The Local Democracy, Economic Development and Construction Act 2009 (LDEDC Act) received Royal Assent on 12 November 2009. Part 8 of this Act amends the provisions of Part II of the Housing Grants, Construction and Regeneration Act 1996 (Construction Act).

Part 8 of the LDEDC Act will come into force on a date appointed by ministers in England, Wales and Scotland. No date has been set for this but Part 8 is unlikely to come into force until after consultation has taken place on the appropriate revisions to the Scheme for Construction Contracts 1998 (Scheme). It is anticipated that this consultation will take place in early 2010.  

Once Part 8 of the LDEDC Act does come into force, the new provisions will apply to construction contracts entered into on or after the date appointed.

Exclusions from construction operations

The Construction Act applies to construction contracts related to the carrying out of construction operations. Construction operations themselves are defined by reference to a long list of activities. Section 105 (2) and section 106 contain the exceptions and there is one exclusion order, the Construction Contracts (England and Wales) Exclusion Order 1998.

No change in the definition of construction operations has been introduced by the LDEDC Act. However, the LDEDC Act does introduce a new section 106A. This contains a broad discretion for the Secretary of State to disapply part or all of the Construction Act from a particular class or type of construction contract. Currently, an exclusion order can only disapply the whole of the Construction Act 1996, an “all or nothing” power. Under the new arrangements, it will also be possible for the devolved authorities in Scotland and Wales to issue their own exclusion orders; or not to issue an exclusion order which has been introduced to England.

The Government explained that this new approach would “allow us to ensure that many of the valuable features of the1996 Act, as amended by this Bill, continue to apply … while giving us the flexibility to deal with specific issues of direct concern. The legislation could also respond proportionately to future contractual innovation”.

There has been some speculation that this new power could be used to disapply the provisions of the Construction Act to PFI contracts. This would provide a way round the current difficulties whereby the project agreement between the public entity and the project company is excluded from the Construction Act by virtue of the Exclusion Order, but the PFI subcontracts are caught by its provisions.

The key provisions of the LDEDC Act

The amended Construction Act will:

  • abolish the requirement for construction contracts to be “in writing”; the Construction Act will therefore apply to oral, partly oral and written construction contracts;
  • introduce a right for the adjudicator to correct a clerical or typographical error and a right for the parties to agree that the adjudicator can allocate costs, fees and expenses of the adjudication;
  • make wholesale amendments to section 110 and section 111 of the Construction Act, introducing a new regime for payment provisions in construction contracts;
  • prohibit clauses which make payment conditional upon the payer’s entitlement under another contract;
  • entitle a contractor, in the event of non-payment, to exercise a statutory right to suspend part of his work and enable the contractor to recover the cost of re-mobilisation and extensions of time as a result of such suspension; and
  • clarify the effect of the House of Lords decision in Melville Dundas v George Wimpey [2007] UKHL 18 in the case of contractor insolvency.

Key implications of the LDEDC Act

  • The payment provisions are far from straightforward; and may well give rise to difficulties in practice.
  • The provisions prohibiting clauses which make payment conditional upon the payer’s entitlement under another contract will have significant implications for PFI projects.
  • The introduction of a right to suspend performance of part only of the contractor’s obligations in the event of non-payment may lead to increased use of this remedy particularly by sub-contractors.

Local Democracy, Economic Development and Construction Act 2009: the detail

Contracts in writing

Currently, section 107 of the Construction Act requires a construction contract to be “in writing” before its provisions apply. The LDEDC Act repeals section 107. As a result, the Construction Act will apply to oral and partly oral, as well as to written, contracts.

However, the adjudication provisions of a construction contract will be required to be in writing. This means that the parties will need to include in their contracts an adjudication procedure compliant with the requirements currently set out in section 108 (2) (3) and (4). In default of the inclusion of a compliant adjudication procedure, the Scheme adjudication provisions will apply. The LDEDC Act also introduces a new requirement for the adjudication procedure to include a written provision permitting an adjudicator to correct his decision so as to remove a clerical or typographical error arising by accident or omission (section 108 (3A)).

Adjudicator’s costs

The Construction Act is currently silent on who pays the costs of adjudication. In the future, the parties will be able to agree in their construction contracts that the adjudicator has the power to allocate costs, fees and expenses; or to agree this in writing after the notice of intention to refer has been served (section 108A (2) (b)).

New payment/withholding notice regime

The basic entitlement of a party to receive regular payments under a construction contract is not altered. Equally, the construction contract will still need to provide an “adequate mechanism” for determining what payments are due and to provide for a final date for payment. What will change is the regime of payment and withholding notices.

The current section 110(2) payment notices are to be replaced with section 110A notices which are “payer” notices of the sums considered due. A ‘specified person’ (that is, a person specified in the contract such as an architect, engineer or employer’s agent) may issue a ‘payer notice’ on behalf of the employer. This notice is to be given not later than five days after the payment due date. Provision is also made for “payee” notices under section 110B where the payer fails to give the appropriate section 110A notice.

Both types of notices must specify the amount the party considers due and the basis of the calculation of that sum. The amount set out in the “payer” or “payee” notice becomes the “notified sum”.

A payment notice should still be issued even if the notified sum is zero.

