By Edwin Giesteira

I share some thoughts on the consequences of the termination of a principal building agreement by the employer due to contractor’s default. I share some thoughts on the consequences of the termination of a principal building agreement by the employer due to contractor’s default. Part 3 of 3.

There appears to be a degree of conflict between the provisions of clause 38.5.4 on the one hand which, by reference to clause 34.0, places the final account within the ambit of the normal relationship between contractor and subcontractor, and clauses 38.5.5 and 38.5.7 which provide for payment by the employer to the subcontractor. The following thoughts are submitted to deal with the provisions of these clauses:

  1. The challenge of excluding the contractor is that there may be matters as between the contractor and the subcontractor that need to be dealt with by the contractor and in which the employer does not wish to and should never become involved. The continuation of the construction and payment guarantees up to the issue and payment of the final payment advice would generally cover any adjustments that may occur after the last payment advice statement issued prior to termination.
  2. The principal building agreement at clause 36.0 Termination by employer – contractor’s default provides that the contractor is entitled only to nil interim payment certificates until after the final payment certificate is issued. This would mean that by reference to the provisions of clause 31, the subcontractor would similarly not be entitled to any payments until the issue of the final payment certificate and an employer wishing to retain a n/s subcontractor’s services to complete the work would find itself at a disadvantage by not being contractually entitled to make good at least the uncertified part of the unpaid balance due to the subcontractor, particularly where liquidation supervenes.
  3. PBA clause 38.0 Termination by contractor – employer’s default provides for ongoing interim payments to the contractor similarly to NSSA clause 38.0 and therefore there would be no problem with payments in the (unlikely) event the employer does pay. However, the subcontractor could be prejudiced by issues between the contractor and the employer that result in non-certification or non-payment to the contractor.
  4. Therefore, the n/s final account for work completed prior to termination should be processed through the contractor and in terms of all the provisions of and referred to in clause 34.0 with all its sub-clauses, which include inter alia sub-clause 34.7 providing for amounts recoverable by the employer in terms of a recovery statement. A subcontractor when dealing with an insolvent contractor will probably only be entitled to recover payments certified and paid by the employer prior to termination in terms of the distribution account from the insolvent estate. This may be a very good reason for the exercise of any liens or other defences and the removal from site of any unpaid goods.
  5. The subcontractor can and should immediately exercise a lien and/or reservation of ownership over unpaid materials and goods, even to the point of including identifiable and detachable and removable elements which have been placed/fixed but can be easily removed, in the lien.
  6. The difficulty of providing for defects or overpayments to the subcontractor before termination is a matter that could be adjusted if the subcontractor is appointed to complete the n/s works. However, when the subcontractor is not available to continue after termination or where the employer prefers to employ a new subcontractor, it could but should not create a challenge for the employer if it pays directly and then tries to deduct any sum for defective or overpaid work from the contractor’s final account, notwithstanding that the contractor remains the party that is liable to the employer for defects in any part of the works including any n/s works. A direct payment for unpaid materials and goods (and completed n/s work) should at the very least be very specific as to what is being paid for and the amount thereof as well as the specific terms on which it is made so that the possibility for a later vindicatory action by the employer against the subcontractor is at least possible on the basis of records.
  7. It is therefore submitted that aside from a reconciliation of the amount due to the subcontractor for materials and goods on site and payment of any outstanding balance directly to the subcontractor, the settlement of the amount due on the n/s final account would have to be through the office of the principal contractor and in terms of clause 34.0 which would, for those purposes, be deemed to survive the termination as suggested by the wording of clause 38.5.4.
  8. NSSA clause 34.5 very specifically provides that except for terminations in terms of clauses 36 (subcontractor’s default) and 39 (vis major), the issue of the final completion certificate is a pre-requisite for the issue of the final payment certificate. Therefore, whilst the subcontractor is entitled to interim payment of amounts for work and materials not certified by the date of termination, the subcontractor will not be entitled to a final payment advice before the final payment certificate is issued to the contractor. This potentially impinges the available security between the contractor and subcontractor.
  9. The principal agent should compile and issue a final account for the n/s works as completed at date of termination including materials and goods payable in terms of clause 38.5.5 and 38.5.7, reflecting the full amount due to the subcontractor and adjust for direct payments in terms of clause 38.5.5 and 38.5.7 by way of a recovery statement item. Sadly, the principal building agreement at clause 33.2.8, whilst providing for direct payments in terms of clauses 20.6 (failure to pay nominated subcontractors) and 21.6 (failure to pay selected subcontractors) does not include a specific provision for recovery of direct payments in terms of NSSA clause 38.5. The conclusion can be made that the direct payments resort under PBA clause 33.2.6 (… expense and loss … resulting from … the agreement being terminated [36.0]) thereby defining the need to make direct payment as a prejudice incurred by the employer as a result of terms stipulated for in the termination provisions of the subcontract which practically result in privity of contract between employer and subcontractor because the subcontractor acquires a direct entitlement to payment. This would probably be the preferable route when insolvency supervenes as the liquidator is only entitled to such funds as may become available for the completed project after deduction of all costs of bringing the works to completion.
  10. Any direct payment of certified amounts in terms of PBA clauses 20.6/21.6 based on certificates issued prior to termination but after insolvency has supervened would probably be capable of challenge by the liquidator and should be carefully considered. This does not preclude the subcontractor from adding them as an effective premium claimed by the subcontractor within its price for completion of the n/s works thereby effectively rendering it an expense and loss to the employer in terms of PBA clause 33.2.6.

