A client of our firm acted as a subcontractor in a construction project. When it was time for our client to receive payment, the primary contractor argued that because it did not received payment from its customer, it is not obliged to pay the subcontractor, despite the fact that there is no agreement between the parties that determines so. Is there a dependency between the primary contractor’s obligation to pay its subcontractors and the receipt of funds by it?
In many construction projects the contracting party enters into an agreement with a contractor for the whole work and the contractor then enters sub-contractor agreements for segments of the work. The sub-contractor’s agreements often include a back-to-back clause. The meaning of a back-to-back clause is that the agreement between the main contractor and the subcontractor is subject to the agreement between the original customer and the primary contractor and usually the original customer is the only one to confirm the work and the payment and payment of the primary contractor to the subcontractor is contingent upon receipt of payment by the primary contractor.
Such a clause has a commercial logic, because without this stipulation, the primary contractor may find itself paying subcontractors whole not being paid - which may result, especially on large projects, in a credit crisis and even insolvency. However, sometimes non-payment is not due to the fault of the sub-contractor.
In a construction project dispute discussed in Court in late June, 2016, there was no agreement in place between the contractor and sub-contractor but the Court held that in practice, the parties acted as if there was a back-to-back clause and the original not only approved all payments but acted directly vis-à-vis the sub-contractor to approve the works. The Court held that the payment to the subcontractor was subject to the receipt of payment by the primary contractor.
In a case discussed in Court at the beginning of 2016 an engineering company acted as a contractor in a project and contracted with a subcontractor for specific works with a "back to back" clause. The Court held that the purpose of a "back to back" clause is, normally, to prevent a situation where the contractor need pay the subcontractor for work that was not approved or paid for by the client due to grounds related to the subcontractor, such as partial or improper work. Despite the existence of a "back to back" clause in the agreement between the parties and even if the contractor did not receive payment from the client it does not cancel the obligation of the contractor to pay the subcontractor if it is found that the subcontractor did properly conduct the work. In another case, discussed at the end of April, 2016, the customer did not pay due to flaws in the work. The Court held that despite the back-to-back clause, the main contractor is obliged to pay the subcontractor because the failure was by the main contractor.
In many cases the engagement between contractors and subcontractors is done without any agreement or an agreement made without legal advice (especially by the subcontractor). In view of the complexity of the relationship where there is another factor (the customer) in the picture, it is even more important than usual to involve an attorney specializing in the field already at the pre-contract stage, but surely as there is a delay in payments.