Proposed SOP Act in Hong Kong – “Pay when Paid” Clause in Construction Contract

In the Hong Kong construction industry, it is common for main contractors to include a provision in subcontracts which provides that payment to the main contractor is dependent on the main contractor receiving payment from the client or other project funders.

With this provision, the main contractor shares the cash flow risk of projects with their subcontractors.  The problem is with the subcontractors with less bargaining power to accede to this payment arrangement and leading to high risk of subcontractor insolvency, “pay when paid” provisions are upheld and enforced by the courts in Hong Kong if they are sufficiently and clearly drafted.  In the HK’s SOPL public consultation report published in April 2016 (Report on Public Consultation on Proposed Security of Payment Legislation for the Construction Industry (April 2016), Hong Kong SAR Development Bureau), it sets out the four questions and responses of the public and stakeholders n regard to pay when paid provisions:

Question 1: Do you agree that “Pay when paid” clauses should be rendered ineffective?

Question 2: Do you agree that “Pay when paid” clauses should be ineffective even where the reason for non-payment is insolvency higher in the supply chain?

Question 3: Do you agree that clauses which make payment under a contract conditional on certification or performance of obligations under another contract should be rendered ineffective?

Question 4: Do you agree that no exception should be made for nominated sub-contractors?

The first two questions received a majority support, with a comment from the minority opposing the underlying proposal to apply in consultancy contracts because consultants do not suffer significant problems from “pay when paid”, otherwise hardship could result to lead consultants and negotiation of consultancy agreements was generally between “independent professionals” who do not need protecting in the same way as smaller sub-contractors or self-employed workers. 

The matter in question 2 was analysed in the Malaysia’s Court of Appeal in Bauer (Malaysia) Sdn Bhd v Jack-In Pile (M) Sdn Bhd  (Civil Appeal No: B-02(C)(A)-1187-06/2017).  The contract between the parties contained a progress payment clause, where “All payments shall be made within 7 days from the date the Specialist Contractor received their related progress payment and subjected to 5% retention…”  Section 35 of the Malaysian’s SOP Act contains the provision:

  1. Any conditional payment provision in a construction contract in relation to payment under the construction contract is void.
  1. For the purposes of this section, it is a conditional payment provision when:

           a. The obligation of one party to make payment is conditional upon that party having received payment from a third party; or

           b. …

The issue of this case relates to whether the SOP Act has a prospective or retrospective effect, because this conditional payment provision existed before the effective date of the SOP Act.  Bauer relied on this conditional payment provision to withhold payment against Jack-In Pile after the client was wounded up and no payment was received by Bauer.  Despite the Malaysian’s Court of Appeal held that the SOP Act had a prospective effect, the cause of non-payment was insolvency in the higher supply chain and the conditional payment provision would have been determined ineffective if it had  been agreed after the effective date of the SOP Act.  The HK’s proposed SOP Act is more specific along with this level of payment safeguard.

Question 3, surprisingly, received less than 50% support by the respondents.  The matter of contingent payment under a contract conditional on the certification of obligations under another contract can be found in a recent Australian cases Maxcon Construction Pty Ltd v Vadasz [2018] HCA 5.

In Maxcon case, the sub-contract contains a provision that retention money shall be held as security by Maxcon until after the project client issues a certificate of occupancy for the work done under the sub-contract.  However, regulatory requirements were that the certificate of occupancy would only be issued after Maxcon had completed all the works under the main contract.  Vadasz, the sub-contractor, ran into difficulties with this pay when paid provision.

Section 12 of the South Australian SOP Act defines pay when paid as:

  1. A pay when paid provision of a construction contract has no effect in relation to any payment for construction work carried out or undertaken to be carried out (or for related goods and services supplied or undertaken to be supplied) under the contract.   

        2. In this section –

           ...

         Pay when paid provision of a construction contract means a provision of the contract –

        a. …

        b. …

        c. that otherwise makes the liability to pay money owing, or the due date for payment of money owing, contingent or dependent on the operation of another contract.

The High Court of Australia upheld the adjudicator’s decision that the retention money provision in the sub-contract was ineffective because payment was dependent on the certificate of occupancy in the main contract.

The HK proposed SOP Act uses the words ‘conditional on certification or performance of obligations under another contract’.   It appears to be more narrowly drafted than the Southern Australian SOP Act where ‘contingent or dependent on the operation of another contract’ is stated.

The problem with only limiting this provision to the certification and performance of obligations might mean that other contingent payment provisos on another contract continue to have a legal effect.  For example, a payment term dependent on the resolution of an extension of time dispute might be regarded as an operation of contract but may unlikely be construed as certification or performance of obligations.

The last question on having no exception made for nominated sub-contractors was also supportive by the respondents.  The shortcoming of this proposal is the unfairness on contractors who have no involvement in the selection and evaluation of nominated sub-contractors, but are exposed to the risks of adjudication about payment to nominated sub-contractors.  A project bank account (PBA) provision analogous to the recent reform of the Queensland’s SOP Act (Queensland’s Building Industry Fairness (Security of Payment) Act 2017) might regulate a better payment control on nominated sub-contractors and fairness to their upper tier contractors.

The HK’s proposed SOP Act shall be handled with cautious as it may contain ‘pitfalls’ for those who are unfamiliar with the requirements and objectives of the SOP Act and the legal principles that affect its operation.

Jurisdictions: 

Chartered civil engineer, chartered project management surveyor and construction arbitrator.  He is currently Honorary Secretary of the YMG of the Chartered Institute of Arbitrators (East Asia Branch).  He is also regularly appointed as construction adjudicator and mediator in the East Asia region.