Non-payment: What’s a Contractor to do?

Payments to contractors are widely subjected to extensive delays. Within the Gulf region, it is without a doubt the most common form of breach that occurs in any construction contract.

Unfortunately, it is so common that the practice is widely tolerated by contractors. In some cases, non-payment can be coupled with an atmosphere of coercion, where powerful employers use their position to prevent contractors from seeking to enforce their rights under the contract. Other times, non-payment may just be a case of an employer electing to (or perhaps forced to by its financier) hold on to as much cash as possible throughout the project.

In a paper by Deloitte titled “GCC Powers of Construction 2021” it was reported that during the pandemic “the cash conversion cycle for contractors, i.e. the time taken from when work is performed on site to being certified and then being paid, was almost 1 year in 2020.” A statistic that is somehow both shocking, but not surprising.  

Whilst there are immediate benefits to employers in withholding payments in this way, such benefit is often short sighted. As the practice has to be anticipated by contractors, it leads to higher costs across the industry. Late payments and the damage caused by such breach often comes to afore and can result in very costly judgements, either on the applicable interest rate applied to late payments, or the harm that can be proven to have resulted by such breach.

Without legislative intervention of the likes seen in Australia[1] and the United Kingdom[2], such practices seem unlikely to change. Whilst data suggests that the situation has improved since the outset of the pandemic, the practice continues to be a very disruptive aspect of the construction industry in the Gulf.

So whilst it is the case that payments should be made on time, the question is, what can a contractor do when payments are delayed? It is usually the case that a contractor has essentially four options. Below we consider these four options in light of the FIDIC 1999 red book.  

1. Do nothing.

With every contractual breach, the party harmed needs to assess the circumstances and decide the extent that such breach will be tolerated. Rights under the contract have to be weighed up by the cost of:

(a) taking action to enforce those rights (both time and cost of such endeavour); and

(b) the potential long-term commercial impacts such action may have between the parties.

A contractor trying to secure future contracts with a large employer with a pipeline of potential future work will obviously tolerate tougher conditions. As such, employers can exploit this at times, in order to delay payments, though they ultimately bear the price for doing so if contractors allow for this in their pricing.

Lawyers advising contractors always need to acknowledge the commercial impacts of their advice. At a minimum, a lawyer should recognise that whilst such rights might exist, enforcing them may not be in their client’s immediate best interest. It is important to appreciate that other commercial factors may be at play when a client chooses to ignore such advice.  

That said, whilst action to suspend or terminate (see below) might not genuinely be within the contractor’s mindset, the contractor should take the necessary steps to protect their position in this scenario, so as to not lose such rights that may be needed later on.

2. Claims for Interest

Clause 14.8 of the FIDIC 1999 suite is titled “Delayed Payment” and provides that the contractor is entitled to interest on late payments. The rate of such interest can be agreed by the parties, however in the absence of such agreement being recorded in the contract, the applicable rate is 3% above the annual discount rate of the central bank of the relevant country, compounded monthly.

Such sums can be claimed immediately by the contractor, and would subsequently form a line on all the subsequent interim payment certificates submitted during the course of the contract, until such amounts are paid. 

Of course, this assumes that the standard clause has not been deleted.  In the region, clause 14.8 (perhaps along with clause 2.4 which will be noted below) is one of the most commonly deleted clauses of the FIDIC general conditions, viewed as not beneficial to the employer.

Is deletion the best approach for employers?  In principle, an agreement to pay interest in the event of such breach is a form of liquidated damages and may cap the employer’s potential liability for late payment. Interest on overdue payments may be substantially less than the actual damage caused by the breach. This is particularly the case where the lack of funds causes delays or more expensive bridging finance arrangements.  

Contractors will find that employers will usually defer the obligation to pay interest on overdue payments voluntarily. As a result, the claim for such funds is often used as a bargaining chip by the parties during the final account negotiations. That doesn’t discount the fact that the entitlement is real, can often be proven quite easily, and will therefore be enforced at arbitration.

Contrast this with the position in the United Kingdom where the Late Payment of Commercial Debts (Interest) Act 1998 (as amended) allows a payee to claim reasonable costs (potentially more than you may first expect) of recovering a debt if the contract excludes the statutory interest rate and fixed compensation but fails to provide for an alternative “substantial remedy” for late payment. 

