Construction Act update: the unwritten rules of construction contracts

Posted: 29/11/2012

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Last year Part 8 of the Local Democracy, Economic Development and Construction Act 2009 (Construction Act 2009) introduced a series of changes to Part 2 of the Housing Grants, Construction and Regeneration Act 1996 (Construction Act 1996). As a result, all construction contracts used in the UK (including building contracts, professional appointments and sub-contracts) entered into after 1 October 2011 must now comply with the new changes in the law.

The Act’s changes were introduced at a time of growing concern in the construction industry over late, disputed and non payment in construction contracts and an overall desire to the widen access to adjudication. A year on, and the Act has had a relatively smooth first year avoiding the tumultuous effects predicted on adjudication and the mass confusion over the complex new payment mechanism. Importantly, the courts have hardly been troubled by the Act in its first year.

The major changes brought about by the Construction Act 2009 related to:

• the adjudication process; and
• payment provisions.  

These are mandatory changes and parties cannot contract out of them. In addition, construction contracts that do not comply with the amendments will automatically have the new rules implied into them by the Scheme for Construction Contracts as amended (the Scheme).

Adjudication

Oral contracts

Under the old rules, a party had the right to refer a dispute to adjudication implied into the contract provided that the contract was in writing and for the carrying out of construction operations. Under these old rules, adjudication became the most commonly used mechanism of formal dispute resolution in the construction industry.

The Construction Act 2009 aims to build upon this trend. Under the amendments, oral and part oral construction contracts will now also have the right of adjudication automatically implied into them.

While adjudication clauses themselves must still be in writing to be valid, if they are not then the Scheme will automatically imply the right to adjudicate into the construction contract.

• Parties should still follow the age old advice of ensuring that the contract is clearly and fully set out in writing.
• Parties should ensure they mark pre-contract negations as “subject to contract” to make it explicitly certain that they are not later deemed to be part of the contract.
• The flood of adjudications over oral contracts has not yet occurred. When adjudicators are asked to adjudicate on oral contracts they will first have to take on the unenviable role of determining firstly what was said to form the contract. It is likely this process will result in more decisions being taken to the courts.

Adjudication costs

Previously the law was silent on how the costs and fees of an adjudicator should be awarded between parties. This had led to the prominence of Tolent clauses in contracts – clauses which stipulate that the referring party is to be responsible for the adjudicator’s costs, and in some instances even the legal costs of the responding party. Such clauses were often used by main contractors to deter sub-contractors from referring disputes to adjudication.

The Construction Act 2009 shifts away from this approach and provides that any contractual provision inserted by parties that seeks to pre-allocate the costs of the adjudication will be ineffective unless:

• the clause allocating liability is in writing; and
• provides the adjudicator with the power to allocate his fees and expenses between the parties.

If, however, the parties agree in writing to apportion the liability of the costs of the adjudicator after the notice of intention to refer the dispute for adjudication has been issued the apportionment will be effective.

If neither of the above scenarios apply then the Scheme will imply into the contract a provision giving the adjudicator the power to apportion payment of his fees and his expenses between the parties. As was previously the case, both parties remain jointly and severally liable for the unpaid fees of the adjudicator.

While the parties can in theory still agree to apportion their own costs of the adjudication it is unlikely that this was the objective of the legislation. It would be best practice for parties to avoid pre-allocating costs of adjudication under the contract for fear of being on the end of a test case decision that clarifies the law.

Slip rule

Under the new rules adjudicators now have a statutory power to correct any “slips” or minor typographical errors in their decision. This confirms the position that the courts had adopted and verifies what has become standard practice. The new rules set no time limit in which “slip” amendments must be made, however, case law suggests that the correction should be made within a reasonable timeframe.

Payment

The Construction Act 2009 creates a new statutory payment mechanism, including new payment notices and a positive obligation on the payer to pay the notified sum. It is important to check that the standard form you are using is compliant with the new rules.

“Pay when paid” and “Pay when certified” clauses

Construction contracts must still include an “adequate mechanism” for payment which sets out what needs to be paid and when, and provides a final date for payment. The old rules had prohibited “pay when paid clauses” with the aim of securing the flow of cash down the construction supply chain. The amendments further curtail the use of “pay when certified” clauses, whereby a contractor’s obligation to make payment to a sub-contractor is linked to certain obligations under the main contract i.e. the issues of a certificate or the allocation of monies.

There are two exceptions to the prohibition on “pay when certified” clauses. Firstly, where the construction contract is an agreement between two parties which requires a third party to carry out construction operations (that is, a management agreement). Secondly, for first tier PFI sub-contracts where the contractor only becomes entitled to payment by the Project Company once it has become entitled to payment under the Project Agreement.

Payment notices

The amendments create a new set of notice requirements for payments made under the contract.

A “payment notice” must be issued no later than 5 days after the “payment due date” under the contract. The notice must specify the sum due and the basis on which it is calculated. A payment notice can now be given by the payer, a “specified person” (such as an architect or quantity surveyor) or payee depending on what the contract dictates. Even if no money is considered due, a notice for a zero sum must still be issued on the contractual date.

The amount stated in the payment notice becomes the “notified sum”.

Positive obligation to pay

The new legislation imposes a positive obligation on the payer to pay the “notified sum” in the payment notice on or before the final date for payment. This is subject to the payee issuing a “Pay Less Notice”.

Pay Less Notice

The old rules intended to improve cash flow in the construction industry by preventing the practice of withholding payment for unsubstantiated claims not communicated to the other side. If a party wanted to withhold payment then the only way this could be done was through serving a “Withholding Notice”.

The new rules replace “Withholding Notices” with “Pay Less Notices”. A “Pay Less Notice” operates similarly and gives the payer (usually the employer) the right to specify the sum it considers is due to the payee (usually the contractor) if it believes that the “Payment Notice” is wrong. “Pay Less Notices” must specify the sum the payer considers due and the basis of the calculation.

The sum stated in the “Pay Less Notice” becomes the “notified sum” that the payer must pay before the final date for payment.

The only TCC case to consider in detail the new payment provisions has made it clear that in the absence of a “Pay Less Notice” the “notified sum” must be paid regardless of any later counter claim.

Suspension rights

Under the Construction Act 1996, if a sum due was not paid in full by the final date for payment and a “Withholding Notice” was not issued, the contractor acquired the right to suspend his performance under the contract. The new rules enhance this right so that the contractor can now:

• suspend performance for all or part of his obligations under the contract;
• claim a reasonable sum in respect of his costs and expenses incurred as a result of suspending performance; and
• claim an extension of time “in consequence” of exercising his right to suspend (i.e. time for the re-mobilisation of staff and equipment). This is in addition to the current right to seek an extension of time for the actual period in which the work is suspended.

Construction contracts that fail to comply with the new payment provisions will have the new rules implied into them by the Scheme. As is the case with adjudication, it is no longer necessary for a construction contract to be in writing for the amended payment provisions to apply.

The courts have traditionally been hesitant to imply terms into construction contracts relying on parties to manage their own performance and take responsibility for agreeing terms between themselves. Through the Construction Act 2009, Parliament has chosen to imply terms into all UK construction contracts. A failure to identify these implied terms at the outset will mean that on important issues such as payment and adjudication the contract might not mean what it actually says on the face of it.

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