and that an error had been made. The dominant principle is that a party seeking relief from legal liability must use clear words. A pay-when-paid clause does not share the risk of insolvency but relieves the main contractor of a liability to pay that it would otherwise be under. Thus, the main contractor must ensure that a clause of that nature is right if it wants to rely on it; it cannot rely on the principles relating to drafting errors to resolve a lack of clarity in its favour. In the instant case, there was no evidence that an error had been made and the clause as worded did work, albeit that the number of court-ordered administrations would be small compared with self-certified administrations.
The following cases are referred to in this report.
Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38; [2009] 1 AC 1101; [2009] 3 WLR 267; [2010] 1 P&CR 9; [2010] 1 All ER (Comm) 365; [2009] 3 EGLR 119
Dairy Containers Ltd v Tasman Orient Line CV (The Tasman Discoverer) [2004] UKPC 22; [2005] 1 WLR 215; [2004] 2 All ER (Comm) 667; [2004] 2 Lloyd’s Rep 647
Investors Compensation Scheme Ltd v West Bromwich Building Society (No 1); Investors Compensation Scheme Ltd v Hopkin & Sons; Alford v West Bromwich Building Society; Armitage v West Bromwich Building Society [1998] 1 WLR 896; [1998] 1 All ER 98, HL
William Hare Ltd v Shepherd Construction Ltd [2009] EWHC 1603 (TCC); [2010] BCC 332
This was an appeal by the appellant, Shepherd Construction Ltd, from a decision of Coulson J, sitting in the Technology and Construction Court, allowing claims by the first respondent, William Hare Ltd, for payment under a building subcontract, and by the second respondent, CR Reynolds (Construction) Ltd, for declaratory relief, notwithstanding the presence of a “pay-when-paid” clause in the subcontract.
Stephen Furst QC and Krista Lee (instructed by Wragge & Co LLP, of Birmingham) appeared for the appellant; Sean Brannigan QC (instructed by Addleshaw Goddard LLP, of Leeds) appeared for the first respondent; Alexander Nissen QC and Glen Davis (instructed by Gosschalks, of Hull) appeared for the second respondent, another subcontractor on the same project that had brought a separate claim for declaratory relief.
Giving judgment, Waller LJ said :
[1] This is an appeal from the judgment of Coulson J in the Technology and Construction Court handed down on 25 June 2009: |page:11| see [2009] EWHC 1603 (TCC)*. He held in favour of a subcontractor, William Hare Ltd (Hare), that the main contractor Shepherd Construction Ltd (Shepherd) could not refuse payment of £996,683.35 in reliance on a “pay when paid clause” following the going into administration of the employer Trinity Wakefield Ltd (Trinity). It was accepted as between the parties that the judge’s decision also covered a similar dispute between another subcontractor, CR Reynolds (Construction) Ltd (Reynolds), and Shepherd, and it is for that reason that both subcontractors are parties to the appeal. The point I would understand to affect a number of other subcontractors as well.
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* Editor’s note: Reported at [2010] BCC 332
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[2] The judgment is a model of clarity and I would like at the outset to pay tribute to it, and indeed reveal a strong inclination simply to say that, for the reasons that the judge gives, the appeal should be dismissed. However, because I would have been less inclined to explore construction by reference to slightly unreal, albeit perfectly permissible, assumptions and been inclined to put at the forefront what seems to me the straightforward answer to this appeal, I shall set out as shortly as I can why, in my view, this appeal was bound to fail in my own words.
[3] The detail of the statutory provisions can be found in the judge’s judgment. The essence can be put shortly as follows. Section 113(1) of the Housing Grants, Construction and Regeneration Act 1996 (the 1996 Act) outlawed “pay when paid” clauses in the construction industry unless it could be shown that the third-party employer was insolvent. Subsection (2) provided: “For the purposes of this section a company becomes insolvent (a) on the making of an administration order against it under Part II of the Insolvency Act 1986”, that is, by order of the court. (Subsections (b), (c) and (d) identify other processes whereby a company becomes insolvent, two of which, it is right to say, do not require an order of the court. The wording will appear from the clause of the contract with which the appeal is concerned set out in [6] below.)
[4] By the Enterprise Act 2002, the Insolvency Act 1986 (the 1986 Act) was amended, retaining Part II in its then form in respect of a few special types of company, but substituting a different Part II for all other companies through Schedule B1. Schedule B1 provided for three different types of administration still one by virtue of a court order and two without a court order conveniently labelled “self-certifying options”.
[5] That led to an amendment to section 113 of the 1996 Act by the Enterprise Act 2002 (Insolvency) Order 2003, which substituted the above wording of (a), with “when it enters administration within the meaning of Schedule B1 to the Insolvency Act 1986”, thus clearly including both administration through court order and “self certifying”. (Other subsections remained the same.)