3. Suspension

Pursuant to clause 16.1, a contractor may suspend the works in the event that payment is not certified or made on time. The only requirement is a 21-day notice period, after such certification or payment has become due.

Clause 16.1 permits the contractor to completely suspend the works or to reduce the rate of its work. Furthermore, where the suspension comes into effect, the contractor is entitled to recover its reasonable costs and profit, along with an extension of time. 

A mistake often made by contractors is that steps to reduce the rate of its work are taken informally, perhaps as an act of protest (or out of necessity due to an inability to pay for materials, staff and/or sub-contractors). Whilst reams of correspondence may note the issue of non-payment, often no notice pursuant to clause 16.1 has been properly issued. Taking this informal approach will significantly complicate matters for the contractor.

Without issuing a notice pursuant to clause 16.1 to suspend the whole or part of the works, or to reduce the rate of the works, the delays on site may be viewed as the contractor’s fault. In the absence of such notice, the employer’s solicitor and experts can point to the insufficient labour on site, the delays in the delivery of materials and/or the delayed performance of the sub-contract works, to argue that the delays are the contractor’s responsibility. Such arguments can be very convincing to an arbitrator who would expect only to see the works slowdown in this way, after a notice pursuant to clause 16.1 has been served.

When a notice pursuant to clause 16.1 has been duly served, with clear guidelines available to the employer on how to avoid such action and clear consequences if that is not done, the contractor can suspend or reduce the rate of work, with a contractual right to recover costs and reasonable profit!

For this reason, clause 16.1 is a very powerful tool and, with a 21-day warning period, is not an unreasonable demand.

Issuing such notice also does not prejudice the contractor’s rights to financing charges pursuant to clause 14.8, nor the right to proceed with issuing a termination notice pursuant to clause 16.2.

Clause 16.1 is aligned with the United Kingdom’s aforementioned legislation regulating cash flow in the construction industry; similarly empowering the payee to suspend the whole or part of the works / services albeit on just 7 days’ prior notice, with the right to claim the reasonable cost of suspending. 

4. Termination

Clause 16.2 of the FIDIC suite of contracts sets out the right of the contractor to terminate the contract.

Under clauses 16.2(b) and (c), the contractor can issue a notice, giving the employer 14 days to remedy the breach:

• where payment has not been certified within 56 days, or
• the contractor has not been paid within 42 days of the due date for payment under the contract.

If the employer does not pay what is owed, the contractor can terminate the contract.

Contractors beware!

• FIDIC is drafted for international use. As such, it does not take account of some of the particular requirements of the regional civil codes for terminating a contract. Without particular conditions permitting the parties to terminate without court approval, termination by such notice may be of no lawful effect.
• The civil code gives judges absolute discretion to approve the termination, or defer the employer’s obligations in order to keep the contract on foot.
• Whilst clause 16.2 does not require a contractor to have suspended the works first, it is advisable that this is the approach taken. Rather than threatening termination out of the blue in 14 days if payment is not made, an escalation of the consequences of non-payment is advisable.

This enables the contractor to show the court that it has acted reasonably, giving the employer sufficient time to remedy the situation. It puts a more convincing case to the court to proceed with effecting the termination at the contractor’s request.

Top tips

As is noted above, finance charges often don’t feature as an effective tool to encourage or force payment on time.  They can become substantial when sums are not paid for years. Proper records should be kept, and if the right to such payments exist, they are best claimed contemporaneously.

Beware of getting it wrong

The more powerful rights under the contract, such as reducing the rate of the works, suspending the works and/or terminating the contract are all measures that need to be taken with the greatest level of care.

Without properly observing the requirements of the contract and the applicable law, the contractor is exposed to very serious risks.  A strong claim for costs and damages, being turned into a claim for delays and/or unlawful termination, is a nightmare situation for a contractor, and a very real risk where the contract and the law is not adhered to.

Legal advice should be obtained before any such action is taken to suspend, and/or terminate a contract for non-payment.

[1] For example, the Building and Construction Industry Security of Payment Act 2002 (Vic),  with similar legislation in other states.
[2] Housing Grants, Construction and Regeneration Act 1996 (as amended) and the Late Payment of Commercial Debts (Interest) Act 1998 (as amended).