In order to maximise liquidity during the on-going pandemic, private and public sector developers are now more than ever taking advantage of contractual mechanisms to withhold payment under construction contracts. As a consequence, SME construction companies are being exposed to cashflow pressures at an already difficult time, with many sites subject to labour capacity restrictions and orders for the next 12 months remaining uncertain.

Understandably, SME construction companies and developers are increasingly seeking clarity as to the contractual rights and obligations of the parties involved in the carrying on of construction works. Since this can be a complex and confusing area of law, I thought it may be beneficial to provide an overview of the basic principles which govern construction contracts and payments for those practitioners who may have cause to advise SME construction companies and developers For ease, I use the term “developer” to refer to any party other than a residential occupier which instructs a construction company to undertake construction works.

The Caveat

It is all too common for construction companies and developers to enter into construction contracts by exchange of e-mail or verbally such that no formal contract is entered into. In such circumstances, the rights and obligations of the parties will be regulated through the insertion of implied terms into the agreement between the parties by the Housing Grants, Construction and Regeneration Act 1996 (“Construction Act”), the Sale of Goods Act 1979 and the Supply of Goods and Services Act 1982. The legislation does not, however, serve to entirely replace those terms which have been agreed between the parties. Rather, only such terms as are necessary to formalise the agreement between the parties will be implied, and any terms which have been expressly agreed will remain effective in addition to those implied terms.

It follows that, in practice, the basis of the construction contract between a construction company and a developer can include terms drawn from a variety of sources and it is not possible to set out a definitive overview of the legal principles which will apply to all forms of contract. This article has, therefore, been produced for information purposes only and should not be relied on as advice in relation to any specific form of construction contract.

Construction Contracts and the Construction Act

Whether a contract has been entered into in writing or not, an agreement for the carrying out of “construction operations” by a construction company (whether directly or by sub-contract) is a “construction contract” and will be governed by the Construction Act. The definition of the term “construction operations” is extensive, covering all aspects of construction works and including the construction, demolition and refurbishment of buildings and other structures. The Construction Act does not, however, apply to construction contracts entered into with residential occupiers and which principally relates to construction operations on the dwelling in which the residential occupier resides or intends to reside.

In those construction contracts to which it applies, the Construction Act will imply terms relating to dispute resolution and payment if such terms have not been expressly agreed between the parties.

Dispute Resolution

With regards to dispute resolution, the Construction Act provides that any party to a construction contract has the right to refer a dispute arising under the contract to adjudication. It follows that in a construction contract, other than a contract entered into with a residential occupier, it is not possible to avoid the legislative right to adjudicate even if the contract makes express provision for alternative forms of dispute resolution.

Adjudication is a form of dispute resolution which is interim binding; meaning that a determination obtained through adjudication is binding on the parties until such time as a final remedy is obtained through arbitration or court proceedings. As the law currently stands, however, in circumstances where an adjudication award is made in favour of one party, the opposing party will not be able to seek an alternative outcome through arbitration or court proceedings until such time as the adjudication award has been complied with. That means if, for example, an adjudicator awards payment of a sum of money to a construction company in relation to construction works which have been undertaken but the developer denies the value of those works, the developer cannot seek an alternative outcome until it has paid the relevant sum to the construction company. A further primary feature of adjudication is that the adjudicator’s decision must be provided within 28 days of the referral unless an extension up to 42 days is allowed by the referring party. The ability of the parties to adjudication to gather evidence and investigate the issues is, therefore, extremely limited. The nature of adjudication can, therefore, afford key advantages to one party over the other in circumstances where limited evidence may be available to support the position of the opposing party with regards to, for example, the quality or value of works. It follows that practitioners should be conscious of the fact that, for those construction contracts to which the Construction Act applies, adjudication may present a cost and time effective form of dispute resolution for SME construction company and developer clients in contrast to arbitration and claims in the County or High Court.