Clause 38.5.5

‘The employer shall be liable to the subcontractor for the cost of materials and goods including those ordered before such termination where the subcontractor is bound to accept and make payment. The subcontractor shall deliver such materials and goods to the employer in good order’.

As already raised above, materials and goods on site can be the subject of a lien exercised by the subcontractor who can then demand payment (or a guarantee for payment) before relinquishing the lien and this matter has already been canvassed in preceding bullets. A subcontractor wishing to exercise any lien should issue notice thereof and mark all property over which the lien is to be exercised. Records of such marks should be kept for use in the event a party tries to remove them.

Materials and goods on site, including those ordered but not yet delivered but which the subcontractor cannot cancel (or which the employer does not want the subcontractor to cancel), must be handed over to the employer who is liable for taking delivery and paying the subcontractor for them. This means the subcontractor must ensure there is a signed proof of delivery for them from the employer or his designated agent – such designation must be in writing from the authorised signatory for the employer e.g. the principal agent. Where the employer refuses or fails to properly take delivery of goods, the subcontractor should submit the list of goods and declare its willingness to make delivery to the employer and then issue a notice that the employer is in breach of its contract and take necessary steps to protect its interests. This may include removal to safe storage.

Normally the undelivered orders in question are related to bespoke or special items not normally held in stock by the supplier but it could relate to stock items not prematurely ordered where the supplier insists on and is entitled to a cancellation amount (say a bulk order for copper piping at a reduced price for bulk). NSSA clause 31.6 limits the ability to place orders for goods prematurely and without justification and provides a very good reason why subcontractors should ensure that the placing of such orders should be covered by notice to the employer and contractor and their agreement thereto even where it is necessary as part of a price fixing agreement. The subcontractor has a common law obligation to mitigate damage and may have to communicate with the contractor and employer on preference for a termination fee rather than specific performance because, in the event of a termination fee on a bulk order such as the example above, the contractor would be the party having to pay the damages for the termination [NSSA clause 38.5.6] whilst the employer may have to pay an increased cost for the balance of the goods if the initial order is terminated and then reclaim them as part of the costs of completing the works.

The employer cannot forcibly or against the subcontractors will take over an order issued by the subcontractor – it would have to be by mutual agreement and interest. If the employer deals directly with the supplier and arranges for a termination of the subcontractor’s order and direct sale to the employer (inducement) there could be a case for wrongful interference by the employer or wrongful termination by the supplier but inevitably such actions are more often than not avoided due to practical and financial reasons and a subcontractor would normally make use of its dispute resolution provisions to recover any funds due to it as part of its contractual entitlement.

It is submitted that the value of materials and goods included in a paid interim certificate may be excluded from this provision although this is extremely arguable if the subcontractor has not been paid by the contractor (see Concor Holdings (Pty) Ltd v Potgieter (219/03), [2004] ZASCA (28 May 2004); Administrator General South West Africa v Trust Bank of Africa Ltd 1982 (1) SA 635 (SWA) judgments).

