It is common in the construction industry where payment for works done flows from the employer to the main contractor and then to the sub-contractor. Because of this typical flow, a subcontractor’s contract with the main contractor may have a conditional payment clause, which is also known as “paid-when-paid” clause or a “back-to-back payment” clause. In such clauses, the main contractor states they will only pay the sub-contractor once they get the payment from the employer. If the main contractor doesn’t get paid, neither will the sub-contractor, even if works were completed.
For construction contracts, these conditional payment clauses are considered unlawful under section 35 of the Construction Industry Payment and Adjudication Act 2012 (“CIPAA 2012”). This prohibition only applies to construction contracts made after the coming into force of the CIPAA 2012, i.e. 15 April 2014.
What is a “conditional payment clause” under CIPAA 2012?
CIPAA 2012 specifically refers to these two conditional payment clauses as being unlawful:
- Clauses where the obligation of one party to make payment is conditional upon that party having received payment from a third party; or
- Clauses where the obligation of one party to make payment is conditional upon the availability of funds or drawdown of financing facilities of that party.
However, case laws have provided that since section 35(1) of the CIPAA 2012 uses the phrase “any conditional payment provision in a construction contract in relation to payment under the construction contract is void”, it is therefore the intention of Parliament that any and all conditional payment clauses are void under Section 35 of the CIPAA 2012.
For example, courts have held that clause 25.4(d) of the PAM Contract 2006 is a conditional payment clause and therefore void, because if the contract is terminated, the said clause relieves the employer from paying the contractor until the final accounts are concluded and the works are completed by the contractor.
This also extends to provision governing retention sum where if the release of retention sum from the main contractor to the sub-contractor is contingent upon the release of retention sum from the employer to the main contractor, then such provision is held to be void under section 35 of the CIPAA 2012.
Nevertheless, a conditional payment clause may not be voided if, for example, it promotes corporate governance and efficiency in contracts management where contractor must show proof to the employer that he has paid his sub-contractors before the employer pays the contractor. Such is the discretion accorded to the courts in determining the enforceability of conditional payment clauses.
Can you contract out of the CIPAA 2012?
The High Court in BM City Realty & Construction Sdn Bhd v Merger Insight (M) Sdn Bhd and another case determined that parties cannot contract out of the Act because section 35(1) clearly uses the terms “any conditional payment provision” and it would be against the purpose of the CIPAA 2012 if parties can just thwart the CIPAA 2012 by insisting to rely on the conditional payment clauses in their contracts.
Does section 35 only apply to adjudication proceedings under the CIPAA 2012?
There are 2 school of thoughts here as seen in 2 High Court decisions.
In Bond M & E (KL) Sdn Bhd v Isyoda (M) Sdn Bhd (Brampton Holdings Sdn Bhd, third party), the learned judge took the view that section 35 only applies in adjudication proceedings under the CIPAA 2012 because if Parliament wanted section 35 to be applied outside of adjudication proceedings, it would have amended the Contracts Act 1950 and not just restrict it under the CIPAA 2012.
On the other hand, in Khairi Consult Sdn Bhd v GJ Runding Sdn Bhd, the learned judge took a more expansive approach by holding that Section 35 applies in court proceedings, provided that contract is a construction contract or construction consultancy contract as defined under CIPAA .
Given how the courts can widely interpret provisions of the CIPAA 2012 to reach beyond the realm of the adjudication proceedings, it would be prudent for parties to avoid having any conditional payment clauses in their construction contracts – or at least be aware of the possibility that such clauses may be void and unenforceable when it comes down to the wire.
***
This article was written by Sean Ferdinand Ng (Associate) from Donovan & Ho’s dispute resolution practice.
Donovan & Ho is a law firm in Malaysia. Our dispute resolution provides advice and legal representation in the civil and industrial courts. We also represent clients in both domestic and international arbitration, as well as other forms of alternative dispute resolution. Our experienced lawyers are also able to assist in commercial and civil disputes (such as debt recovery, shareholders’ or directors’ disputes, breach of contract and claims for injunctive relief), constructive disputes (arbitration and/or adjudication proceedings, disputes relating to delays, liquidated damages, defects and rectification work) and employment disputes (unfair dismissal claims, judicial review proceedings, and employment-related civil claims). Have a question? Please contact us.
