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INTRODUCTION
“Conditional Payment Clauses” also generally known as “back to back provisions” commonly form part of the construction contracts[1] in the UAE and are frequently incorporated therein. Generally speaking, such provisions are a common feature of the sub-contractor’s / sub-consultant’s payment terms[2], and subject the payment of the sub-contractor/ sub-consultant to a suspensive condition, e.g. the receipt of the payment by the main contractor from the employer.
Under most foreign laws, such “back to back” provisions are generally demarcated as “paid if paid” clauses and “paid when paid” clauses. However, the UAE laws do not draw a distinction between “paid if paid” clauses and “paid when paid” clauses but rather generally identify the “back to back” provisions as conditional clauses (as discussed below).
This article attempts to explore whether such “back to back” provisions operate as either “paid if paid” clauses or “paid when paid” clauses under the UAE laws.
INTRODUCTION TO BACK-TO-BACK PROVISIONS
Although not specifically recognized as “back to back” provisions under any specific UAE laws (federal or local), the “back to back” provisions are valid and enforceable by the UAE Courts. As confirmed by various rulings of the Court of Cassation, “back to back” clauses are recognized as “conditional clauses” in accordance with Article 420[3] of Federal Law No. 5 of 1985 (“Civil Code”).
Despite their recognition under the UAE laws, these provisions form basis of a vast number of disputes in the UAE construction industry. This is mostly because there are no clear guidelines prescribed by the UAE laws pertaining to their construction, enforceability and the extent thereof (e.g. whether the same operate as “paid if paid” or “paid when paid” clauses).
Generally speaking, “paid if paid” clauses indefinitely subject the payment of a subcontractor to the main contractor’s receipt of payment from the employer. This suggests that “paid if paid” clauses operate as condition precedents and therefore a subcontractor’s entitlement to its payment is always subject to the main contractor successful recovering the monies from the employer. Thus, the subcontractor is only to be paid IF the main contractor gets paid by the employer.
On the other hand, “paid when paid” clauses do not indefinitely subject the payment of subcontractor to the main contractor’s receipt of payment from the employer. The nature of such clauses is more regarding the timing of the payment to the subcontractor rather than the establishment of its entitlement to the same. Such clauses do not operate as condition precedents but rather establish the timing for the payment to the subcontractor and suggest WHEN the subcontractor would get paid. Ultimately, these clauses cannot be argued to “block” the subcontractor’s entitlement to payment until such time that the main contractor gets paid by the employer. This is explored further in detail herein below.
Considering that the UAE laws do not draw a distinction between “paid if paid” clauses or “paid when paid” clauses, this at times has led to the belief that conditional nature of these clauses would prevent the payment of the subcontractor until such time that the condition is satisfactorily fulfilled (i.e. main contractor successfully receiving monies from the employer). Whilst this may arguably be the nature of these clauses, as a matter of UAE law, the inclusion of such clauses in a contract may not necessarily mean that the parties may indefinitely rely on the conditional nature of the same or construe the same as standalone provisions. The validity and enforceability of these clauses are subject to various factors, a few of which have been discussed further below.
This article would explore the nature of such clauses (i.e. whether they operate as “paid if paid” clauses or “paid when paid” clauses) and the circumstances that, in our opinion, lead to their recognition as “paid when paid” clauses under the UAE laws.
Performance of obligation in good faith
In the context of construction contracts, as a matter of UAE laws, conditional clauses/ back to back provisions, albeit applicable and enforceable, are not interpreted independently. This means that as per the relevant provisions of the UAE laws (which are identified herein below), it is apparent that the conditional clauses (back to back provisions), shall at all times be considered along with the corresponding obligation of the main contractor to pursue to the employer in good faith for the payments/ entitlements of the subcontractor.
The duty of good faith is stipulated in Article 246 of the Civil Code, which states:
“1-The contract shall be implemented, according to the provisions contained therein and, in a manner, consistent with the requirements of good faith.
2-The contract is not restricted to what is contained therein but shall extend to its essentials in accordance with the law, custom and the nature of the transaction.”