[6] In around 1998, Masons, the former solicitor for Shepherd, had drafted a form of “pay when paid clause” for insertion into a standard form of subcontract that followed the then terms of section 113 of the 1996 Act. Thus, it provided as follows (it may not always have been 32, but it will be convenient to number it as such):
32.1 Notwithstanding anything to the contrary elsewhere in this Sub-Contract if the Employer or any such person as is responsible for discharging payment to the Contractor under the Main Contract, as the case may be, is insolvent as defined in Clauses 32.2, 32.3 and 32.4, the Contractor shall not be obliged to make any further payment to the Sub-Contractor or any amount which is due or may become due to the Sub-Contractor unless the Contractor has received payment in respect thereof from the Employer or such other person, as the case may be and then only to the extent of such receipt.
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.
[7] Precisely how we have no real explanation, but, in 2008, Shepherd, as the main contractor for the employer, Trinity, used the same clause in the same terms without reflecting the amendment to section 113 in 2002, as clause 32 in their subcontracts with, among others, Hare and Reynolds.
[8] Trinity went into administration by a self-certifying route. Shepherd sought to rely on clause 32 in refusing to pay the subcontractors the very substantial sums otherwise clearly due.
[9] As the judge records in [4] of his judgment, Mr Sean Brannigan QC, for Hare, supported by Mr Alexander Nissen QC, for Reynolds, submitted before him that Trinity was not insolvent within the meaning of clause 32. It obviously did not come within clause 32(2)(b), (c) or (d), and it did not come within clause 32(2)(a) because there was no “order” of a court. Mr Stephen Furst QC did not contest that the ordinary meaning of the words envisaged an “order” of the court, but maintained that it was “absurd” for the subcontract to be construed without taking into account the subsequent amendments to the 1986 Act, and that this was one of those cases where it was so clear that something had gone wrong with the drafting, the court should construe the clause as covering all routes to administration. In effect, he argued that since clause 32.2 reflected the legislation unamended, it should be construed as though it had been amended.
[10] Mr Furst repeated his submissions before us. Although he accepted that there had obviously been a mistake, he did not rely on mutual mistake or rectification, nor could he have done so on the evidence. He relied on the principles to be gleaned from authorities on construction. Thus, he referred us to the well-known passage in Investors Compensation Scheme Ltd v West Bromwich Building Society (No 1) [1998] 1 WLR 896, at p913:
(4) The meaning which a document (or any other utterance) would convey to a reasonable man is not the same thing as the meaning of its words. The meaning of words is a matter of dictionaries and grammars; the meaning of the document is what the parties using those words against the relevant background would reasonably have been understood to mean. The background may not merely enable the reasonable man to choose between the possible meanings of words which are ambiguous but even (as occasionally happens in ordinary life) to conclude that the parties must, for whatever reason, have used the wrong words or syntax: see Mannai Investments Co Ltd v Eagle Star Life Assurance Co Ltd [1997] AC 749.
(5) The “rule” that words should be given their “natural and ordinary meaning” reflects the common sense proposition that we do not easily accept that people have made linguistic mistakes, particularly in formal documents. On the other hand, if one would nevertheless conclude from the background that something must have gone wrong with the language, the law does not require judges to attribute to the parties an intention which they plainly could not have had. Lord Diplock made this point more vigorously when he said in Antaios Compania Naviera SA v Salen Rederierna AB [1985] AC 191, 201:
“if detailed semantic and syntactical analysis of words in a commercial contract is going to lead to a conclusion that flouts business commonsense, it must be made to yield to business commonsense.”
[11] He referred us also to passages in Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38; [2009] 1 AC 1101*. This latter authority (decided, it should be said, after the judge gave judgment in this case) demonstrated that the principle can even lead to an alteration of the words themselves, if the court is compelled to the view that the parties simply cannot have meant what the words say. The particular paragraphs relied on were [14] and [15], at p1112, in the speech of Lord Hoffmann, which are in the following terms, and I quote them for the emphasis they place on the need for a “strong case” if the court is to be persuaded that something must have gone wrong with the language:
14. There is no dispute that the principles on which a contract (or any other instrument or utterance) should be interpreted are those summarised by the House of Lords in Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896, 912-913. They are well known and need not be repeated. It is agreed that the question is what a reasonable person having all the background knowledge which would have been available to the parties |page:12| would have understood them to be using the language in the contract to mean. The House emphasised that “we do not easily accept that people have made linguistic mistakes, particularly in formal documents” (similar statements will be found in Bank of Credit and Commerce International SA v Ali [2002] 1 AC 251, 269; Kirin-Amgen Inc v Hoechst Marion Roussel Ltd [2005] 1 All ER 667, 681-682 and Jumbo King Ltd v Faithful Properties Ltd (1999) 2 HKCFAR 279, 296) but said that in some cases the context and background drove a court to the conclusion that “something must have gone wrong with the language”. In such a case, the law did not require a court to attribute to the parties an intention which a reasonable person would not have understood them to have had.