If uncontested by the subcontractor by the exercise of liens and reservation of ownership, the employer may lay claim to the materials and leave it to the subcontractor to prove a claim for materials and goods certified but not paid to the subcontractor, whatever the reason for such non-payment, but care would need to be exercised to not dispossess the subcontractor improperly and face a spoliation order. This is a double-edged sword because the employer would also be entitled to assert a claim against the alleged lien the subcontractor is trying to enforce if the subcontractor is acting unlawfully.

At worst, this clause is important in protecting the subcontractor from an insolvent contractor by providing an enforceable obligation by the employer to take delivery of and pay for uncertified materials (as distinct from making direct payment for materials certified and paid to the contractor but not paid by the contractor to the subcontractor). At best, it probably provides an opportunity for the employer to treat the payment for unpaid materials as part of its costs of completing the works.

Practically there may be problems in identifying what materials and goods have been paid or included in a certificate. This is normally dealt with by the use of the cumulative payment process used in construction payments.

The principal agent and the subcontractor must ensure that the list, the value and the direct payment are disclosed to the contractor and reflected in the final account issued to the contractor in terms of clause 38.5.4.
The question of payment is further dealt with in the discussion of the provisions of NSSA clause 38.5.7 at bullet 7 hereunder.

Clause 38.5.6

‘The contractor shall be liable to the subcontractor for damages resulting from such termination’
This provision may appear at first glance to be the statement of the obvious but the termination in terms of clause 38.3 is based only on the fact of the termination of the principal contract and therefore the subcontractor’s summary termination could raise questions of liability.
The contractor is the only party with whom the subcontractor had a contract and, if the principal contract has been improperly terminated by either the employer or the contractor, such damages will form part of the one’s damages claim against the other.
Broadly speaking, damages for breach of contract is a monetary sum which is calculated as the difference between the position the innocent party would have been in if the contract had been properly executed and the position that results from the breach. It will include the mark-up on work not executed, the costs incurred in this termination including costs of suspension and dealing with superfluous staff, plant, office overhead costs, special security, balance of contract works and 3rd party insurance costs, extension of warranties on installed equipment, etc. The reality is, however, that it is easier to try to incorporate such costs in the price charged to the employer to complete the n/s works if the opportunity arises and to avoid litigation.
A subcontractor who completes the subcontract works would have trouble claiming loss of profits on the n/s works excluded from the original n/s agreement but subsequently paid for in the subsequent subcontract and other similar theoretical losses.

Clause 38.5.7

‘The principal agent shall continue to certify the value of the n/s works executed by the subcontractor and the value of materials and goods for payment by the employer.’

NSSA clause 38.5.7 differs substantially from the similar provisions in the PBA and NSSA at clause 36.5.10.

PBA clause 36.5.10 provides:

‘The principal agent shall continue to issue interim payment certificates in a nil amount until the quantum of damages [36.5.8] has been determined and the final account [36.5.3] has been completed. The final payment certificate shall then be issued.’

NSSA clause 36.5.10 (termination by contractor of the n/s subcontract due to the subcontractor’s default) provides:

‘The principal agent shall continue to issue interim payment certificates in a nil amount until the issue of the final payment certificate.’

PBA clause 36.5.10 on further interim certification after termination is clear and peremptory – the contractor is not entitled to any further payments and might well not be entitled to payment of any unpaid interim payment certificates.

In NSSA clause 38.5.7, the principal agent is peremptorily required to certify the value of the n/s works and materials and goods for payment by the employer. A comparison of NSSA clauses 36.5.10 and 38.5.7 clearly indicates that the latter is intentionally differently drafted, presumably to deal with the case of an innocent subcontractor caught in the contractor’s or employer’s default which results in the collapse of the underpinning provisions of the principal building agreement. There is no mention of the interim and final payment certificate. The wording of NSSA clause 38.5.5 to the effect that materials and goods should be handed over to the employer who is liable to the subcontractor also support the direct liability of the employer for payments due after the termination.

