Local Democracy, Economic Development and Construction Act 2009

“Pay-when-paid” clauses have long been unpopular with legislators. The Housing Grants, Construction and Regeneration Act 1996 sought to ban these, resulting in clients and their lawyers either ploughing on regardless or seeking to get round the ban by inserting pay-whencertifi ed clauses in place of pay-when-paid clauses. The newly enacted Local Democracy, Economic Development and Construction Act 2009 seeks once again to ban such clauses.

To recap, in PFI projects, lenders have to address the risk of a thinly capitalised SPV becoming insolvent as a result of having to pay out supply chain claims, where it is yet to recover from the Authority. Lenders got comfortable with this risk by ensuring that the SPV’s subcontractor’s rights against the SPV are (in all instances) no greater than the rights of the SPV against the Authority under the project agreement. This was combined in the early days with paywhen- pay clauses (ie even where the subcontractor has a claim, it still only gets paid when the SPV has received an equivalent amount from the Authority).

Following the introduction of the Housing Grants, Construction and Regeneration Act 1996, a more complex approach was adopted. This used a series of defences for the SPV including: a pay-whencertifi ed clause (where payment to the subcontractor is triggered on ascertainment of the SPV’s corresponding entitlement under the Project Agreement, rather than when it actually gets paid by the Authority); a parallel loan agreement whereby the subcontractor or a third party has to make a loan to the SPV equal to any sum payable to the subcontractor which the SPV has not yet recovered from the Authority; a deferred payment provision, whereby payment for a claim due to the subcontractor is deferred for up to two years; and a claw-back provision in respect of any sum paid to the subcontractor which is not recovered by the SPV from the Authority under its equivalent claim under the Project Agreement.

Under the Local Democracy, Economic Development and Construction Act 2009 both pay-when-paid and pay-when-certifi ed (or entitled) provisions will be unenforceable. The new Act however does not prohibit deferred payments or claw-backs – so for future PFIs, subcontractors will be glad to see the deletion of endless equivalent project relief clauses but will be concerned to see long deferral periods for recovery of any claims where the SPV has an equivalent claim against the Authority.

Under the Act, the Secretary of State has power to certify that the prohibitions in the Act will not apply to certain specifi ed categories of construction contracts. It remains to be seen if he will order any special concessions for PFI projects.

The Act is expected to come into force in the next 12-24 months.