Payment

With regards to payment, the Construction Act provides that a party to a construction contract with an estimated duration of 45 days or more is entitled to instalment, periodic or stage payments and that every construction contract will provide a mechanism for determining what payments become due under the contract and when. To the extent that no such mechanism is expressly agreed between the parties, a mechanism (or such part of it as is necessary) will be implied into the contract by the Construction Act and the Scheme for Construction Contracts (England and Wales) Regulation 1998 (“Scheme”). It follows that in a construction contract, other than a contract entered into with a residential occupier, it is not possible to contract out of the legislative mechanism for payment. It is, however, possible to vary the dates which apply under the legislative mechanism for payment. As such, it is important to accurately ascertain in relation to any construction contract to which the Construction Act applies whether it incorporates the contractual mechanism for payment, the legislative mechanism for payment or some hybrid of the two.

The basic mechanism for payment will be as follows. The deadlines which are said to apply to each stage are those which apply under the Scheme and may be subject to variation.

1. By a defined date each month, the construction company will be entitled to make an application to the developer for payment. In doing so, the construction company will value the works which have been undertaken in the preceding (typically one month) period, add that value to the total value of the works undertaken as at the date of the previous application, and subtract any sums which have been paid by the developer. The balancing sum will be the amount due to the construction company.

2. The balancing sum will be “due” for payment within 7 days of the expiry of the relevant (typically one month) period to which the application relates or upon the making of the application by the construction company, if later. Where the application is the final application following completion of the works, the 7 day period is extended to 30 days.

3. Not later than 5 days after the due date for the payment, the developer may issue a payment notice to the construction company specifying the amount (if any) which the developer intends to pay the construction company. The amount may be less than that which has been applied for by the construction company.

4. If the developer intends to pay less than the sum which has been applied for by the construction company, then the developer must issue to the construction company a notice of intention to withhold payment not later than 7 days before the final date for payment.

5. The final date for payment of the relevant sum will be 17 days from the due date.

If the construction company fails to apply for payment on time, the developer may be entitled to value the works with the risk to the construction company that developer’s valuation may be less than the equivalent valuation if undertaken by the construction company. If the developer fails to issue a notice of intention to withhold payment in time, the amount applied for by the construction company becomes payable in full. It is, therefore, critical to ensure that the necessary notices are issued in accordance with the contractual and/or legislative mechanisms to payment to ensure neither party is exposed to an unjust tactical advantage arising from inadvertent non-compliance with the applicable mechanism.

In addition to ensuring that the parties comply with the technical requirements of the construction contract, Act or Scheme, construction company and developer clients should also be advised to ensure all valuations and works are properly substantiated by reference to contemporaneous evidence such as invoices for materials, photographs and timesheets in order to maximise the evidential position of the parties in the event that there is a dispute over payment or the quality of work.

Going Forward

There is scope for practitioners who do not specialise in construction contracts to provide added value to construction company and developer clients by understanding the context in which construction contracts operate and the primary mechanisms by which the parties will be bound whether a contract has been entered into in writing or not. The certainty afforded by the contractual and legislative payment mechanisms and the availability of adjudication to all forms of construction contract to which the Construction Act applies means that disputes over payment are capable of being resolved quickly to maximise cash recovery for construction company clients, and cost effectively to minimise the overhead cost of litigation to developer clients.

How can Berry Smith help?

The construction team at Berry Smith is experienced in the administration of all forms of construction contract and is on hand to advise:

• Pre-contract as to how to best protect the position of construction companies and developers during the carrying out of the contract works with a particular emphasis on the nature of the evidence and records that each party should maintain; and

• Throughout the duration of the contract as issues arise from time to time.

Often, we can provide pre-contract advice for a fixed fee; a sound investment to ensure the client understands the proper administration of the contract and how best to maximise its evidential position from the outset to limit the risk of a costly and time-consuming dispute between the parties at a later stage.

Please contact Gavin Hoccom on 029 2034 5511 or by e-mail at ghoccom@berrysmith.com to discuss how Berry Smith may be able to assist with the success of your client’s next construction project.

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