In Sydenhams v CHG, the TCC held that an employer may be able to pay a subcontractor directly for amounts owing to it in the event of the main contractor’s insolvency by entering into a direct-payment agreement with the sub-contractor prior to the insolvency. CHG employed a main contractor to design and construct a hotel. Part of the design was subcontracted to Sydenhams. The main contractor went into administration and Sydenhams successfully sued CHG under the direct-payment agreement.
An employer may wish to make direct payments to a sub-contractor to avoid the risk that the subcontractor may:
- suspend its works for non-payment by the main contractor; or
- be unable to continue its works due to financial difficulties resulting from the main contractor’s insolvency.
Direct-payment agreements are usually considered objectionable on grounds of public policy because they contravene the principle of "pari passu" in insolvency, i.e. that all creditors of the same class rank equally. By receiving a direct payment of the full amount owed to it, the subcontractor avoids having to wait in line with all the other creditors for payment of a fraction of the amount owing. In Sydenhams the Court distinguished between direct-payment agreements made before an insolvency, and those made after insolvency had occurred. The Court held that direct-payment agreements made before an insolvency would not be objectionable.
The case may increase interest from employers and subcontractors in using direct-payment agreements where doubts exist over the contractor's financial position. A main contractor’s other creditors, on the other hand, may wish to explore ways to fetter the employer’s or sub-contractors' ability to enter into such arrangements.
It is recommended that any direct-payment agreement provides that any direct payments made to the sub-contractor will be deducted from amounts owed by the employer to the main contractor. The main contractor should therefore be a party to the direct-payment agreement, which should be expressed to take priority over both the main contract and the sub-contract.
Reference: Sydenhams (Timber Engineering) Limited v CHG Holdings Limited [2007] EWHC 1129 (TCC).
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The original publication date for this article was 01/06/2007.