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Security Assignments Over Contractor's Receivables - How Secure Are They?
September 2008 | Finance | Business Bulletin

Developers of land can usually raise financing by using their land as security. In contrast, most contractors employed to develop the land do not have such an advantage. Their hard assets are usually limited to their construction equipment and materials which would be woefully inadequate to secure the amount of financing they require.  Further, the equipment and materials brought onto the construction site are usually deemed to belong to the landowner.

The assets of value which the contractors do have are the receivables payable to them under the construction contracts made by them with land developers (who are usually referred to as the "Employer" in such contracts). Banks who finance contractors therefore commonly ask them to assign their construction contracts to the banks as security. The intention is that the monies payable by the Employer under the contract should all be assigned and paid over to the bank.

However, construction contracts often contain prohibitions against assignment. This is the case for two of the most commonly used forms of construction contract terms in Singapore, namely the Building and Construction Authority's "Public Sector Standard Conditions of Contract for Construction Works" (the "Public Sector Conditions") and the Singapore Institute of Architects' "Articles and Conditions of Building Contract" (the "SIA Conditions").

Clause 30.1 of the Public Sector Conditions states that "... unless the Employer shall agree in writing, the Contractor shall neither assign his interests, rights or benefits under the Contract ...". Since "rights and benefits" under the contract include the contractor's right to receive monies, the contractor is not allowed to assign its rights to receive monies unless the Employer agrees. Clause 31.1 goes on to specifically provide that, if the contractor has "acted in breach of Clause 30.1", the superintending officer may issue a termination certificate. If the default is not made good within seven days of such issue, the Employer may terminate the contractor's employment.

The SIA Conditions are even more explicit. Under Clause 15(1), assignment of the contractor's "right to receive monies due under the Contract" is expressly prohibited, except with the Employer's prior consent. Clause 32(3)(b) specifically provides that, if the contractor "assigns the right to receive monies due under the Contract without consent", the architect may issue a termination certificate. This will entitle the Employer to terminate the contractor's employment.

In both these cases, once the Employer terminates the contractor's employment, the contractor must immediately vacate the construction site and surrender possession of the site to the Employer, leaving behind all equipment, tools and materials except for those which the contractor is directed to remove.

In short, an assignment made without the Employer's consent could entitle the Employer to terminate the contract, thus jeopardising the very stream of money which the bank is looking to. Although an Employer is unlikely to terminate the contract just because of such an assignment, contractors would not want to be in technical breach of their contracts (thus possibly triggering an event of default under their financing agreements). Neither would banks want to be in the position of being connected with any such breach of contract.

Typically, Employers will not consent to such prohibited assignments. They have good reason not to: consent will cause the assignment to bind them. Once the Employer receives notice that the contract proceeds or the contractor's rights have been assigned to the bank, the Employer must ensure that all its further payments under the contract are made only to the bank, or as directed by the bank. If the Employer inadvertently pays anyone else (including the contractor) that payment need not be recognised by the bank and the Employer could end up having to pay the bank again. Notice of an assignment which binds the Employer also cuts off certain set-off rights which the Employer might otherwise have had against the contractor.

Banks and contractors often try to get around such prohibitions against assignment by arranging for the contractor to issue to the Employer an "irrevocable" payment instruction instead of a notice of assignment. On their own, such "irrevocable" payment instructions do not give a bank enough protection because the Employer is not obliged to get the bank's consent before agreeing to the contractor's request to change the payment arrangement. The bank's consent is only required if the Employer has entered into a binding tripartite arrangement with the bank and the contractor to obtain the bank's consent to any change in the payment arrangement. An Employer who understands the risks of consenting to an assignment by the contractor will also not enter into any such tripartite arrangement.

The good news is that the prohibitions against assignment contained in the Public Sector Conditions and the SIA Conditions do not extend to the creation of charges. Banks should therefore ask for security over the contract proceeds by way of a charge not amounting to an assignment. As notice of assignment cannot be served on the Employer, banks should also:-

1. obtain undertakings from the contractor to procure that all payments under the construction contract are made directly to the bank (or the contractor's account maintained with the bank), and to "irrevocably" direct the Employer to make payments that way;
2. ensure that such payment directions are indeed served on (and, where possible, acknowledged by) the Employer; and
3. obtain an undertaking from the contractor that, if any contract proceeds are paid to the contractor, the contractor will immediately pay them over to the bank, coupled with a declaration that, pending payment to the bank, the contractor holds all those proceeds on trust for the bank.

The key difference between this security arrangement and an assignment is that, if the contractor (whether due to fraud or any other reason) subsequently changes the payment instruction and arranges for the Employer to pay the contract proceeds to someone other than the bank, the money will be lost to the bank. This is unlike an assignment, where the bank will have the right to claim payment directly from the Employer if the Employer has paid the money to someone not authorised by the bank. It would therefore be advisable for the bank to diligently monitor the progress of the construction project and the timely receipt of progress payments, including requiring the contractor to submit to the bank the construction schedule, payment schedule and copies of all the contractor's progress payment claims and architect's or superintending officer's certificates once issued.