Study of Malaysian Construction Contracts

Background of the study

Construction industry has played an important role in establishing the infrastructure required for socio-economic development and contributing directly to economic growth [1] . During global economic recession in the mid eighties which has deeply affected our country construction industry there was a significant slowdown in overall construction activities. Some of the on going projects have been stop and there were many construction company has fall into bankruptcy and becomes insolvent due to this economic downturn. Due to the cost driven and cyclical nature of the construction industry bankruptcies and company’s liquidations of industry participants becomes flourishing.

The annual Government statistics show that the number of insolvencies is increasing, leading to more and more companies going into liquidation. The standard contract forms protect the employer when a contracting company goes into liquidation, and this contractual protection is necessary because the liquidator’s duty is to the body of creditors as a whole, and under the general law the employer is simply an ordinary unsecured creditor. [2] 

Generally every construction project has a standard contract form which will express all the contracting parties’ intention and provision. This general contracting has been around since 1870 when Cubitts in London first began to offer the services of a general contractor. Before that time building work tended to be procured either as a series of direct contracts between client and trade contractors (the essence of what is nowadays called construction management) or as a lump sum design and build package.

Since general contracting widely used, there are many standards forms that have evolved. In Malaysia construction industry scenes today, there are 3 widely used forms in the construction industry; PWD: Public Work Department Form, PAM; Persatuan Arkitek Malaysia Form, and CIDB; Construction Industry Development Board Form. The details of each contract differ markedly, but many of the general principles are transferable.

The PWD, CIDB and PAM forms of construction contract contain clauses which allow for the determination of the employment of the contractor in the event of specified defaults. Understanding the standard forms is important to the proper and effective management of the contract and in deciding the obligations, rights and remedies of the parties.

Practically every contract has a provision that makes the bankruptcy or insolvency of one contracting party a trigger for the other party to terminate the contract. The bankruptcy or insolvency of either party is frequently a termination trigger. However, when the financial condition of only one contracting party is in doubt, the more financially stable party may insist on a one-sided provision allowing it to get out of the agreement upon the weaker party’s insolvency or bankruptcy.

Clause 25.3 PAM 2006 forms stated that:

“In the event of the Contractor becoming insolvent or making a composition or arrangement with his creditors, or have a winding up order made, or (except for purpose of reconstruction or amalgamation) a resolution for voluntary winding up, or having a liquidator or receiver or manager of his business or undertaking duly appointed, or having possession taken by or on behalf of the holders of any debentures secured by a floating charge, or of any property comprised in or subject to the floating charge, the employment of the Contractor shall be forthwith automatically determined." [3] 

The term ‘insolvency’ is used here to cover bankruptcy and the winding up of the insolvent companies both of which are now mainly covered by the Insolvency Act 1967. In general the same rules apply to personal and corporate insolvency but there are certain differences, some of which are referred to below. No exposition is given of bankruptcy or winding up in general, for which references should be made to the standard textbooks [4] , but attention is drawn here to some matters particularly relevant to building contracts.

Upon the contractor’s bankruptcy the benefit and burden of the contract passes, subject to the effect of any valid forfeiture clause, to his trustee in bankruptcy unless the contract is personal. In the latter case the trustee cannot complete, but if the contractor completes, the contract moneys are payable to, and recoverable by, the contractor’s trustee. [5] In a winding up the contract remains vested in the company and the liquidator may ‘carry on the business of the company so far as may be necessary for its beneficial winding up’.

Statement of issues

The termination of a contract is a serious step and one that must only be taken after careful consideration and proper advice. The right to terminate a contract depends on the nature and the consequences of the other party’s breach. The breach must either be of a fundamental term of the contract, often described as one that goes to the root of the contract, or alternatively the consequences of the breach must be such that they substantially deprive the innocent party of the entire benefit intended by the contract.

Given that these broad rules leave considerable room for interpretation, most standard forms of contract applied in the construction industry include express terms governing the rights of either party to terminate. A failure to strictly comply with those terms may result in the party seeking to terminate being held to have repudiated the contract.

The Standard Contract Form ‘determination’ clause are intended as with the many other contractual remedy provisions, to provide a mechanism that may be operated by one party in the event of specified breached of contract by the other, in lieu of rescission and/or an action for damages. Such contractual remedies, however, are not to be taken as limiting the right of action to that remedy alone; although a particular remedy has been agreed upon in the contract, it will never be implied that such an agreement limits the right to an action at law respect of that dispute unless such limitation is clearly express and even then the remedy so provided could only be construed establishing a condition precedent to action at lav, [6] 

It is an interesting feature of many standard forms of construction contract that their express provision do not include right to determine the contract itself but merely confer rights to determine the employment of the contractor under it, i.e to relieve the contractor of his obligation to complete the work which he undertook. The contract remains in existence and the form usually spell out in detail the rights and obligations of the parties where either of them exercises the express power of determination of employment. There is no consistency of terminology in contract forms prepare by various organisations, e.g. the words ‘determine’ and terminate are used synonymously. [7] 

In term of meaning, the word ‘determination’ (from the verb ‘to determine’ use transitively as in the standard forms) means ‘putting and end to’ (as opposed to its transitive meaning of’ to come to a decision’). To ‘terminate’ is “to end or bring to an end" for example “to terminate an agreement." [8] " For example, in relation to lease, “termination" means bringing the lease to end before the end of the anticipated term of the lease. [9] 

Thus in terms of the dictionary meanings, they both refer to the premature ending of the contract resulting either form a breach or upon the occurrence of a specified event. They operate both upon breach of contract as well as upon a certain contingency or anticipated term exercisable by the party no in default.

