Paying subcontractors directly: stormy waters for employers

United Kingdom

A recent Commercial Court decision has considered the ability of an employer to recover payments made directly to subcontractors from its main contractor. The decision raises interesting questions as to the extent to which an employer must prove liability as between the main contractor and subcontractor in order to succeed in recovering such payments. The decision will be of considerable interest to employers faced with deteriorating commercial relationships at subcontract level and who are considering proactive steps by way of direct payment to avoid potential disruption through subcontractor suspension or termination scenarios.

Introduction

Employers can sometimes find themselves wishing to make direct payments to subcontractors engaged by their main contractor. This might be the case if a payment dispute arises at subcontract level or if the main contractor suffers cashflow difficulties. Subcontractors may threaten to terminate or suspend work in such circumstances and the employer may feel that direct payments are necessary to keep the project afloat.

Although the commercial rationale for such payments is clear, they pose a number of legal issues. The employer will usually wish to recover such payments from the main contractor and may initially seek to set them off against amounts due under the main contract. However, the main contractor is likely to put the employer to proof as to those set-offs and the employer will usually know very little about any disputed claims at subcontract level. It may therefore struggle to prove that the main contractor was liable to pay such sums to the subcontractor. The employer might consider taking an assignment of the subcontractor’s claims and requiring it to lend such assistance as may be required in the proving of those claims against the main contractor. However, the subcontractor may be unwilling to provide such assistance or may not do so in a sufficiently timely or fulsome way.

If the employer’s attempt at reimbursement from the main contractor fails, the employer may wish to reclaim the sums paid back from the subcontractor. The subcontractor may resist such attempts and/or may be unable to repay such sums in the absence of any security taken by the employer.

Cases dealing with these issues are rare, however, a recent arbitration appeal heard by the Commercial Court provides a good illustration of the legal difficulties faced by employers in such circumstances and potential routes to overcome them.

Nobiskrug GmbH v Valla Yachts Ltd

Valla Yachts engaged Nobiskrug, a German shipyard, to build a superyacht – one of the largest private sailing vessels in the world. The contract between the parties did not contain provisions governing direct payments, but during the course of the project, Valla Yachts made a number of payments to certain specialist subcontractors who had brought claims against Nobiskrug.

Nobiskrug contested most of the claims and the subcontractors threatened to cease work. Valla Yachts wished to avoid this result, and the considerable disruption it would entail, and expressly reserved its right to recover the payments from Nobiskrug.

Valla Yachts subsequently commenced arbitration proceedings against Nobiskrug to recover the payments. Among other things, it claimed that Nobiskrug had breached certain co-ordination and project management obligations contained in the main contract, which required Nobiskrug to manage and investigate claims made against it by the specialist subcontractors.

The arbitral tribunal emphasised the reservation of rights made by Valla Yachts, but its award was unclear as to whether the payments could be recovered without proving that Nobiskrug was obliged to make those payments to the subcontractors. Valla Yachts had not been able to submit evidence to the tribunal proving such an obligation.

The tribunal nevertheless accepted Valla Yachts’ case as to project management failings. The tribunal held that Nobiskrug had effectively abandoned its project management responsibilities. That had caused the subcontractor claims to escalate and had placed Valla Yachts in an “extremely difficult position”, given that the subcontractors in question were critical for the completion of the works. However, Valla Yachts would only be entitled to damages for such breaches if they "were an effective cause” of the additional costs claimed by the subcontractors. The tribunal did not go on to determine that issue, but nonetheless ordered Nobiskrug to reimburse certain of the payments made by Valla Yachts on grounds which were not clear from the award.

Appeal to the Commercial Court

Nobiskrug appealed the tribunal’s decision, asserting that the tribunal had made an error in finding that it should reimburse Valla Yachts when there had been no finding that it was under a legal liability to the subcontractors in respect of the payments. Nobiskrug accepted there was a reservation of rights but argued that this did not create a right or a cause of action against Nobiskrug for the recovery of sums paid to the subcontractors. Nobiskrug’s position was that the payments made by Valla Yachts were voluntary and the reservation of rights simply meant that Valla Yachts had not waived its right to recover the monies by pursuing its counterclaims.

Valla Yachts argued that the tribunal’s award could be supported on restitutionary grounds, as follows:

  • The tribunal had found that Nobiskrug had abrogated its project management responsibilities and had failed (i) to investigate the claims advanced so that Valla Yachts was unable to form a proper assessment of whether the payments demanded were due and (ii) to manage their resolution effectively so as to minimize any disruption caused to the works.
  • These breaches had placed Valla Yachts in an extremely difficult position where it was compelled to make the payments if the yacht was to be completed.
  • Its action in making the payments was to the benefit of Nobiskrug in that it was discharging Nobiskrug's project management responsibilities, or at least mitigating the breach of those responsibilities. Payment allowed the project to continue and Nobiskrug to earn the contract price. Therefore, Nobiskrug was unjustly enriched and Valla Yachts had a valid restitutionary claim.

Somewhat inevitably, the Commercial Court remitted the matter to the tribunal for further consideration. The Court did not think the tribunal could be said to have ordered the reimbursement of payments made by Valla Yachts “simply on the basis that it made them subject to a reservation of rights”. On the other hand, it was unclear on what basis the tribunal had ordered reimbursement and Valla Yachts restitutionary analysis was “not spelt out completely on the face of the Award”. Of note, however, the Court considered that the restitutionary claim had “considerable force”.

Conclusions and implications

It will be unsurprising to most that a mere reservation of rights was insufficient to entitle the employer to the reimbursement of direct payments. Of much greater interest, however, is the Court’s encouragement of a restitutionary claim based on the contractor’s failure to adequately manage subcontractor claims. If successful, such an argument would appear to avoid the need for the employer to prove that (i) the contractor had a liability to the subcontractors in respect of the amounts paid by the employer; or (ii) the contractor’s project management failings had caused or contributed to the amounts claimed by the subcontractors. The ability to make such claims would be of considerable assistance to employers finding themselves in a similar position to Valla Yachts.

The restitutionary argument is not without difficulty, however. Such claims are usually unavailable where contractual remedies already exist. It might be said that the employer should be left to its usual remedy to sue the contractor for damages caused by a breach of any project management obligations. A restitutionary claim, if successful, may also work considerable injustice to the main contractor. Having reimbursed the employer for payments made directly to its subcontractors, it may find itself without any ability to recover those amounts. Even if it were to subsequently show that the subcontractors’ claims were invalid, it is difficult to immediately identify what cause of action would be available to it to claim for the reimbursement of the sums it had paid to the employer.

References:

Nobiskrug GmbH v Valla Yachts Ltd [2019] EWHC 1219 (Comm).