Back-to-back agreements, also known as parallel contracts, are a common practice in the business world. Most of the real estate companies and Tech companies enter into back to back agreements with the sub-contractors. These agreements involve two separate contracts, one agreement between a principal and a main contractor and other agreement between the main contractor and a sub contractor for performing a part of the job for principal on behalf of the main contractor. While they serve various purposes, such as risk mitigation, financing, and supply chain management, the legality of such back-to-back agreements specially where the agreement contains clause of “PAY IF PAID” AND “PAY WHEN PAID” is contained has been debated and scrutinized in legal circles. This article aims to explore the concept of “PAY IF PAID” AND “PAY WHEN PAID” CLAUSE IN back-to-back agreements and examine their legality, with reference to relevant case laws.
UNDERSTANDING BACK-TO-BACK AGREEMENTSBack-to-back agreements involve a chain of contracts, where the terms and conditions of main contract are closely tied to the sub contracts entered by main contractor with sub-contractors. Although back to back agreement are essential for development of the society but these agreement involve certain risks and issues which need to be looked after by the government so that general public or small contracts will not suffer losses. One of the major issued faced by subcontractors are with clause “Pay if Paid” and “Pay when Paid”.
The main contractor generally uses this term to delay the payment or to not to make the payment on the ground that they have not been paid by principal. Different countries have taken different view on the clause/term wherein it is mentioned “Pay if Paid” &/or “Pay when Paid” clauses in the agreement. Some of the countries have declared the term “Pay if Paid” & “Pay when Paid” clauses as against Public Policy and some have taken a view that it can be used to delay the payment for reasonable period, but the contractor is entitled for the payment for the work performed by them.
The different view points taken by different countries are as follows:-
United States of America (USA)
a. West Fair Electronic Contractors Vs. Aetna Casualty & Surety Company. (United States court of Appeal, Second Circuit). The New York Court of Appeals reasoned that a “pay-when-paid” provision which operates as a true condition precedent, rather than as a mere schedule for the
disbursement of payments, requires a subcontractor to await payment until the general contractor has been paid by the owner. Because the sub contractor’s right to receive payment is contingent upon this uncertain event, and because a sub contractor cannot enforce a mechanic’s lien until the debt becomes due and payable, see, e.g., In re Schiavone Counstr. Co.,181 A.D.2nd 580, 581 N.Y .s.2d 322(1st Dep’t 1992), the pay-when-paid condition precedent operates to waive Coppola’s rights to enforce its mechanic’s liens. The New York Court of Appeal concluded that this result conflicts with New York’s Lien law, which words any agreement to waive rights granted under the Lien Law. Thus, the court held that a pay-when paid-provision which transfers the risk of the owner‘s default from a general contractor to a sub contractor violates the public policy of New York as set forth Lien and Laws.
United Kingdom
As per Section 113(1) of Housing Grants, Construction and Regeneration Act 1996, provides that any term making payment under the contract conditional on the payer receiving payment from a third person is ineffective.
In addition, section 110 of the Construction Act 1996 provides that every construction contract is required to contain an “adequate mechanism” for determining what and when payments are due. In respect of conditional payment terms, the parties are free to fix the time of payment.
India
In a matter titled as National Project construction Vs. Harvinder Singh Hon’ble Division bench of Delhi High Court held that these clauses cannot be interpreted in such a way, as to disentitle the respondent to payment for
work rendered by it, as instructed by the appellant and in accordance with the agreement between the appellant and the respondent, merely because the appellant did not receive payment from CONCOR. Any such interpretation would be grossly unjust, inequitable and against public policy, as it would amount to holding that the services rendered, and work done, by the respondent for the appellant, in terms of a bilateral contract duly drawn
up between them, would have to be treated as rendered gratis, without any payment therefor. Such an interpretation, needless to say, cannot be adopted or accepted, by any court of law.
Singapore
The Singapore Government had passed a bill on 1st April 2005 whereby enforcing Building and construction Industry Security of Payment SOP Act 2005 with an aim to improve cash flow and protect the interest of the subcontractor. It also provides a fast and low cost adjudication mechanism to
resolve payment disputes.
The main highlights of the SOP Act are :- a. Ensuring parties carrying out work or supplying goods or services for all construction projects in Singapore have a right to payment. b. Barring any “pay when paid” and “Pay if Paid” in any contract. c. Providing defaults “statutory payments period” if there are no contractual provision on terms of payment.
CONCLUSION
Thus looking at various judgments and ordinance passed by the different countries we can easily conclude that “Pay if Paid” & “Pay when Paid” clauses in Back to Back agreement are illegal and against the public policy, as it gives right to main contractor to sit on the payment of sub-contractor
and further the same can be used to delay the payment but it does not mean that if the contractor is not paid he will not pay the sub-contractor.
Varun Ahuja,
Partner, Ahuja Law Ofices, New Delhi