Killer clauses: are they lurking in your contract?

The British sense of fair play is famous throughout the world. We love to queue, we give way to oncoming traffic and we stand up for those that need seats on public transport. But it’s oh so different when it comes to contracts, says Peter Vinden FCIOB.

We are rightfully proud of our reputation for allowing free speech and, within the criminal legal framework crafted by the state, we enjoy a freedom of choice to do what we want (as long as we comply with the law and third persons are not harmed by our actions).

These principles extend into contract law and, as a starting point, contracting parties are free to agree to whatever they wish, subject to a few safeguards that politicians have sought to introduce through statute to provide a degree of protection for the commercially naive. These include the right to interest on late payments, the right to suspend work due to non-payment and the right to have construction disputes dealt with by adjudication.

Parliament has introduced these statutory rights into our common law to prevent weak and vulnerable entities being exploited by the bigger boys in the construction playground.

With the freedom to contract to any terms that they see fit, there are two clauses that are now being regularly introduced into subcontracts, which, if you are a subcontractor, could be extremely detrimental to your business, and possibly a corporate killer.

The first of these clauses is what can be described as a ‘termination for convenience’ clause. Under this provision, a main contractor has the right to terminate the employment of a subcontractor as it sees fit, when it sees fit – even if there has been no default or failure on the part of the subcontractor. What is perhaps most shocking about this clause is that the subcontractor is not automatically entitled to recover its lost profit or even lost overheads on the element of the work that has yet to be undertaken unless the contract specifically allows these losses to be recovered.

The second killer clause, which is also regularly appearing in subcontracts, is a ‘no payment on insolvency’ clause. Under this provision, the subcontractor agrees to forfeit payment for all work done and not paid for if it enters administration, a company voluntary arrangement or goes into liquidation. This clause can be viewed with much cynicism as it could tempt main contractors to cash-starve the subcontractor, triggering subsequent insolvency. Of course, a party in breach of contract is not entitled to take advantage of its own breach and it might be possible to have such a clause declared unenforceable if you can prove that the contractor has deliberately underpaid a subcontractor, but who will fund the insolvency practitioner’s attempts to prove this in court or arbitration to defeat the effect of the clause?

Those who believed that the courts should imply a duty to act in good faith in construction contracts to assist a subcontractor being abused by a main contractor in either of the above situations will be disappointed. The decision of the Court in TSG Building Services v South Anglia Housing Ltd makes it crystal clear that if an obvious worded express provision in the contract is absent, no implied duty to act fairly exists.

Mr Justice Akenhead declared: “Although this has been an extremely well researched and argued case by both Counsel, I have no doubt that South Anglia are entitled to the declaration sought by it that having exercised its right to serve notice to terminate the Contract under Clause 13.3, TSG has no entitlement (whether as damages for breach of contract, or as a sum due under the contract) to receive monies and/or compensation in respect of overheads and profit which it would have recovered over the balance of the Term of the Contract following termination had the Contract not been terminated.”

Perhaps the court did not intend to give a green light to the sort of corporate abuse that can be the effect of such a clause, but the judgement in the TSG case does not seem to be consistent with the British concept of fair play.

Tedious as it may be, unless you want to see your company disappear down a black hole, it is prudent to check all contracts and ensure an explicit understanding of each clause and the impacts should they be exercised. “Termination for convenience” and “no payment on insolvency” clauses are just some of the examples that could lead to the untimely demise of your life’s work.

Peter Vinden FCIOB is managing director of The Vinden Partnership and can be contacted at [email protected]. More articles on construction, corporate protection and dispute resolution, are available at www.vinden.co.uk