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CIArb Features

Can't Pay, Won't Pay - Does Failure to Pay Give Rise to the Right of Termination?

7 June 2017 Features
By Stuart Thwaites, Legal Director, Wright Hassall LLP

Cartoon graphic showing a male figure with empty pockets

Failure to pay on time, and even failure to pay at all, is unfortunately a common feature of the construction industry.  A question that often arises is whether a party that has not been paid on time can terminate the contract due to the failure to make payment.

The answer to this question is important. If the party is not able, legally, to terminate the contract due to non-payment, then termination would be a repudiatory breach of contract. That is, a breach of contract so serious that the other party would be able to accept it, thereby bringing its further obligations to an end, and be entitled to claim damages arising from the wrongful termination.

The right to terminate can arise in two ways; under an express term of the contract, or at common law.

In the absence of an express contractual condition to the contrary, a single failure to pay on time does not give rise to a right to terminate.  To give rise to such a right, there must be a breach of the contract which is so serious that it goes to the root of the contract, known as a “repudiatory” breach. Proving this is in relation to payment is not an easy hurdle to overcome. 

The general approach of the courts is that terms as to payment do not go to the heart or root of the contract (a view which is no doubt not shared by those waiting to get paid!). So breach of a payment term gives right to a claim in damages (for the unpaid money), but not normally the right to terminate. 

However some guidance, and potential hope, for those suffering from non-payment was given by the Court of Appeal late last year in the case of Grand China Logistics Holding (Group) Co Limited v Spa Shipping AS (Rev 1) [2016] EWCA Civ 982.  Although that was not a construction case, the principles in question are highly relevant to the construction sector.

Two clear issues arise from this judgment.

The first issue is that if you want time of payment to be so important that if it is breached it gives you the right to terminate, then it is best to draft the contract so that is an express term. Otherwise the courts are likely to find that a missed payment does not give rise to the right to terminate.

The second issue is perhaps the more usual scenario where there has been a series of failures to pay or pay on time, and the question arises as to whether, and if so when, the party can terminate as a result.  How many missed payments must it endure before it can terminate, whilst in the meantime incurring ongoing costs? Two missed payments, three, four…?

There is no clear cut guidance from the courts on this issue.  But in the Grand China case, the Court of Appeal found that as a result of the extended period over which the paying party failed to pay on time, and importantly the likelihood that it would not in the future be in a position to make payment on time, this did give rise to the right to terminate. 

Unfortunately it is not possible to use this judgment as authority for the proposition that if “x” number of payments are late, then that gives rise to the right of termination.  Instead, each case must be dealt with on its own facts. But the case is helpful in confirming that non-payment can give rise to the right to terminate.

As noted above, the risk inherent in going down the termination route can be avoided (or at least minimised) by appropriate drafting of the contract terms in relation to payment. But that is not always possible. It is often the case that the paying party is in the dominant position when negotiating contract terms, and such a clause would not be in its favour.

Where there is no such clause, very careful consideration must be given to whether to terminate due to non-payment. For those working under appropriate construction contracts, the Housing Grants, Construction and Regeneration Act 1996 (as amended) gives the statutory right to suspend performance of all or part of one’s obligations under the contract.

This avoids the risk of the termination approach, providing the correct procedure is followed. The caveat to this is that if payment is found not to have been owed, then that suspension would likely be unlawful and itself a repudiatory breach of contract.