The conclusion from the above differing wording indicates that the following situation therefore results:

Whatever has been certified for the n/s works through the principal building agreement prior to termination and has been paid by the employer to the contractor, remains so and the subcontractor is required to recover such amounts from the contractor (subject of course to the right to request direct payment by reference to liens and reservations of ownership as discussed hereunder).

After termination, payment for uncertified n/s work completed prior to termination (together with materials and goods per clause 38.5.5) is no longer certified through the principal contractor but is made directly by the employer in terms of the subcontract.

The final account of the contractor must include the total value of the n/s works and materials and goods which includes sums paid directly to the subcontractor after termination. Such a final account must be processed in terms of clause 34.0 and any direct payments to n/s subcontractors reflected in the recovery statement (PBA clause 33.2.6).

None of these provisions suggest that the provisions of clause 38.5.1 (the works must cease) are removed and that the subcontractor is required to continue with the n/s works.

With regards to (a) the employer is possibly entitled to elect to make direct payments to subcontractors [PBA 21.6 and 35.1.2] and to recover such direct payments from the contractor as expense or loss [PBA 35.2, 33.2.8]. The n/s agreement in turn also provides for an election by the employer to make direct payment to the subcontractor upon receipt of a request from the subcontractor on 2 grounds. These are:

Clause 35.1.1 – A failure to provide an n/s payment guarantee in terms of clause 3.1.1 or 3.1.2 (right to a payment guarantee for the outstanding balance of the subcontract value where the contractor has defaulted on a payment in terms of clauses 31.9.2, 31.15, 34.10.2 and 34.14).

Clause 35.1.2 – A failure to make payment of an amount paid to the contractor for the subcontractor.

This election that is available to the employer is not a right that is available to the subcontractor but one available to the employer to protect its own interests. These interests could be anything such as delays to the execution of the n/s works, prejudice it may suffer if the subcontractor is not paid and/or exercises a lien over any of its works and materials provided probably that there has been no supervening liquidation of the contractor, loss of manufacturers’ warranties and maintenance, etc. It is incumbent on the subcontractor to act swiftly and decisively to ensure that the employer has an interest in and elects to make direct payment by exercising liens, withholding product and other guarantees, rejecting any calls for liability for latent defects, encouraging the employer to continue to use the subcontractor’s services to complete the works without delays, and the like or alternatively, where the subcontractor is interested in completing the n/s works, by allowing the subcontractor to effectively add it to its price for completing the n/s works after termination.

Clause 38.5.8

‘The security [14.5] shall expire and be returned by the employer to the subcontractor’.

The security due in terms of clause 14.5 – advance payment guarantee – must be returned to the subcontractor. This guarantee is issued by the subcontractor to the employer specifically to cover the value of advances by the employer which would typically terminate when the principal building agreement is terminated but it is submitted that there would simultaneously have to be a form of delivery of all the goods covered by such advance payment guarantee. As the principal contract and the subcontract have been terminated the subcontractor no longer carries the liability for the n/s works and has no further interest in protecting them once delivered to the employer.

This clause makes no reference to the n/s construction guarantee/retentions nor does it make reference to the payment guarantees due in terms of clause 3.1, both of which have been discussed under bullet 4 above.

Clause 38.5.9

‘The latent defects liability shall end [27.2.2]’

According to Du Bois et al, Wille’s Principles of South African Law at p. 945 the principles of contracts of locatio conductio operis in the Roman-Dutch common law provide that if the employer approves the opus, he absolves the builder from liability for all defects, latent as well as patent.

A latent defect is defined in clause 1 as ‘a defect that a reasonable inspection of the n/s works by the principal agent would not have revealed before the issue of the defects list.’ The defects list is a list issued in terms of clause 26 Final Completion. Clause 27.1 provides for a latent defects liability period of 5 years from the date of the final completion certificate but sub-clause 27.2 distinguishes two different liability periods in the event of termination. Clause 38.5.9 therefore provides that the latent defects liability period ends on the date of termination in accordance with clause 27.2.2.

This provision can be used as a basis for negotiating direct payment or as a negotiating tool in establishing the cost of completing the n/s works. However, it is submitted that it does not displace the provisions regarding the terminated contractor’s obligation to ensure the work executed by specialised trades is correctly done and an entitlement for the employer to recover any costs of making good defective work in the work completed prior to termination by way of a reduction to the value of the work completed or by a claim for damages against the contractor (see also discussion under bullet 4).