This suggests that despite the presence of a “back to back” provision in a construction contract, the Courts shall not be bound to interpret it as a definite condition, and shall also pay heed to the customs and nature of the disposition and the practice in the relevant industry when enforcing the same.
The rationale for the same stems from the concept of “privity of contract”[4] and the fact that the subcontractor cannot pursue the employer directly for its entitlements. It is the main contractor that has a direct contractual relationship with the employer, and therefore, the subcontractor has to rely on the main contractor to ensure that its rights are properly claimed from the employer. In this regard, it ought to be noted that the relationship between the main contractor and the subcontractor is considered to be a relationship between an employer and a contractor, which is governed by the sub-contract, wherein on one hand, the main contractor shall be considered the employer towards the subcontractor, and shall bear the all obligations of an employer. On the other hand, the subcontractor shall be a contractor for the main contractor, and shall have all obligations of a contractor[5].
Furthermore, it ought to be noted that the relationship between the main contractor and a subcontractor is governed by a construction contract and not a partnership arrangement. Therefore, as per the general practice in the UAE construction industry, there is a legitimate expectation to get paid upon the completion and delivery of the works as the same is conducted/ performed for a consideration[6].
Based on the above, it can be concluded that even though “back to back provisions” are “conditional clauses”, they should be read along with the requirement and obligation on the party relying on the same (e.g. in construction contractors, the main contractor) to do all that is necessary to ensure that the condition (the “back to back” clause) is satisfied and materialized.
The UAE Courts have, by a vast majority of judgements, confirmed that should an obligation be dependent on a condition precedent, which is provided for the benefit of the obligor, the condition precedent shall cease to be effective if the obligor defaults on its duty of good faith.
Therefore, in the event it is established that a main contractor has failed to do all that is necessary to pursue the employer in “good faith” to ensure that the conditional clause is satisfied and materialized, then the same shall cease to exist and the main contractor may be required to pay the subcontractor, notwithstanding that it did not receive the corresponding payments from the employer.
Prevention of the materialization of a condition
It has been decided by the Dubai Court of Cassation[7] that a condition precedent would suspend the enforceability of an obligation until that time when the event, on which it is dependent, takes place. However, a condition shall be deemed to have materialized – even if it has not actually materialized – if the obligor commits deception or a fault to prevent materialization of such condition.
The Dubai Court of Cassation has defined deception as refrainment from performing the obligation arising out of the contract in bad faith (even in the absence of an intention to cause damage to the other party)[8]. Furthermore, a fault takes the form of either party’s failure to perform an obligation arising out of the contract or delay in the performance of such obligation, and established harm, which shall give rise to liability for compensating the resulting harm[9].
This suggests that the threshold for “wrongdoing” on the part of the obligor is considerably low, and does not require intention to cause damage to the other party. Therefore, a mere refrainment from performing an obligation (or a delay thereof), which causes the obligee to sustain “harm”, shall result in an obligation on the obligor to ensure that the obligee is adequately compensated in this regard[10] and could potentially suffice for the purposes of establishing the “deemed materialization” of a conditional clause.
Based on the same, the following factors could be considered in deciphering as to whether the main contractor has satisfactorily pursued the employer for payment of the subcontractor’s dues or whether it can be argued that the main contractor committed deception or fault which should lead to the deemed materialization of a condition:
- The lapse of time since the completion of works by the subcontractor. In this regard, it ought to be clarified that the mere completion of works is unlikely to render the conditional clause as materialized. However, based on the discussion above, a main contractor cannot be allowed to rely on the back to back provision for an indefinite period of time and various factors may be considered to suggest that the condition shall be deemed materialized e.g. completion of works, certification of payment applications, expiration of defects liability period, handing over the site etc.;
- The failure of the main contractor in actively pursuing the employer for the payments of the sub-contractor, in good faith;
- The delay by the main contractor in actively pursuing the employer and in this regard, initiating proceedings against the employer. In this regard, it ought to be noted that there are no clear guidelines under the UAE laws in regards to the extent of the obligations of the main contractor to sufficiently pursue the payments from an employer in order to rely on the back to back provisions. However, Article 484 of the Civil Code states: “The period prescribed to bar the hearing of the case is interrupted by a court claim or any legal proceedings instituted by the creditor claiming his right”. Based on the same it can be deduced that it is a requirement of a judicial claim that interrupts the prescription period to satisfy the meaning of request asserting the claimed right (debt), and therefore is the extent that the main contractor must pursue against the employer to claim the due of the sub-contractor;
- Any acts/ omissions by the main contractor that may lead to the prevention of the materialization of the condition. It has been established by the Dubai Court of Cassation[11] that the harmful act could either be a positive or negative act and therefore, any omission by the main contractor in actively pursuing the employer for the payment of the subcontractor shall arguably render the condition as materialized;
- Whether the main contractor has actively utilized other relevant legal measures at its disposal as per the UAE laws to confirm compliance with its ancillary obligations as per Article 246 of the Civil Code which would result in securing the subcontractor’s entitlements for the works it completed under the sub-contract.
