11 December 2019
In this case, the Court of Appeal gives useful guidance on adequate payment mechanisms under the Construction Act, as well as how to apply the payment provisions in the Scheme for Construction Contracts.
Bennett was the main contractor of a new hotel in East London and Verbus were contracted by Bennett to design, supply and install a number of pre-made modular bedroom units for the hotel.
The parties used some of the standard contractual terms from the JCT Design and Build sub-contract form, but chose to amend the payment terms, opting for a payment mechanism based on milestones. Some of these milestones were linked to a sign-off element of the works but the requirement of a sign-off was not defined clearly in the sub-contract.
A problem arose when Bennett alleged the prototype of the bedroom units and the bedroom units themselves, produced by Verbus, were not compliant with the sub-contract. There was therefore no actual sign-off of the prototype or the units, and a dispute arose surrounding the payments and the sign-off requirement.
At first instance it was held that the milestones in the sub-contract linked to a sign-off element were not an adequate payment mechanism as required by ss109 and 110 of the Construction Act.
In the judge's view the payments linked to a sign-off element were to become due on the date on which sign-off physically took place. The reference in the sign-off to the contractor or the underlying client who potentially could refuse sign-off of the units even if they had reached the necessary stage of completion, meant that sign-off was too uncertain and vague.
The judge therefore went on to apply the payment provisions in paragraphs 2,4 and 5 in the Scheme for Construction Contracts in a wholesale fashion. The consequence of this application of the Scheme was that the basis of the payments which the parties had agreed was entirely disregarded; milestone payments based on stages of progress were turned into interim payments calculated by reference to the value of the works in the relevant periods.
On appeal, Coulson LJ held instead that the milestone payment provisions in the sub-contract were adequate for the purposes of ss109 and 110 of the Construction Act. The sign-off requirement was to be interpreted objectively denoting the state in which the prototype and units were to reach before payment became due; it did not require a physical sign-off.
However, importantly, the Court of Appeal went on to consider how the Scheme should be applied had their finding been that the payment mechanism was inadequate under the Construction Act. In doing so, the Court of Appeal drew a distinction between Part I of the Scheme (provisions on adjudication) which is to be applied wholesale, and Part II of the Scheme (provisions on payment) which is to be applied in a piecemeal fashion.
Coulson LJ emphasised the importance of finding a way to apply the payment provisions in the Scheme that did as little harm as possible to the parties' original agreement. The Scheme was not designed to delete a workable payment regime which had been agreed by parties and replace it with an entirely different regime.
In this particular case, Coulson LJ considered paragraph 7 of Part II of the Scheme to be a catch-all provision and suggested it would be the most appropriate provision to apply where the parties have agreed a milestone payment mechanism. This would result in payment becoming due on the later of the expiry of 7 days following completion of the work to which the payment related, or the making of the claim by the payee. Importantly, this would maintain a mechanism whereby payments fell due with reference to the stage of progress of the works and avoid the implication of a payment arrangement by reference to interim valuations. This resulted in a payment arrangement that did "the least violence to the agreement between the parties".
It is clear that milestone payments can be an adequate payment mechanism for the purposes of ss109 and 110 of the Construction Act.
However, this case also demonstrates the importance of ensuring that payment provisions in construction contracts are expressed clearly and in specific terms. Parties should give thorough consideration to when payments are to fall due and any requirements surrounding payments. This is particularly important given that the fall-back provisions within the Scheme are to be applied in light of the parties' agreement and to give effect to their intentions as far as possible.
The Court also confirmed the view that where the contract provisions are not Construction Act compliant, the payment provisions of the Scheme are to be applied in a piecemeal fashion, only where necessary, as opposed to the adjudication provisions of the Scheme which are to be applied wholesale.