Whilst parties are free to determine what their payment provisions will be, it is important to remember the importance of the provisions of the Housing Grants Construction and Regeneration Act 1996 Part II as amended by the Local Democracy Economic Development and Construction Act 2009 (“the Act”). In this case, the Court of Appeal considers the relationship between milestone payments agreed between the parties and the requirements for a payment mechanism to be compliant with the Act.
Section 109 of the Act provides an entitlement for a party to a construction contract to be paid by “instalments, stage payment or other periodic payments”. Section 110 of the Act supplements section 109 by requiring an “adequate mechanism for determining what payments become due under the contract, and when”. Failure to comply with these sections of the Act means that the Scheme for Construction Contracts (the “Scheme”) applies and implies certain default payment provisions.
This case is of particular importance for milestone payments and put to test the sections above. Bennett was the main contractor for the construction of a new hotel in Woolwich, London. Bennett entered into a sub-contract with CIMC to design, supply and install 78 prefabricated bedroom units for the hotel. The sub-contract between the parties incorporated the JCT Design and Build Sub-Contract 2011 edition, but provision for interim payment was replaced by various Milestones which provided for percentage payments of the contract sum:
- Milestone 1: 20% deposit payable on execution of the contract.
- Milestone 2: 30% on sign-off of prototype room by Park Inn/Key Homes/Bennett in China.
- Milestone 3: 30% on sign-off of all snagging items by Park Inn/Key Homes/Bennett in China.
- Milestone 4: 10% on sign-off of units in Southampton.
- Milestone 5: 10% on completion of installation and any snagging.
Milestones 2, 3 and 4 provided for payment on “sign-off” of modular units at various stages. During the works, the parties disagreed what “sign-off” meant. Bennett stated that the prototype did not comply with the contract and there were defects, as a result, there was no “sign-off” of the relevant Milestones.
The parties took the matter to adjudication leading to a decision in Bennett’s favour. However, CIMC issued proceedings and at first instance in the TCC (reported as CIMC MBS Ltd v Bennett (Construction) Ltd  EWHC 2440 (TCC),  7 WLUK 417), they obtained a decision that Milestones 2 and 3 (but not 4) did not comply with the Act (s.110(1)(a)) in relation to an adequate payment mechanism. In conclusion, it was held that Milestones 2-5 should be replaced with paragraphs 2,4 and 5 of the Scheme. This resulted in a liability on Bennett to make interim payments by reference to the value of the work carried out, regardless of whether or not the works had reached a stage where it could be signed off.
Bennett appealed against the decision that it was liable to make interim payments to CIMC. Lord Justice Coulson disagreed with the TCC and held that the contract did in fact contain adequate payment mechanisms. He held that Milestones 2 and 3 were compliant with the Act and concluded that an objective interpretation of “sign-off” meant when the units were complete and, in a condition, where they could be signed off (that is, they complied with the contract specification). He rejected a subjective interpretation that payment was not due until the date sign-off actually occurred.
This case is a reminder that where payment provisions in construction contracts do not comply with the Act, Part II of the Scheme is implied, but only to the extent that such implication necessary to achieve what is required by the Act. In effect, the Courts will step in to amend contracts to ensure that they comply with the Act – but they will only do so with the lightest of touches. Lord Justice Coulson said:
“"…. the [underlying] purpose of the Act was to provide for certain minimum, mandatory standards so as to achieve certainty and regular cash flow. Save in perhaps exceptional circumstances, it was not designed to delete a workable payment regime which the parties had agreed, and replace it with an entirely different payment regime based on a radically changed set of parameters. It seems to me that that could only happen where the regime which had been agreed was so deficient that wholesale replacement was the only viable option. That is plainly not this case”
The ruling of the Court of Appeal highlights its commitment to honour the payment regime actually agreed between the parties. Lord Justice Coulson describes the commercial effect of the TCC decision as “stark and effecting a significant reapportioning of the commercial risk which the parties had agreed”. He continued that “it would take very clear wording in the Act in order to bring that about”. The ruling in this appeal make it clear that the Act does not contain such words.
This is an important decision of the Court of Appeal clarifying the correct approach to applying the Schemes provisions where the payment provisions of a construction contract may not satisfy the requirements of the Act. It is warning that at the point the contract is being drafted and negotiated, the parties need to ensure the payment provisions are clear and reflect the deal both parties have agreed. The Act’s provisions will provide a backstop position, but it has been made clear that there will be focus on the apportionment of commercial risk agreed by the parties in the outset. The Court sets out to make it clear that the contractual provisions will be preserved where possible, and only deficient provisions should be replaced.
These notes have been prepared for the purpose of an article only. They should not be regarded as a substitute for taking legal advice.