Construction contracts and cash
“Cash is king”; “cash is the lifeblood of construction”; “cash flow is everything”. These phrases are bandied around commonly, and perhaps too lightly. The message is serious and it is very real. Profit margins are often low in construction, insolvencies are frighteningly common and the impact of covid-19 on the economy has only worsened the situation in 2020. Getting paid the right amount, on time, is more important than ever; so ensuring clarity and certainty in payment provisions is too.
Drafting clauses that are compliant with the Construction Act and that line up with internal accounting mechanisms is not straightforward. All too often the process becomes unclear, convoluted or is not applied in practice, leading to arguments over payment and creating opportunities for payment to be withheld. To help get it right, here is a refresher and update on payment, especially in light of the recent decision in Rochford v Kilhan.
What the Construction Act Requires
First, a quick reminder that the Construction Act says each construction contract must include:
- Stage payments, e.g. monthly assessments or milestone payments.
- An adequate mechanism for determining what amount becomes due for payment and when.
- A final date for payment of the sum due, so there is certainty over when payment will be made.
- For one party to provide a payment certificate notifying the sum that is due to be paid and the basis for its calculation, within 5 days of the due date. In the absence of a payment certificate, the recipient’s application for payment can stand as a payment notice in default.
- For a valid pay less notice to be issued by the payer if it intends to pay less than the notified sum within a prescribed period before the final date for payment.
Implied Terms Under the Scheme
If any of the above requirements is deficient or missing, then the equivalent provision from the Scheme for Construction Contracts will be implied into the contract in its place.
If the payment structure agreed by the parties is challenged, the Court will try to uphold it as far as possible and will imply only what is necessary. In Manor Asset v Demolition Services, for example, the Court worked hard to interpret the contract as compliant. It upheld “seventy-two hours of receipt of invoice” as the final date for payment. In consequence it found that the parties must have agreed that a pay less notice could be given right up to the final date for payment, i.e. nil days beforehand. The quid pro quo for fast payment was short notice of any intention to pay less. The Court also found that the due date must be the achievement of a milestone because that was what triggered the right to issue the invoice.
" Drafting clauses that are compliant with the Construction Act and that line up with internal accounting mechanisms is not straightforward. All too often the process becomes unclear, convoluted or is not applied in practice, leading to arguments over payment and creating opportunities for payment to be withheld. "
Where it is not possible to rely wholly on the parties’ own drafting, the Court in Yuanda v Gear confirmed that parts of the Scheme can be implied piecemeal so that only offending clauses will be replaced by their corresponding provisions. It is not the case that the entire payment process will be replaced by that of the Scheme (as is the case with non-Construction Act compliant adjudication provisions).
Only in exceptional cases will the entire payment provisions of the Scheme be imported. This was confirmed in Bennett v CIMC MBS in which HHJ Coulson stated “that could only happen where the regime which had been agreed was so deficient that wholesale replacement was the only viable option”. Consequently, if contractual payment terms are challenged, the ultimate result may be a combination of express terms and others implied by the Scheme.
Rochford v Kilhan
This case saw Cockerill J wrestle with uncertain payment terms but ultimately fall back on the Scheme almost entirely. Kilhan issued an interim payment application dated 20 May 2019 for £1.4m, but did not invoice until October 2019. On 23 October 2019 Rochford issued a payment certificate for £1.2m. Kilhan adjudicated for the balance and won, but Rochford challenged the point in Part 8 proceedings. Cockerill J had to determine the due date, validity of the payment certificate and final date for payment.
Decision: Due Date
The parties had not agreed a due date so paragraph 4 of the Scheme applied, meaning it was the date of Kilhan’s application, 20 May 2019.
Rochford had argued that the application was invalid because it should have been issued on the last day of the month based on the contractual provision “valuation monthly as per attached payment schedule end of month”. The Judge dismissed Rochford’s argument on the basis that it was not what the contract said, not what the parties had applied in practice and was practicably unworkable especially because there was no payment schedule.
