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“Theft by Contractor” and the Need for Further Protections Under South African Law

 

Have you ever performed on a project as a subcontractor only for the main contractor to refuse to pay, even after it has been paid by the employer?  How many projects have you witnessed where the main contractor has misused funds provided by the owner for other projects or failed to allocate funds received from the owner for your project, only for it to run out of money before completion?  Maybe you are a main contractor and you have juggled funds across projects and found yourself in the unenviable position of trying to then balance payments to suppliers and subcontractors.

 

In South African law, we do not have any specific principle or law that deals with such a scenario, except what may be provided for in one’s contract, which often isn’t much.  Moreover, an averment of misuse of funds is often ignored by adjudicators, especially clevear senior counsel who often view adjudication as nothing more than a summary judgement proceeding and refuse to resolve disputes of fact - more on that in another article.

 

Recently, the construction industry received a proposal regarding a “pay when paid” statute, as well as a statute formalizing adjudication.  These are admirable attempts to provide more certainty to the industry, but do not appear to strike at the heart of a key issue that often arises in construction disputes.  In any event, a number of these provisions already exist in standard contracts, for example.

 

To that end, I would add a third critical consideration for role players in a construction project, one that is more important than statutory adjudication or the “pay when paid” principle – namely one addressing the role of the main contractor (or project manager) on a project and how it handles funds received from the owner.

 

It is time that South Africa looked to hold irresponsible main contractors to account by passing a law that deems all monies paid by the owner be effectively held in trust for the project’s subcontractors, service providers, suppliers, and laborers (“role players”).  The main contractor would then be prohibited from taking any monies out of the project in advance of satisfying claims of these role players.  This would not require an actual trust but rather ringfencing these funds in a quasi-trust setting that ensures the main contractor accounts for these funds and does not abuse its overly dominant control over the purse strings by shuttling money into other projects or for personal use prior to paying the role players.

 

Failure to apply these monies to the project itself should be met with penalties, potentially personal, to ensure reliable accounting by the main contractor and an honest allocation of monies due/owed to these role players for work completed against funds received.

Consider the concept of “theft by contractor” in the United States.  Some states have passed laws denoting these funds as funds held in “trust” and failure to render payment to these role players, if proven, may result in stiff penalties for the main contractor.[1]

Key elements of such a statute would be, as follows:

 

• The party receiving funds acted as a main contractor;
• The main contractor received the funds for improvement to a property/construction project;
• The main contractor “knowingly” allocated these funds for purposes other than bona fide claims of these role players; and
• The owner/employer did not consent to this alternative allocation, ie there is no scapegoat approval by the owner.

 

This would not only provide protection to the role players but also the owners by bringing more certainty to the success of projects, as the misuse of funds would be much less likely.  Take, for example, the recent strikes in Benmore, Sandton where the laborers claimed they had not been paid in 2 months.  Or, think back to the plethora of unfinished projects reported on in our newspapers over the years.  We could significantly reduce the risk of a project failing because the funds have run dry due to mismanagement.

While “pay when paid” and adjudication statutes are nice, they will not resolve a scenario where a main contractor has burned through the funds for a project.  No legal recourse will likely bring that money back once gone, either.  That is, where a party is ultimately successful in adjudication or arbitration, that does not necessarily mean that the main contractor will actually have the money to pay in the end.  Relying on an overwhelmed State to enforce such abuse through the courts is inefficient when it could be done through statute and significant financial penalties privately.

 

Since the enactment of such a statute happening any time soon is extremely unlikely, I would encourage subcontractors, alternatively principal agents and owners, to consider contractual amendments that may give effect to this principle.

If you are a role player in the construction space that may need advice on how one may provide such protections in a contract, even a standard form one, please contact me.

 

[1] See Wis. Stat. § 779.02

 

Paul Bellin is an advocate of the High Court of South Africa and an admitted attorney in the United States.  He also advises on construction contracts and disputes and represents parties in both adjudication and arbitration proceedings.