What is A Conditional Payment Clause and When is it Void?
In construction field, whenever the subcontractor want to claim payment from main contractor, the main contractor might use the excuse that they have yet to receive the payment from the developer or project owner, therefore they cannot issue the payment to the subcontractor. So today this article is going to discuss whether is the argument pay when paid i.e. when the main contractor get the payment from the developer or project owner then only pay the subcontractor is still valid?
The Construction Industry Payment and Adjudication Act 2012 (“CIPAA”) came into force on 15 April 2014. The CIPAA has brought in significant changes to the construction industry. However, like other newly introduced legislation, CIPAA too is facing teething issues and several issues have arisen since it came into force.
This article will discuss the effect of CIPAA and the position of conditional payment clauses in the light of recent developments. Briefly, CIPAA provides a new regime in which an unpaid contractor can claim for payment for work done or services rendered under the express terms of a written construction contract. CIPAA was introduced with the objective of providing a speedy procedure for the temporary resolution of payment disputes under construction contracts. With such an objective in mind, CIPAA has invalidated conditional payment clauses in construction contracts, mainly to ease cash flow in the construction industry.
What is Conditional Payment as Envisaged in Section 35 CIPAA? Section 35(1) of CIPAA provides that any conditional payment provision in a construction contract in relation to payment under the construction contract is void. Section 35(2) provides that it is a conditional payment provision when
(i) the obligation of one party to make payment is conditional upon that party having received payment from a third party, or
(ii) the obligation of one party to make payment is conditional upon the availability of funds or drawdown of financing facilities of that party. Is “conditional payment” therefore to be restricted to the two instances described in section 35(2)?
In the case of Econpile (M) Sdn Bhd v IRDK Ventures Sdn Bhd and anor  7 MLJ 732, the High Court held that for the purposes of section 35, “conditional payment” is not restricted to the two instances described in section 35(2). The High Court held that a more expansive interpretation has to be adopted because in describing the two instances, Parliament did not use the expression “conditional payment means” or “conditional payment includes” but rather, the Parliament had chosen to state a general principle first in section 35(1) and has couched it to be all encompassing by using the expression “any conditional payment provision”. In this regard, the High Court held that clause 25.4(d) of the PAM Standard Form of Contract amounted to a conditional payment clause within the ambit of section 35 of the CIPAA. Clause 25.4(d) provides that:
“Until after the completion of the Works under Clause 25.4(a), the Employer shall not be bound by any provision in the Contract to make any further payment to the Contractor, including payments which have been certified but not yet paid when the employment of the Contractor was determined. Upon completion of the Works, an account taking into consideration the value of works carried out by the Contractor and all cost incurred by the Employer to complete the Works including loss and/or expense suffered by the Employer shall be incorporated in a final account prepared in accordance with Clause 25.6” What is the effect of section 35 of the CIPAA? Section 35 of the CIPAA effectively takes away the contractual right of the paying party to pay only upon the satisfaction of certain conditions and replaces the same with a default payment provision under sub-sections (3) and (4) of section 36 of the CIPAA which provides that: “Section 36(3) The frequency of progress payment is (a) Monthly, for construction work and construction consultancy services; and (b) Upon the delivery of supply, for the supply of construction materials, equipment or works in connection with a construction contract. Section 36(4) The due date for payment under subsection (3) is thirty calendar days from the receipt of the invoice.”
When is conditional payment clause void?
The Federal Court in Jack-In Pile (M) Sdn Bhd v Bauer (Malaysia) Sdn Bhd (“Jack-In Pile”) held that CIPAA could only apply prospectively, i.e. it applies only to construction contracts executed after 15.4.2014, based on the following reasoning:
- CIPAA affects the substantive rights of contracting parties, and hence, it can only apply prospectively.
- Jack-In Pileconcerns a “pay-when-paid” clause, a common term found in construction contracts. A “pay-when-paid” clause is a conditional provision where the obligation of one party to make payment is conditional upon that party having received payment from a third party. All condition payment clauses are rendered void pursuant to section 35 of the CIPAA.
- It was held in Jack-In Pile that the “pay-when-paid” clause concerns substantive rights which, “parties have acquired pursuant to the agreement”. The Court went on to say that such right existed even before CIPAA came into force. Therefore, section 35 of CIPAA “which takes away the substantive rights of parties cannot be applied retrospectively” as this right under the agreement existed before CIPAA came into force on 15.4.2014. In the absence of a clear legislative intention, Section 35 of CIPAA which takes away the substantive right of parties cannot be applied retrospectively.
- Before the operation of CIPAA, parties were entitled to agree on a “pay-when-paid” payment regime. Section 35 of CIPAA takes away this right and parties no longer enjoy this freedom to contract after the coming into force of CIPAA on 15.4.2014. Freedom to contract is a substantive right, and regulations which affect substantive rights should only operate prospectively.
- The Federal Court also held that the date of commencement of an Act, including CIPAA, is only prospective in nature unless expressly stated otherwise. Therefore, in the absence of an express provision, which can only be enacted by Parliament, CIPAA cannot operate to a construction contract entered into before 15.4.2014.
- The enactment of CIPAA creates an alternative access to justice and dispute resolution forum by way of adjudication. This is a substantive right which can only apply prospectively.
As a result of the Federal Court’s decision in Jack-In Pile, the Asian International Arbitration Centre (“AIAC”) as the adjudication authority, announced that AIAC will no longer register payment disputes arising from construction contracts executed before 15.4.2014. Although statutory adjudication is no longer an option for Pre-CIPAA construction contracts, an aggrieved party may still resort to court or arbitration to resolve disputes over payments.
In short for construction contract signed after 15.04.2014, condition payment i.e. pay-when-paid is void and this argument cannot be used by the main contractor to refuse to make payment to the sub-contractor.
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