Resolving the pay when paid problem

The pay when paid issue has troubled the construction industry for many years. It refers to payment terms contained in a sub-contract, which typically provide that the main contractor shall pay the sub-contractor a certain period of time after the main contractor has received payment from the employer. The controversy is whether the phrase should be construed as creating a condition precedent to the main contractor's liability to the sub-contractor. Sub-contractors will argue that pay when paid is different from pay if paid and that only the latter will create a condition precedent. For instance, a pay when paid term only specifies the timing (not liability) for payment, so that even if the main contractor has not received payment from the employer after the lapse of reasonable time, the sub-contractor is entitled to be paid after completion of its sub-contract works.

Before Wo Hing Engineering Ltd v Pekko Engineers Ltd (1998) (we acted for Wo Hing in that case), the Hong Kong courts had no opportunity to decide on the true meaning of pay when paid. All cases which had touched upon the issue were only in the context of applications for summary judgment and the courts in those cases did not give a final ruling on the issue. In the Wo Hing case, having considered various authorities from the US, Australia and New Zealand, the judge accepted that a typical pay when paid term does not create a condition precedent for payment to the sub-contractor.

Arguments on the true meaning of pay when paid have continued after the Wo Hing case. Some main contractors still try to distinguish Wo Hing by arguing that the payment term in that case was nothing like that in the standard nominated sub-contract commonly used in Hong Kong (known as the Green Form). They also argue that Wo Hing is a case involving domestic sub-contract payment terms and that it is not fair for the main contractor to undertake the risk of non-payment by the employer when the sub-contractor is nominated by the employer itself.

A recent court of first instance decision has touched on the pay when paid issue. In Kim Hung Construction & Engineering Co Limited v Standard Refrigeration & Engineering Co Limited (2013), the sub-contractor claimed against the main contractor in an arbitration for delay in completion of a project, where the main contractor had not been paid by the employer. The arbitrator ruled that the main contractor was liable to pay the sub-contractor despite the fact that the main contractor had not been paid by the employer. The main contractor sought leave in the high court to appeal against the arbitrator's ruling, under the old Arbitration Ordinance (Cap 341).

The deputy judge was asked to construe the payment terms in a domestic sub-contract commonly used in Hong Kong, which contains elaborate provisions governing the time for payment, together with a number of provisions in the letter of acceptance. Construing those provisions as a whole, the judge found that the payment for the delay claim had not yet become due under the sub-contract.

While there is nothing unusual about the judge disagreeing with the arbitrator's finding, it is interesting to note the deputy judge concluded that the agreed payment arrangement between the parties was one on a pay when paid basis. As explained earlier, we will usually describe payment by the employer to the main contractor as a condition precedent for payment to the sub-contractor as pay if paid. Using pay when paid rather than pay if paid to describe the payment terms in question may cause confusion. It may now leave room for main contractors to argue that even if the payment term is pay when paid (as opposed to pay if paid), the sub-contractor is still not entitled to payment before the main contractor has received the corresponding payment from the employer.

Proposed legislation for Security for Payment

In order to address the pay when paid or pay if paid problem the Construction Industry Council commissioned a survey and found that it is indeed serious in Hong Kong. The Government is preparing a consultation paper to be published this year on the legislation to introduce measures to assist contractors and sub-contractors to secure payment for their works. It is anticipated that the bill will be put to the Legislative Council in 2015 or 2016.

While it is not clear what will be proposed by the Government, it is generally expected that the following measures will be put forward, judging by other jurisdictions, such as the UK, Australia, New Zealand, Singapore and Malaysia that have security for payment legislation in place:

1. prohibit pay when paid or pay if paid provisions in sub-contracts;

2. give statutory rights to contractors to suspend work for non-payment;

3. require main contractors to give prior notice before withholding payment; and

4. introduce statutory regime for adjudication of payment disputes.

It is hoped that after the passing of the security for payment legislation, this question is resolved and the energy of the parties can be better spent on completing their construction projects.