Clause 25.3 of the PAM 98 Form deals with the position where the contractor is in financial difficulties as evidenced by insolvency, for example bankruptcy under the bankruptcy Act 1967, and related matters like making a composition or arrangement, winding up order and appointment of liquidator or receiver or manager under Companies Act 1965. The clause provides that as soon as the events occurs the contractor employment under the contract is ‘automatically determined’ [10] .

Malaysia Public Work Department contract form 203(Rev.10/83) Clause 51(b) also stated that when the contractor commits an act of bankruptcy, becomes insolvent or compounds with or makes arrangement with creditors or having a provisional liquidator, receiver or manager of his business or undertaking duly appointed , or possession taken by or on behalf of creditors or debenture holders secured by a floating charge of any property comprised in or subject of the said floating may give right to the government to determine the employment without even having to serve a prior notice of default to the Contractor. [11] In this respect the government merely has to serve the notice of determination by registered post on the Contractor upon the occurrence of one of the specified acts.

There are clearly stated in the PAM 98 and PWD contract form that once the party is insolvent therefore the contract will be determine automatically. Broadly, they may be said to be insolvency situations, and in effect treat insolvency as a breach of contract justifying determination. At common law insolvency is not a breach at all, but rather a misfortune. [12] In a true insolvency position of bankruptcy and liquidation, it is sensible to provide for determination as the official assignee or liquidator has the statutory right to disclaim contract. [13] . It’s mean that the contractor company remains in legal existence even though the possession of its undertakings and assets are in the hand of the receiver.

The gist of the problems really is when the standard contract form clearly put the contract to an end due to the occurrence one of the events and it is contradict with the Companies Acts 1965 which gives a right to official assignee or liquidator to continue the contract. Furthermore, the new PAM 2006 contracts form clause 25.3 remains unchanged. Why this happen?

Objective of Study

The objective of the research is to determine the validity of the provision in the PAM 98 Contract Form Clause 25.3 and JKR Clause 51(b) when automatic determination operates in insolvency situation which contradict with the Companies Act 1967.

Limitation of Study

There are not many cases either in Malaysia or in England that have dealt with the validity of the automatic determination clauses in construction contracts in the event of the contractor’s insolvency. In England generally, the validity of such provision has not been seriously challenged. The parties appeared to have agreed that they were bound by it and in consequences; the courts have not made any clear decision on the point.

The Significant of Research

This research is very important as guideline to the parties in the construction project mainly to the contractor and the client which facing a business difficulties due to some reason and becomes insolvent. However, in the meantime, the construction project still on going.

In a true insolvency situation and a trustee in bankruptcy or liquidator is appointed, the provisions are of doubtful legal validity. If insolvency is used as a pretext for automatic determination, the courts might hold that the employer had repudiated the contract and was himself in breach. Furthermore, the trustees in bankruptcy and liquidator have a statutory right to disclaim any unprofitable contract. The automatic determination provision may well not be valid as against the trustee in bankruptcy or liquidator eventhough it is so in the case of the appointment of a receiver. [14] 

In Re Harrison ex party Jay, James LJ said:

“a simple stipulation that, upon a man’s becoming bankrupt, that which was his property up to the date of the bankruptcy should go over the some one else and be taken away from his creditors, is void as being violation of the policy of the bankrupt law" [15] .

Thus, this research is perhaps would contribute towards enhancement of the contracting parties some information and knowledge regarding their right when their company facing the bankruptcy or liquidation orders by the Courts.

Research Method

In pursuance of the aim or objective as stipulated above, the primarily methods that have used to complete this project are research by literature review.

Sources for literature review are from books, journals, newspaper article, lecturer notes and magazines. These sources provide lots of data that can help to determine the background of the research.

All these reading sources can be obtained at the internet sites that are related to this dissertation and library; Perpustakaan Sultanah Zanariah, UTM and Perpustakaan Negara and Perpustakaan Undang-undang, Universiti Malaya. Analysis of cases collected from Malayan Law Journal (MLJ) & All English Cases.

The introduction stage of this research started with the overview of the current situation when the contract determination clause look likes contradict with the Companies Act 1967 since the PAM 98 form until the new 2006 PAM form released. The liquidator definition, powers and roles are discusses in Chapter 2. This was followed by an extensive Literature Review on contracting out clause definition and application in Chapter 3.

After setting the performance indicator and data collection stage, the following stage is the data analysis stage as in chapter 4. We will analyze all the contract determination cases by insolvency cases and all the contracting out cases from the entire statue. The data analyses results make from the judicial decisions as reported in law reports and further explore related cases. Finally as in chapter 5, present the conclusion of research.

Organisation of the report

The dissertation consists of five chapters. The brief descriptions of each chapter are as follows:

Chapter 1: Introduction

This chapter presents the overall content of the whole project writing. It introduces the subject matter, the problems that are purported to solve. The objective is specified with an appropriate research method to achieve them.

Chapter 2: Liquidator

This chapter with discuss the meaning of the liquidators, the liquidator powers and the liquidator roles in the winding up process.

Chapter 3: Contracting Out

-Please advice-

Chapter 4: Results and Analysis - Contractor’s liability

This chapter analyse the results from the judicial decisions as reported in law reports and further explore related cases regarding the construction insolvency cases and the contracting out cases. Attempts were made to analyse the reported judicial decisions and to state the law there from. This would allow not only the law to be stated, but equally important, it allows the law to be assessed in relation to the facts as found by the court.

Chapter 5: Conclusions

This chapter presents the conclusions for the overall dissertation.