If the construction contract does not comply with section 110A (1) then the relevant payment provisions of the Scheme will apply.

A point to note is the issue of the payee notice in circumstances where the payer has failed to issue the appropriate payer notice. The provisions of section 110B (4) when combined with section 110 B (2) make it clear that in those circumstances, if the payee has already submitted a payment application as part of the payment process, then that payment application is deemed to be the payee notice. The payee will not be required to issue a separate payee notice. It is therefore in the payer’s interests to make sure that its payer notices are issued on time.

Section 111 withholding notices are to be replaced with a section 111 notice “to pay less than the notified sum” (counter-notice). The new section 111 will require the payer to pay the notified sum on or before the final date for payment, unless the payer issues a counter notice. This notice must be given not later than the prescribed period - agreed by the parties or in default of which set out in the Scheme - and set out the sum that the payer considers due and the basis for the calculation of that sum.

The payer will be required to pay the amount it considers due (where it has served a counter notice) before the final date for payment. Where the amount of payment is disputed but the adjudicator determines that a further amount is due, that sum must be paid not later than 7 days after the adjudicator’s decision or the date which would have been the final date for payment, whichever is later.

Finally, there are no equivalent provisions to the current provisions entitling a payer to serve only one notice which doubles as a payment notice and a withholding notice.

Conditional payment provisions

There is no specific amendment to section 113 (prohibition of conditional payment provisions) which prohibits pay-when-paid clauses, except where a payer itself is not paid because of a third party’s insolvency.

However, a new section 110 (1A) provides that a payment provision will not be "adequate" if it makes payment conditional on (a) performance of obligations under another contract or (b) a decision by a person as to whether obligations under another contract have been performed. In other words, a payment mechanism cannot seek to link to obligations under another contract. The stated intent is to avoid scenarios where one sub-contractor finds that payment is conditional upon certification being given under the main contract, where this certification cannot be given until another sub-contractor has completed its works.

New section 110 (1C) creates an exception to this general prohibition on pay-when-certified clauses by stating that the prohibition does not apply to construction contracts where the works are to be carried out by a third party under a sub-contract or similar arrangement. This is designed to allow, as the explanatory notes state “payments in a superior contract … to continue to be dependent on the work carried out in a sub-contract”. The exception therefore permits payment arrangements in which the amount payable to a contractor depends on an assessment of work performed by sub-contractors. Payment arrangements such as those contained in management contracting arrangements will still be acceptable.

However, the new section 110 (1A) is likely to cause difficulty for PFI contracts and equivalent project relief clauses. The effect of such clauses is that the sub-contractor only becomes entitled to payment under the sub-contract if and to the extent that the project company has become entitled to such payment under the project agreement and usually expressly require that the sub-contractor has complied with the terms of the PFI contract or that certification has occurred under the PFI contract. These mechanics are designed to keep the project company (usually just a thinly capitalised project vehicle) whole. If such provisions are no longer capable of constituting adequate payment mechanisms and are ineffective, there will be an increased emphasis on other fall back mechanisms in PFI contracts.

Pay when notified

New section 110 (1D) provides that a payment mechanism which provides that the giving of a payment notice by the payer will determine when payment becomes due under the contract will not constitute “an adequate payment mechanism”. Therefore, any provision in a construction contract which provides that the due date for payment commences when a payment notice is given is therefore ineffective.

Insolvency and new section 111

A new provision is introduced to limit the effect of the decision in Melville Dundas v George Wimpey [2007] UKHL 18. In that case, the House of Lords decided that the payer could legitimately withhold monies even though no withholding notice had been served, in circumstances where the payee had become insolvent after the period for giving a withholding notice had expired and the contract included a provision which provided that monies need not be paid in the case of the payee’s insolvency.

New section 111 (10) is intended to clarify that the scope of the decision will not be extended to allow events set out in specific contract provisions to override the requirement to serve counter notices. To this end, the new section 111 (10) will not require payment of the notified sum to be made in insolvency situations where (a) the contract allows withholding of sums due in cases of insolvency and (b) the insolvency occurs after the expiry of the time for giving the counter notice. In other words, if the contractor were to become insolvent before the employer had the opportunity to serve a counter notice then the employer would still be required to serve the relevant counter notice.

Suspension and remobilisation costs

Currently section 112 allows a party to a construction contract to suspend performance of all of their obligations under a construction contract in the absence of payment.

The right to suspend for non-payment under section 112 will be enhanced under the new provisions. First, a party will be entitled to suspend part of his obligations. Secondly, the suspending party will be entitled to be paid a “reasonable amount in respect of costs and expenses reasonably incurred” as a result of such suspension. This would include costs associated with removing plant and equipment and re-mobilisation costs. Finally, in addition to the current right to seek an extension of time covering the period of the suspension, the suspending party will be entitled to time “in consequence” of exercising the right to suspend. This would include extra time to re-mobilise staff and to return plant and equipment to the site.

It is likely that the right to suspend could become much more frequently used than in the past when contractors could only suspend all of their obligations as it is likely to be seen by payees as an effective way to secure payment without embarking on adjudication.

Summary

It has taken over five years and two consultations for the review and amendments of the Construction Act to be put in place. The next step involves the amendments to the Scheme and consultation followed by the announcement by Ministers of the commencement date when the revised legislation comes into force.