In 2009 Parliament enacted changes to Part II of the Housing Grants, Construction and Regeneration Act 1996 (“the Construction Act”).  They will apply to construction contracts (as defined) entered into from 1 October 2011 (insofar as England and Wales are concerned) and 1 November 2011 (Scotland).  The Construction Act, in requiring certain minimum provisions for payment and adjudication, does not (in its current and amended forms) apply as well as it might to the diversity of construction contracts it covers.  The problems arising from the Act’s “one size fits all” approach are particularly apparent in the case of PFI and PPP arrangements.

The 2009 changes insert a new section 110(1A) into the Construction Act.  That section seeks to ban, amongst other things, terms in construction contracts that make payment conditional on obligations being performed under another contract.  Examples would be “pay-when-certified” and “pay-what-certified” (collectively, “PWC”) provisions which make a subcontractor’s right to be paid conditional on a corresponding payment being certified to the contractor under the main contract.  The principal aim of the Construction Act’s payment regime is to help cash flow, in this example the subcontractor’s cash flow.

Different concerns generally arise where the subcontractor is a first tier subcontractor in a PFI or PPP arrangement and in contract with a ProjCo (a special purpose vehicle that has contracted under a project agreement with a public authority).  First tier subcontractors (that construct the asset or operate and maintain it) often themselves or through their parent or sister companies have an interest in ProjCo.  It suits them (and even more so the lenders who provide project finance) to limit the cash flow exposure of ProjCo.  As ProjCo’s only income is that which it receives under the project agreement, it is necessary to minimise or avoid ProjCo having to pay any sums to first tier subcontractors until ProjCo receives a corresponding sum.  Often the subcontractors’ entitlements, not just for payments, are made co-extensive with ProjCo’s corresponding entitlements under the project agreement by way of an Equivalent Project Relief (“EPR”) provision. 

Unfortunately, the Construction Act (in its current and amended forms) fails to see that PFI and PPP arrangements benefit from this approach to cash flow, rather than suffer from it. 

When the Construction Act came into force in 1998, government acknowledged the special nature of PFI arrangements by providing that PFI project agreements did not have to achieve the Act’s minimum standards for payment and adjudication. This Exclusion Order particularly benefited public authorities while ProjCos still had to meet those standards in first tier subcontracts.

Early on in the consultation for changes to the Construction Act (in 2004) government rejected taking any further specific action in respect of PFI and PPP arrangements.  However, after much lobbying, very late in the parliamentary passage of the Act’s changes, a power was inserted allowing yet to be specified construction contracts to be excluded from the Act’s provisions in part rather than wholesale (as per the original Act). 

The draft Exclusion Order for England published earlier this month (and now before Parliament for its approval) will disapply section 110(1A) from first tier PFI and PPP subcontracts.  That is, it seeks to permit EPR provisions.  (Similar Exclusion Orders for Wales and Scotland have been published in draft and are expected to come into force by 1 October and 1 November 2011 respectively.)

Curiously, however, the draft Exclusion Order does not also disapply section 113 of the Construction Act (which an explanatory note says is intentional).  Section 113 bans clauses that make payment to, say, a subcontractor conditional on the main contractor first receiving payment itself (unless its payer is insolvent); that is “pay-when-paid” (“PWP”) clauses – which have the same aims as PWC clauses.  There is no good reason not also to disapply section 113 to first tier PFI and PPP subcontracts and it would be far better if the Exclusion Order did so.  That is because, as previously reported in Law-Now (click here) Mr Justice Jackson (now Lord Justice Jackson) said in Midland Expressway Ltd v Carillion Construction Ltd (No.2) that section 113 cannot be avoided by “by the use of circumlocution”.  That is, he held that section 113 should be applied with its purpose in mind such that it renders invalid not just PWP but also PWC clauses, an example of which was in the EPR clause in that case and was not applied.

The same concern may not survive the Exclusion Order, as it is potentially persuasive authority on the meaning of section 113, such that after 1 October 2011 it only strikes down PWP (and not PWC) clauses in PFI and PPP first tier subcontracts.  On the other hand, though, the courts may interpret the Exclusion Order as maintaining how section 113 was applied in Midland Expressway, such that PWC as well as PWP clauses would be rendered invalid in PFI and PPP first tier subcontracts (i.e. EPR provisions, as far as deferring payment is concerned, retain the same risk of not working as they do now).  Unfortunately this is another example of less than clear drafting in the changes to the Construction Act.  At best, the Exclusion Order is a missed opportunity; at worst it will have no effect.  It is hoped that the government will act and as part of our continuing involvement in the Act’s changes, we are lobbying the government to that effect.

Reference: The Construction Contracts (England) Exclusion Order 2011.