6 July 2021 by , and Dispute Resolution Alert

Employers’ direct payments to subcontractors in times of financial distress: A penniless pursuit

Subcontracting portions of a construction project is a well-established practice in South Africa and is an important and effective means of involving small-, medium- and micro-sized enterprises (SMMEs) in the construction industry. Subcontracting is generally required in complex construction projects where the main contractor needs to acquire specialist capabilities to perform certain portions of the work. In other contracts, there may be a need to subcontract portions of the work to increase the contracting capacity of the main contractor or to satisfy the client’s expectations relating to the use of local SMMEs or to meet Broad-Based Black Economic Empowerment requirements.

In recent years, several large South African construction companies have buckled under economic distress, often resulting in protracted business rescue proceedings and terminations of the main contracts by employers. In the case of ongoing projects, this would likely result in direct engagement between the employer and SMMEs to achieve continuity of the project prior to the appointment of a new contractor. In such circumstances, it is not uncommon for a subcontractor to seek payment directly from the employer for work done but not paid for by the main contractor.

Does the subcontractor have recourse against the employer?

Privity of contract is a well-established legal principal in South African law that means only the parties who voluntarily enter into an agreement are bound and have obligations and rights under that agreement. The subcontractor enters into an agreement with the main contractor to perform certain works on the project. The main contract for the works is separate from that of the subcontractor agreement and there is no direct contractual relationship between the employer and the subcontractor. This means the employer is under no legal obligation to the subcontractor and the subcontractor has no contractually enforceable rights against the employer, even for payment for work completed under the contract and unpaid by the main contractor.

The Supreme Court of Appeal (SCA) case of Concrete Construction (Pty) Ltd v Keidan & Co (Pty) Ltd 1955 (4) SA 315 (A), concerned an employer that intended to erect a building in Johannesburg costing £127,500. A subcontractor had secured a contract to supply and bend steel for reinforcement for the building following negotiations with the architect (acting as an agent of the employer), the main contractor and the building owner. The question before the SCA was with whom did the subcontractor contract.

The SCA, contrary to the court of first instance, found that there was no room for an inference by the subcontractor that it was contracting directly with the employer. The SCA ruling stated that the cost of the subcontractor’s deliveries appearing in the main contractor’s monthly certificates would make it clear to him that he was a subcontractor.

In our experience, to achieve continuity of a project and avoid delays in construction, situations can arise whereby an employer contemplates making direct payment to subcontractor(s). Generally, the employer is neither obliged nor entitled to remedy the failure of the main contractor to make payment to the subcontractor unless the main contract expressly permits it to do so or cessions in respect of direct payment to the subcontractors are entered into between the employer and the main contractor. However, the legal challenge arises when the employer, in the absence of an agreement with the main contractor, makes direct payment to the subcontractor and subsequently seeks to recover such payments from the main contractor.

The only exception, which is outlined below, is where the contract expressly provides for direct payment. Such a provision would generally include a right for the employer’s agent to request proof that amounts included in any previous interim payment certificate in respect of work, materials, or services supplied by any subcontractor have been paid. If the contractor is unable to provide such proof, the employer may pay the amount in question directly to the subcontractor and deduct that amount from any future payment due to the main contractor under the contract.

The JBCC Principal Building Agreement (JBCC PBA) (Edition 6.2, 2018) is the most commonly used standard form construction contract in South Africa. The JBCC PBA provides a mechanism for an employer to make direct payment to a subcontractor where the contractor has defaulted in terms of its payment obligations. Clauses 14.5 and 15.5, which refer to nominated and selected subcontractors respectively, allow for the employer to instruct the principal agent to certify direct payment to the subcontractor and recover such amount from the main contractor in instances where the contractor fails to provide proof of payment to the subcontractor within five working days of a notice by the principal agent. Clause 27.2.7 further entitles the employer to recover expenses or loss incurred, or to be incurred, resulting from amounts paid directly to subcontractors on default by the contractor.

In terms of these provisions, the JBCC PBA has a mechanism to safeguard the employer in instances where direct payments are made to the subcontractor, by creating an avenue for the employer to recover this money from the contractor.

In conclusion, employers are under no contractual obligation to make direct payment to subcontractors since the contractual relationship exists between the main contractor and the subcontractor. In circumstances where the employer elects to make direct payment to the subcontractors for various proactive and practical reasons, without agreement with the main contractor, attempts at recovery of those monies from the main contractor is likely to be a penniless pursuit. For this reason, the inclusion of a direct payment clause does provide a potential safeguard in instances where employers make direct payment to subcontractors.

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