Understanding Pay When Paid Clauses in Construction
Pay when paid clauses shift payment risk downstream in construction contracts, but are largely unenforceable in the UK except for insolvency cases. Accurate drafting and clear alternatives are essential.
What is a Pay When Paid Clause?
A pay when paid clause is a contractual arrangement—most commonly found in construction and subcontracting agreements—stating that a subcontractor is paid only when the main contractor is paid by the project’s client. On the face of it, such clauses are designed to manage cash flow risk for the main contractor, allowing them to avoid advancing funds before receiving upstream payments.
- Example: “Subcontractor will be paid within 10 days after receipt of payment from Owner by Contractor.”
Such clauses can have significant implications in commercial relationships and deserve thorough understanding.
The Legal Position in the UK
The UK’s approach is largely shaped by the Housing Grants, Construction and Regeneration Act 1996 (the Construction Act). Under section 113 of the Act:
- Pay when paid clauses in construction contracts are void and unenforceable.
- The sole exception is where the payee above (the Employer) has become insolvent. Even then, the clause must be tightly drafted to match statutory definitions.
Insolvency Exception
Under UK law, insolvency is precisely defined, encompassing events such as administration, voluntary winding-up, or a winding-up court order. For a contract to benefit from this exception, the relevant clause must:
- Accurately reference statutory triggers.
- Account for any future legal amendments.
"Pay when paid clauses lacking precise statutory wording will not stand up in court. Outdated or vague references render the clause unenforceable."
— William Hare Ltd v Shepherd Construction Ltd [2010]
Case Law: A Lesson in Drafting
The William Hare Ltd v Shepherd Construction Ltd [2010] case offers a cautionary tale: a new method of client insolvency was not recognised in the subcontract’s wording. The result? The clause failed, and payment was due to the subcontractor.
Key lesson: Courts will not rewrite contracts to rescue poor drafting. Pay when paid provisions must be kept up to date with legislative changes.
Employment and Other Contracts: Strictly Prohibited
A critical note—these clauses have no place in employment contracts. UK law does not permit employers to make employee wages conditional on being paid by a client, in any sector. Similar skepticism surrounds such clauses outside construction.
Who Bears the Risk?
Subcontractors and Suppliers:
- May experience severe cash flow delays.
- Remain exposed to the knock-on effect of upstream payment issues.
- Often lack flexibility to negotiate such terms, particularly in competitive markets.
Main Contractors:
- Find comfort in managing their payment obligations in line with client receipts.
- Bear responsibility for careful contract drafting to remain within the law and avoid legal penalties.
In practice: Unless the upstream party is insolvent (and the clause says so correctly), the main contractor is ultimately liable to pay the subcontractor within a reasonable time.
Practical Contract Drafting: Avoiding Pitfalls
To be enforceable, a pay when paid clause must:
- Reference current legal definitions of insolvency.
- Include language anticipating statutory changes (e.g., "or any re-enactment thereof").
- Be reviewed regularly—don’t let contract templates gather dust.
- Remember: Exclusionary clauses are interpreted against the party relying on them.
Alternatives to Pay When Paid Clauses
Given the legal restrictions, what strategies remain for fair payment practices?
Common Alternatives:
- Stage/milestone payments: Release funds on completion of agreed phases.
- Retentions: Withholding a portion until satisfactory completion.
- Advance payments: Agreed upfront sums for work carried out.
- Security of payment provisions: Statutory rights enabling a subcontractor to serve notice or seek payment directly in certain cases.
| mechanism | Effect on Main Contractor | Effect on Subcontractor | Legal Standing in UK |
|---|---|---|---|
| Stage/milestone pay | Predictable cash flow | Predictable payments | Fully valid |
| Retention | Secures performance | Delays full payment | Valid if transparent |
| Advance payments | Greater risk exposure | Boosts cash flow | Valid by agreement |
| Security of payment | Prompt risk notification | Early warning, leverage | Statutory backing |
Comparative Note: US and Global Perspective
While the UK position is clear, international practice varies:
- US states: Some outlaw both pay when paid and pay if paid. Others strictly limit them to timing (not absolution of payment).
- Many allow only for a "reasonable" delay, never a perpetual one.
- In the US, mechanics lien rights usually endure regardless of pay when paid terms.
Takeaway Quotes
"Few clauses generate as much contention as pay when paid. Ultimately, UK law prioritises fair, prompt payment in the construction supply chain."
“Drafting matters. Only the most precise contracts will stand up to judicial scrutiny if challenged.”
Call to Action
Are you reviewing or negotiating contracts in construction? Don’t rely on outdated or vague templates. Seek legal advice to ensure all payment terms—including insolvency exceptions—are legally watertight. Sound contracts keep business relationships, and cash flow, running smoothly.
In Summary
- Pay when paid clauses are generally unenforceable in UK construction, save for properly drafted insolvency exceptions.
- Main contractors must stay abreast of statutory definitions and review contracts frequently.
- Subcontractors should push for fair and transparent alternatives, safeguarding their right to timely payment.
For further guidance on drafting robust contracts or understanding your payment rights, consult a qualified contracts solicitor or specialist construction lawyer.