The purpose/consequence of the provision could be:

  1. To provide a cut-off point placing the eventual latent defect liability on the new contractor completing the works as it is possible for this contractor to inspect the works, report work that is defective and obtain a contract instruction for the correction of the defect.
  2. Alternatively, and possibly concurrently, it is also intended to provide the employer and principal agent with a cut-off which enables them to finalise and pay the n/s works final account leaving the liability for any unobserved defective work in the n/s works within the ambit of a reduction to the price for the principal contractor’s works final account or a recovery in the final payment certificate as between the contractor and employer and thereafter a final recovery statement adjustment as between the contractor and the subcontractor which is patently the correct place for these adjustments to keep the employer out of that [sub]contractual relationship. The further benefit of this latter interpretation is that the liability for correction of the defects then resides in its proper place and, insofar as it affects the employer, is subject to the principal building agreement’s termination provisions which differ between terminations resulting from either the employer’s or the contractor’s default.

It is up to the subcontractor to price for this risk or to stipulate for any limitation to its liability in a subsequent agreement for completion of the n/s works.

*Note: This is not a legal opinion and no liability for reliance on its contents attaches to the writer or sender.

  1. Inter alia sub-clause 31.5.1

  2. Hence the need for clause 38.5.5 and 38.5.7 providing for direct payment to the subcontractor as discussed under those provisions.

  3. See inter alia Concor Holdings (Pty) Ltd v Potgieter (219/03), [2004] ZASCA (28 May 2004); Administrator General South West Africa v Trust Bank of Africa Ltd 1982 (1) SA 635 (SWA)

  4. Legal opinion should be sought if the lien is disputed and a discussion on liens falls outside the scope of this paragraph. Suffice it to point out that the principles accessio inaedificatio (ownership through attachment of goods to immobile property) do not fully preclude the availability of a lien on easily identifiable isolated and detachable goods (see inter alia Melcorp SA (Pty) Ltd v Joint Municipal Pension Fund (Transvaal) 1980 2 SA 214 (W).

  5. See Minister of Public Works and Land Affairs v Group Five Building Ltd 1999 (4) SA 12 (AD)

  6. Reliance on common law actions such as the actio quanti minoris, condictio indebiti and the like is subject to very strict application and there is no better than a mutually agreed process and grounds for correction of an overpayment.

  7. It is submitted that there is an error in this clause, and it should read 38 rather than 36.

  8. See Administrator, Natal v Magill, Grant & Nell (Pty) Ltd (in Liquidation) 1969 (1) SA 660 (A) 671H-672B.

  9. See Neethling–Potgieter-Visser Law of Delict, 6th Edtn, LexisNexis Durban 2010 pp. 306-307 and particularly p. 307 where the inducement causes a lawful termination of the contract.

  10. Materials and goods included in a payment certificate become the property of the employer in terms of NSSA clause 31.6

  11. See Thomas Construction (Pty) Ltd (In Liquidation) v Grafton Furniture Manufacturers (Pty) Ltd 1988 (2) SA 546 (A) 563C, but this judgment was on the basis of the wording of clause 22.3.4 ‘until after completion of the works under this clause no payment shall be made to the contractor under this contract’. In terms of the JBCC 2007 editions’ contract wording, the principal agent must continue to issue monthly payment certificates in a nil amount until the final payment certificate is issued – this is different from the provision ‘no payments shall be made’ in the judgment even if it amounts to the same and may influence future judgments.

  12. Clauses 34.10.2 and 34.14 deal with the final payment.

  13. See PBA clause 20.6 and 21.6.

  14. See Administrator Natal v Magill, Grant & Nell (Pty) Ltd (In Liquidation) 1969 (1) SA 660 (A), 672B and discussion under bullet 4.

  15. 9th Edtn, Juta, Feb 2007.

  16. See Minister of Public Works and Land Affairs v Group Five Building Ltd 1999 (4) SA 12 (AD)

  17. Refer dicta in BK Tooling (Edms) Bpk v Scope Precision Engineering (Edms) Bpk 1979 (1) SA 391 (A) generally at pp. 438-440.

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