In this post-pandemic landscape with ever-present inflation issues, we are seeing an increasing number of deteriorating commercial relationships – largely due to payment issues in the supply chain. Often, a payment dispute will arise at sub-contract level which results in sub-contractors threatening to halt work until they receive payment. In situations like this, Employers may consider making direct payments to sub-contractors to protect the project timeline. Whilst the commercial benefit of such direct payments is obvious, this situation can lead to problems in the Employer – Main Contractor relationship down the line. A 2019 Commercial Court decision exemplified these potential problems. We discuss the case below and then explain what Quigg Golden can do for you.
Nobiskrug GmbH v Valla Yachts Ltd
Valla Yachts (the Employer) engaged Nobiskrug (the Contractor) to build a superyacht. During the course of the contract specialist sub-contractors brought claims against the Contractor, which the Contractor denied. The sub-contractors subsequently threatened to cease their work on the superyacht until they were paid. Unsurprisingly, Valla Yachts wished to avoid this disruption to the project and made numerous direct payments to the sub-contractors during the course of the project. However, the main contract did not contain provisions that governed direct payments between the Employer and the sub-contractors, but Valla Yachts did expressly reserve the rights to recover the payments from the Contractor.
i) Arbitration
Valla Yachts commenced arbitration proceedings against Nobiskrug to recover the payments made to the sub-contractors. Valla Yachts argued that Nobiskrug was in breach of various project management obligations contained in the main contract, including duties to investigate and manage sub-contractor claims. Whilst the arbitration tribunal accepted Valla Yachts’ line of argument regarding failed project management requirements on the part of the Contractor, it was unclear as to whether Valla Yachts could recover the sub-contractor payments without proof of Nobiskrug being contractually obliged to make those payments, and Valla Yachts offered no evidence of such an obligation. However, the arbitration award mandated that Nobiskrug should reimburse some of the payments made, without giving clear reasons.
ii) Commercial Court
Nobiskrug appealed to the Commercial Court, claiming that the Tribunal had made an error in law on its findings. They claimed that no legal liability in respect of the payments was found on the evidence. Whilst the Contractor accepted that there had been a reservation of rights by Valla Yachts to recover the payments, they argued that the reservation of rights did not create a cause of action against Nobiskrug for the recovery of these payments. Mr Justice Cranston agreed with this line of reasoning. Valla Yachts could not recover payments which it made on a purely voluntary basis without being able to evidence that Nobiskrug was legally obliged to make them. These rights would only exist if included in the contract.
However, the Court did agree that Nobiskrug exercised poor management. The issue for Valla Yachts with this line of argument however, was that there was no finding that the Contractor’s failures directly caused additional costs. The Tribunal had not found it necessary to find on this issue initially, but the Commercial Court referred the issue back to the Tribunal for further consideration and assessment of this complex issue.
So, what does this mean?
The Valla Yachts case has demonstrated that directly paying sub-contractors is not a good idea. Employers are not entitled or obliged to directly pay sub-contractors and so they should avoid voluntarily paying sub-contractor costs. No direct contractual relationship exists, unless a collateral warranty is in place. The case above demonstrates how paying these amounts can lead to disputes between the Employer and Contractor which are disadvantageous for the Employer. Employers should be aware that a simple reservation of rights is insufficient to recover payments for costs paid directly to sub-contractors. What needs to be present is an express and clear contractual term in the main contract that governs direct payments, or, a new contractual agreement between the Employer and main Contractor on the issue.
For more information about paying sub-contractors directly, click here for an earlier article on this issue.
What can Quigg Golden do for you?
If you are an Employer in a situation like Valla Yachts where there is a supply chain disruption owing to payment issues by the main Contractor, the best next step you can take is seeking legal advice.
Quigg Golden offers a broad range of legal services in the construction and procurement sector. Our expert team can guide clients through complex construction contracts towards successful project delivery, avoiding disputes and challenges. In the event that you are faced with a dispute, we are experts in managing the dispute resolution process and guiding our clients towards commercially focused outcomes.
If you have any questions on the topic of paying the sub-contractor directly, or any other matter, please do not hesitate to contact us.
Published 20 February 2024