15. It clearly requires a strong case to persuade the court that something must have gone wrong with the language and the judge and the majority of the Court of Appeal did not think that such a case had been made out. On the other hand, Lawrence Collins LJ thought it had. It is, I am afraid, not unusual that an interpretation which does not strike one person as sufficiently irrational to justify a conclusion that there has been a linguistic mistake will seem commercially absurd to another: compare the Kirin-Amgen case [2005] All ER 667, 684-685. Such a division of opinion occurred in the Investors Compensation Scheme case itself [1998] 1 WLR 896. The subtleties of language are such that no judicial guidelines or statements of principle can prevent it from sometimes happening. It is fortunately rare because most draftsmen of formal documents think about what they are saying and use language with care. But this appears to be an exceptional case in which the drafting was careless and no one noticed.
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* Editor’s note: Also reported at [2009] 3 EGLR 119
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[12] Mr Furst then sought to demonstrate how unrealistic some of the assumptions made by the judge were, for example as to whether there was any practical benefit for subcontractors in the position of Hare and Reynolds in a requirement for an order of the court, as compared to other forms of administration. He pointed out, indeed, that even two of the other subsections allowed for companies becoming insolvent without a court order, and thus a court order could not realistically have been something that the subcontractors would have relied on to establish insolvency. He argued that any reasonable person (and it seems to have been common ground in the court below that that reasonable person would have knowledge of section 113 and its amendment: see [18] of the judgment) would have appreciated that something had gone wrong with the drafting and that the intention was that the words of the amending legislation were intended to be inserted.
[13] He did not argue that, on the words as actually used, they could not be made to work because he accepted that, under the substituted Part II B1, a court order could be obtained, but he showed us some statistics as demonstrating that the vast majority of administrations in the modern era are “self-certified”. This again, he submitted, would be knowledge that the reasonable person would have, and supported his submission that that reasonable person would conclude something had gone wrong.
[14] We pressed Mr Furst as to whether the principles on which he relied from the speeches of Lord Hoffmann were applicable at all or in any event with the same force in the case of an exclusion clause inserted by one party entirely for its own benefit. His response was to argue that clause 32 was not an exclusion clause but a clause sharing the risk between subcontractor and contractor of the employer becoming insolvent. In any event, he argued that there was no reason for the principles not to apply if it could be demonstrated that a reasonable person would conclude that something had clearly gone wrong with the drafting.
[15] I am very doubtful whether the principles relied on would apply at all in a case such as this. 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. If a main contractor wants to have a pay-when-paid provision in a subcontract, it would be bound, if the clause were to be effective, to identify a way in which the third-party employer became insolvent as defined in the legislation. If it chose a way that was not in accordance with the legislation because it misdrafted the provision, I can see no reason why, however obvious it was that it had misdrafted the provision, the principles identified by Lord Hoffmann would come to the rescue.
[16] If it has drafted its provision in a way that actually does work, even if a reasonable person would guess that it was not intended by the proferens to be so limited and that there has been an error, I see even less reason for the courts to come the rescue.
[17] In this case, there is in fact no evidence of any appreciation that an error had been made; the clause as worded does work, although, as we were told, the number of court orders are miniscule as compared with self-certified administrations. This clause was not truly “sharing” the risk of insolvency, it was relieving Shepherd of a liability to pay that it otherwise had and it was for Shepherd to get a clause of this nature right if it wanted to rely on it.
[18] The principle that the courts have always applied to clauses by which a party seeks to relieve itself from legal liability, namely that to do so they must use clear words, should, in my view, be the dominant principle. As Lord Bingham of Cornhill recently reiterated in [12] of Dairy Containers Ltd v Tasman Orient Line CV (The Tasman Discoverer) [2004] UKPC 22; [2005] 1 WLR 215: “The general rule should be applied that if a party, otherwise liable, is to exclude or limit his liability… he must do so in clear words; unclear words do not suffice; any ambiguity or lack of clarity must be resolved against that party” (emphasis added). It is not therefore, in my view, open to Shepherd to argue that there is a lack of clarity in a provision that it drafted so as to relieve ifself from liability, and that the court should use the principles identified by Lord Hoffmann as applicable in rare cases to rescue them.
[19] These are my reasons for dismissing the appeal.
Rix LJ said:
[20] I agree.
Sir Scott Baker said:
[21] I also agree.
Appeal dismissed.