The main legislation dealing with payment and dispute resolution in the construction industry is changing from 1 November in Scotland.  The changes already apply in England and Wales with effect from 1 October.  This is because the Housing Grants, Construction and Regeneration Act 1996 is being amended by the equally catchily named Local Democracy, Economic Development and Construction Act 2009.  The 1996 Act is usually referred to in the construction industry as the "Construction Act".  After years of consultation, the amendments are designed to address concerns with the current regime and to take advantage of over a decade of experience of the 1996 Act.

Anyone in the property sector that is involved with "construction" contracts will need to be up to speed with the changes to ensure compliance.  Broadly speaking "construction" contracts include building contracts, professional appointments and sub-contracts but the Act may also apply to "development agreements" if that agreement does not include the grant of an interest in land (either a sale or a lease of over a year).

If the relevant construction contract does not comply with the basic requirements of the Act then certain mandatory provisions will be implied into your contract.  These mandatory provisions relate to payment notifications and timescales; suspension rights and statutory adjudication of disputes.

Experienced procurers of construction works may be familiar with the Construction Act.  However, one-off clients of the construction industry can easily fall foul of the various requirements of the Act and can find themselves having to pay out money to contractors and consultants even when there is a valid reason to withhold payment.  For example, if the client of the project has a valid entitlement to liquidated damages for delay where the contractor is late in delivering the works, then a "pay less" notice must be issued in order to deduct those liquidated damages from other payments due to the contractor.  In these circumstances, clients will rely heavily on their advisors (such as project managers, cost consultants and lawyers) to guide them through the maze and make sure all appropriate procedures are complied with.

To deal with the changes to the Construction Act, industry bodies who produce standard form building contracts and professional appointments (such as the Scottish Building Contracts Committee/Joint Contracts Tribunal, the NEC and RIBA) are publishing new versions or changes to their suite of standard form contracts.

Background to the "Construction Act"

The Construction Act was designed to improve cashflow in the construction industry and to outlaw perceived payment abuses (e.g. main contractors only paying their sub-contractors once the ultimate client had paid the contractor).  It was also intended to provide parties to construction contracts with access to speedy "rough and ready" justice in the form of statutory adjudication.

Payment

The Construction Act introduced a requirement for stage payments in construction contracts (e.g. based on milestones or regular intervals) and a "due date" and "final date" for payment.  It also required payers to issue "payment notices" after the due date, setting out the amount proposed to be paid although there was no statutory remedy for a failure to issue such a notice.  Of more significance was the introduction of the concept of the withholding notice which required the paying party to issue a notice in advance of the final date for payment if it intended to withhold or deduct monies which were due under the contract (e.g. if the payer had an entitlement to recover liquidated damages).

Suspension

The Act introduced a right for unpaid parties to suspend performance under a contract for non-payment provided a notice was given.  It appears that this "nuclear" option was not widely used perhaps due to the effect that a suspension would have on the parties' relationship.

Adjudication

The 1996 Act introduced a form of statutory dispute resolution called adjudication which allows parties to construction contracts to obtain very quick decisions on disputes.  The aim of adjudication is to provide a resolution within 28 days of a dispute being referred to adjudication although this timescale can be, and often is, extended.   Adjudication has undoubtedly been a success in the construction industry and is now used for disputes of a far greater value and complexity than was originally envisaged.  The rise of adjudication has coincided with reduced uptake of arbitration, which has been seen as almost as slow and costly as the court process (although there are hopes that arbitration will become a more popular dispute resolution option generally, under the new procedures introduced by the Arbitration (Scotland) Act 2010 – see article Arbitration (Scotland) Act 2010 – A Landmark Decision in this E-Bulletin).

"Development agreements"

As mentioned above, agreements for lease and sale agreements with development obligations are not subject to the provisions of the Act.  This is because "development agreements", where the agreement provides for the disposal of a relevant interest in land, are excluded from the provisions of the Construction Act. For this purpose a relevant interest in land means the disposal of the ownership of the site or the granting of a lease for a period which is to expire no earlier than 12 months after the completion of the construction operations under the contract.

However, where parties enter into a development agreement without the disposal of an interest in land (e.g. where an owner-occupier engages a third party developer to deliver a project) then the contract will need to be compliant with the Construction Act.

Key changes: Payment mechanism

  1. Each time a payment is to be made, a payer, or specified person (employer's agent etc.), or payee (where the contract so provides), must serve a notice specifying the sum to be paid and how it is calculated no later than five days after the payment due date, even where sum due is zero.
  2. If the payer fails to issue a payment notice within five days, then the payee may serve a notice stating the sum it believes to be due and how calculated.
  3. The amount set out in the payer/payee notice becomes the "notified sum". If the notice is issued by the payee under 2, above, then the final date for payment is postponed by the number of days by which issue of the notice was delayed.
  4. If the payer intends to pay less than the notified sum, then he must issue a pay less notice.  This notice replaces the current withholding notices, and must specify the sum to be paid and how it is calculated.  Unless the parties agree otherwise, the notice must be served seven days before the final date for payment (17 days from the date that payment becomes due), failing which notified sum must be paid.

Click here to view diagram

Key changes: Adjudication

  1. "Construction Contracts" will no longer need to be "in writing" for the Act to apply.  The statutory provisions relating to adjudication, payment and suspension will therefore also apply to construction contracts that are oral or are only partly in writing.
  2. Contractual provisions for adjudication must be in writing, failing which the adjudication provisions of the (amended) Scheme for Construction Contracts will apply.
  3. Effect is given to the "slip rule", which allows an Adjudicator to correct any clerical, typographical or arithmetical errors in his decision, provided that he does so within five days of his decision.
  4. Any agreement as to the allocation of the parties' adjudication costs is of no effect, except where made after commencement of adjudication.

Further changes: of particular note for employers

The 2009 Act confirms that contractual provisions allowing a party to withhold payment of sums due in the event of the payee's insolvency are valid.

Further changes: of particular note for contractors/sub-contractors

"Pay when certified" clauses in sub-contracts are outlawed, as are clauses making payment conditional upon performance under another contract or upon a third party decision upon such performance.  There is an exception for first-tier PFI sub-contracts (for example, the main construction sub-contract).

Section 112 of the 1996 Act is amended to allow partial suspension of performance for non-payment.  The Act further allows a party exercising the right to suspend to recover its reasonable costs.  It is likely this will include mobilisation / demobilisation costs.