Impossibility of Condition
Article 423 of the Civil Code states:
“In order that suspension be valid, the context of the condition must neither be materialized or impossible.”
Based on the abovementioned Article 423, in the event that the condition is, or becomes impossible, the condition shall become invalid and cease to exist.
CONCLUSION
In light of the discussion above, is it evident that the “back to back” provisions are identified under the UAE laws and can be relied on by the main contractors. However, as discussed above, such provisions shall be taken into consideration in light of various factors, all of which shall decide the validity and enforceability thereof. There are the factors that would be considered by the UAE Courts that may result in the invalidity or the materialization of a condition (even though it has not actually materialized) and shall render it inapplicable thereafter.
This suggests that the UAE Courts interpret the “back to back” clauses as “paid when paid” clauses as their validity and enforceability is not definite and is subject to the observance of the requirement factors discussed herein above.
Disclaimer
This information contained in this article shall not be considered legal advice as it is general in nature and it is recommended that the reader shall seek proper legal advice from a licensed and registered consultant before taking any actions (legal or otherwise) in relation to the subject matter of this article. Mahmood Hussain Advocates & Legal Consultants constantly advices and represent clients in regards to the subject matter of this article.
[1] Article 872 of Civil Code defines “Construction Contracts” as “Contract for work is one by virtue of which one of the parties undertakes to do a piece of work in consideration of a remuneration which the other party undertakes to pay.”
[2] Michael Grose – Construction Law in the United Arab Emirates and the Gulf.
[3] Article 420 of the Civil Code states: “The condition is a future fact upon which the existence of the act or its extinction depends on its materialization.”
[4] Article 250 of the Civil Code states: “Subject to the rules relating to successions, the effects of a contract shall apply to the contracting parties and to their universal successors in title, unless it follows from the contract, the nature of the transaction or a law provision that such effect shall not apply to the universal successors in title.” Article 252 of the Civil Code states: “The contract does not impose any obligation on third parties, but may establish a right in their favor.” Article 891 of the Civil Code states: “The subcontractor may not have a claim against the master, as regards the dues of the first contractor, unless the latter refers him to the master.”
[5] Al-Wasit fi Sharh al-Qanun al-Madani al-Jadid – “Al Wasit: An Explanation of the Civil Code – Author: Abd el-Razzak el-Sanhuri – Vol. 7 – p. 212
[6] Article 872 of Civil Code states: “Contract for work is one by virtue of which one of the parties undertakes to do a piece of work in consideration of a remuneration which the other party undertakes to pay.” Article 885 of the Civil Code states: “The master is bound to pay the remuneration for the work upon taking delivery of the work contracted, unless otherwise agreed or practiced by custom.”
[7] Dubai Court of Cassation Nos. 405/428 of 2001 Rights – Hearing of 21 January 2002, Dubai Court of Cassation in Cassation No. 398/2003 Rights
[8] Dubai Court of Cassation in Cassation No. 562/2016 Commercial
[9] Dubai Court of Cassation in Cassation Nos. 494/2017 Civil
[10] Article 282 of the Civil Code25 states: “The author of any tort, even if not discerning, shall be bound to repair the prejudice.”
[11] Dubai Court of Cassation in Cassation No. 150/2007