It is quite a common occurrence for employers to make direct payments to sub-contractors, circumventing the main contractor. This practice creates a lot of issues for the main contractor concerned, for example, how would the main contractor hold the sub-contractor liable for defects if the sub-contractor has been fully paid. And yet, the employer who made the direct payments would have no qualms about holding the main contractor liable for defects occasioned by the sub-contractor.
Oftentimes, the employer thinks that making direct payments is a way to ensure that the sub-contractors get paid, and consequently, the works will proceed as usual.
But is it true that employers have no risk in doing so? Think again.
In Desa Samudra Sdn Bhd v Bandar Teknik Sdn Bhd, the Appellant was the owner of Wisma E&C in Damansara Heights. The appellant appointed Autoways Constructions Sdn Bhd (“Autoways”) as the main contractor under the PAM form to erect the office building. Autoways got into financial trouble and applied for a scheme of arrangement under the previous s176 of the Companies Act 1965. In light of Autoways’ financial trouble, the Appellant issued a notice of termination of the contract. Autoways vacated the site, but allowed its sub-contractor (the Respondent) to re-enter the site and remove equipment and goods. In the process, the building was damaged.
The Appellant sued for trespass and conversion. The Respondent counter-claimed for direct payments based on an alleged oral contract and due to past practice of direct payments. The High Court favoured the Appellant and dismissed the counter-claim. The Court of Appeal reversed the High Court’s decision. Following that, the Appellant appealed to the Federal Court.
The bulk of the Federal Court decision focused on whether a scheme of arrangement would result in the automatic termination of the PAM Form contract. This article won’t focus on that discussion, but the short answer is No.
What is more disturbing is that the Federal Court took the view that certain minutes of meeting and the past conduct of making direct payments evidenced an oral agreement between the Appellant (as employer) and the Respondent (as sub-contractor) for direct payments to be made.
The Federal Court concluded that such minutes of meeting and past conduct of making direct payments created a legal relationship between the employer and the sub-contractor. As a result, the employer ended up being liable for all payments due to the sub-contractor.
Bear in mind that in the factual matrix of this case, Autoways as the main contractor had already fallen into bad times. Therefore, if there was no legal relationship between the sub-contractor and the employer, the sub-contractor would most likely end up not being paid.
So, should employers make direct payments to sub-contractors? Think carefully before doing so, because you may end up biting off more than you intended to chew.
M/s Kheng Hoe is a firm of construction lawyers in Malaysia focused on handling construction disputes. If you have any query, e-mail firstname.lastname@example.org.