Keep your insolvency event clauses up to date

When an employer went into administration, a contractor wanted to rely on a standard definition of insolvency contained in one of its sub-contracts to avoid paying a sub-contractor nearly £1m. The contractor must have been surprised to discover that the clause did not work. The decision of the Technology and Construction Court in June 2009 has now been confirmed by the Court of Appeal in William Hare Limited v Shepherd Construction Limited and CR Reynolds (Construction) Limited v Shepherd Construction Limited [2010] EWCA Civ 283

Facts

The particular definition of insolvency was originally drafted in 1998 for use with a “pay when paid” clause. A “pay when paid” clause does what it says: the contractor with the benefit of the clause need only make payment when he has himself been paid by the employer. However, s.113(1) of the Housing Grants, Construction and Regeneration Act 1996 outlawed “pay when paid” clauses in the construction industry unless it could be shown that the third party employer was insolvent. The 1996 Act included a definition of insolvency that referred, among other things, to an administration order.

Before the Enterprise Act 2002 introduced changes to the administration regime, company’s wishing to go into administration could only do so by court order. Following the Enterprise Act changes, two out-of-court filing routes (or “self-certifying routes” as the judge referred to them) became available. The definition of insolvency in s.113 of the 1996 Act was amended accordingly to include administration accessed by an out-of-court filing.

However, the contractor in this case somehow failed to update its definition of insolvency in the contract and used the pre-Enterprise Act definition of insolvency in a sub-contract in 2008. The part of the clause dealing with administration referred only to “the making of an administration order…” and not to the out-of-court filing routes into administration.

The employer in the case went into administration via an out-of-court filing route. The contractor tried to rely on the “pay when paid” clause to refuse to pay the subcontractors substantial sums that were otherwise clearly due.

There was no dispute that the ordinary meaning of the definition of insolvency in the contract did not include a reference to an out-of-court filing for administration, but the contractor argued that it was “absurd” for the sub-contract to be construed without taking into account the subsequent amendments to the insolvency regime and that this was one of those cases where it was so clear something had gone wrong with the drafting, the court should construe the clause as covering all routes to administration. In other words, the contractor argued that the clause should be construed as if it had been amended with an updated reference to administration. Seeking to rely on the well-known authority on contractual interpretation, ICS v West Bromwich Building Society [1198] 1 WLR 896, the contractor argued that this was one of those cases where the parties must, for whatever reason, have used the wrong words, but that the parties’ intention was clear.

At first instance, Coulson J sitting in the Technology and Construction Court in June 2009 was not persuaded and held in favour of the sub-contractor. The contractor appealed.

Court of Appeal decision

On appeal, the Court agreed with Coulson J. The Court cited Chartbrook Limited and Another v Persimmon Homes Limited and Another [2009] 1 AC 1101, which stresses the need for there to be a “strong case” if the court is to be persuaded that something must have gone wrong with the language.

The Court of Appeal was doubtful whether the principles in ICS v West Bromwich would apply to a case such as this. Giving the judgment, Waller LJ said that: “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 wishes to have a pay when paid provision in a subcontract he would be bound, if it was to be effective, to identify a way in which the third party employer became insolvent as defined in the legislation. If he chose a way which was not in accordance with the legislation because he misdrafted the provision, I can see no reason why, however obvious it was that he had mis-drafted the provision, the principles identified by Lord Hoffman [in ICS v West Bromwich] would come to his rescue.”

The appeal was dismissed.

Comment

Where a party wishes to include in a contract a clause that is intended to relieve him of a liability to pay what he otherwise would have to pay, it is for him to get the clause right. Only clear words will do. Any ambiguity or lack of clarity will, as in this case, be resolved against the party seeking to rely on it.

Despite coming to a result that is, perhaps, counter-intuitive to insolvency professionals, we respectfully agree with the Court of Appeal on contractual interpretation principles. Let it be a salutary lesson to all parties entering into contracts to ensure that insolvency event clauses have been updated to reflect the 2002 changes.