Decision: Validity of Payment Certificate
The Construction Act requires payment certificates to be issued within 5 days of the due date and, as this one was not (being dated 23 October 2019), it was not valid. That meant Kilhan’s application stood as the payment certificate in default. Consequently, as the payment certificate was invalid and there was no pay less notice, Rochford should have paid the notified sum in the application of £1.4m.
Decision: Final Date for Payment
The contract stated that payment terms were 30 days from invoice, but the invoicing arrangements were linked to a payment schedule that did not exist and included uncertain payment certificate references. The intended position was insufficiently clear, so the Judge inserted paragraph 8 of the Scheme which states that the final date for payment is 17 days after the due date, reducing the payment terms that Rochford thought it had agreed by almost half.
Obiter, the Judge stated that the final date for payment should be a fixed period of time linked to the due date. It should not be set by reference to an invoice (for example) because that did not make the timing sufficiently certain.
Those unfamiliar with the Construction Act often base their payment provisions around invoices and invoicing requirements. This case is another reminder that when scrutinising contractual payment provisions, the Court is not interested in the invoicing process, but only in the requirements of the Construction Act and the certainty of timescales. Careful drafting is needed to provide for and align the two. Otherwise, the replacement of agreed terms with parts of the Scheme (and its relatively short timescales) will follow.
In Rochford v Kilhan the contract referred to a payment schedule that did not exist. If it had done, the Judge said that “it seems far less likely this dispute would have arisen”. Whilst they are a useful and practical tool for managing payments, this is not the first time that payment schedules have tripped up parties and brought them to court.
Balfour Beatty learned this the hard way. It had agreed with Grove Developments a schedule with dates running up to the contractual date for completion. That date came and went but no extension to the payment schedule was agreed and Grove refused to make further payment until completion was achieved. The resulting argument was resolved in Balfour Beatty v Grove. Despite Balfour Beatty’s complaint that such a position made no commercial sense, the Court of Appeal (like the Court at first instance) held it to its bad bargain. It found that there was no agreement for interim payments beyond the last date in the schedule, until after completion.
A payment schedule also led to an adjudication and litigation in Bouygues v Febrey. The payment schedule included an error in the dates for one of the monthly payment cycles. The Court found that the date for the payment notice was obviously wrong because it was inconsistent with the pattern that applied to every other cycle. The schedule must be interpreted so that the payment certificate followed 5 days after the due date. Accordingly, Bouygues had not served a payment or pay less notice on time.
If the contract provides for a payment schedule then it must be drafted clearly and correctly, and incorporate a mechanism for its extension. Whilst updates to a payment schedule could be agreed during a project if delays materialise, that leaves a lot to chance. Agreeing an extension mechanism at the outset is probably easier and more certain.
Paying parties do not have to pay the sum demanded by the recipient in its application. They can choose to pay a lesser sum reflecting their own assessment. But, they can only do this if they have set out that sum and the basis for its calculation in either (a) the payment certificate (payment notice) or (b) in a pay less notice. In each case the notice must comply with contractual requirements for substance, form and service or it will be ineffective.
If the notified sum (i.e. that set out in the payment certificate, or payment certificate in default) is not paid and there is no valid pay less notice, then the recipient can launch a “smash and grab” adjudication to recover it. If the recipient succeeds, the paying party is permitted to counter with an adjudication over the “true value” of the sum due, provided that the sum ordered to be paid in the smash and grab adjudication is paid first (Grove v S&T).
The message is clear. The recipient should know what it is going to receive and is entitled to challenge a payment that is less than it expected.
When it comes to payment the TCC has consistently insisted that cash must keep moving. That is the underlying purpose of the Construction Act after all. The cases discussed above show that cash flows a lot faster if clear and compliant contractual processes are agreed and implemented. Easier said than done, but definitely something to aim for in these difficult times.