A hidden risk – assignment of subcontracts on termination

November 17th 2020

Occasionally main contracts are terminated due to the main contractor’s default. For when this occurs, many construction contracts include a mechanism to deal with the termination process. A common provision in such mechanisms is the contractor is required to “assign any subcontracts” to the Employer. Legally this means assigning the benefit (i.e. the subcontractor’s obligation to properly perform the subcontract works) of the subcontract.

On the face of it, this assignment provision appears fairly innocuous. As the main contract has been terminated the Employer benefits from a direct relationship with the subcontractor. The contractor in turn has no further use for the subcontractor. So why not assign?

If only it were so simple. It turns out the assignment on termination clause has the potential to cause a whole lot of trouble for the assigning contractor. For those who like to read case law, the relevant case is Energy Works (Hull) Ltd v MW High Tech Projects UK Ltd [2020].

The problem with the assignment clause identified in that case is that the main contractor’s default, which led to termination of the main contract, was caused by the subcontractor’s default under the subcontract. The contractor wanted to pass on those losses to the subcontractor, because it was ultimately the subcontractor that caused the loss. However, because the contractor had assigned the benefit of the subcontract to the Employer, the contractor was not itself able to claim against the subcontractor.

This difficulty arose because the assignment on termination transferred all past and future rights under the subcontract. This meant that while the Employer could have, if it chose to, pursue the subcontractor directly for the subcontractor’s default, the contractor could not. In other words, when the contractor assigned the benefit of the subcontract to the Employer, the contractor gave up the right to make a claim against the subcontractor for past breaches of the subcontract. The main contractor was still liable though to the Employer for past breaches under the main contract, which included the losses caused by the subcontractor’s breaches.

The clause under consideration in the Energy Works case was not dissimilar to the assignment on termination clauses found in the JCT suite of contracts (e.g. clause 8.7.2.3 in D&B 2016) and the NEC4 ECC (clause 92.2). Thus the risk for the contractor in that case which arose in relation to assignment of the subcontracts on termination, appears to be a risk that main contractors routinely take. The same applies in some subcontracts (e.g. JCT D&B Subcontract 2016, clause 7.7.2.3).

So now we are all alive to this risk, should we be addressing this when contracts are entered into? Some contractors may take the view the risk is small in that the likelihood of this occurring is small. That may be true, but if the risk materialises, as it did for MW High Tech, the cost could be significant (for MW High Tech possibly as high as £133M).

The sensible approach might be to make a few minor amendments to the assignment on termination clause. For example, the assignment could be expressly limited to future rights. At least that way the contractor would not lose the right to pass down claims to subcontractors after the assignment.

As this is a generic commentary (and not advice that should belied upon), if the issues above are relevant to your contracts, we would be happy to provide specific legal advice to you.

The above information is intended to be a snap shot of the issues we have been advising on recently.

If you need any further information or specific advice, please contact us.

Warren Berwick

warren.berwick@berwick-law.com

07825 171 925