IMPROVING PAYMENT PRACTICES IN

THE CONSTRUCTION INDUSTRY

Report of the DTI’s post-consultation event

held in London on 14th February 2006

On Valentine’s Day 2006, the Right Honourable Alun Michael MP compared

the construction industry to ‘a multi-dimensional marriage’ in his keynote
address to the DTI’s post-consultation conference on improving payment
practices in the construction industry.1 Others were, I am sure, wondering if
the conference was going to bear any similarities to the infamous Valentine’s
Day Massacre of 1929!

On 1st May 1998, Part II of the Housing, Grants, Construction and

Regeneration Act 1996 (the Act) came into force. It sought to improve the
bitter relationships between the industry’s contracting parties. Largely due to
a lack of trust prior to the Act, conflicts and disputes were the norm; the Act –
heralded as one of the most important pieces of legislation to hit the
construction industry for decades – was set to change this.

The legislation introduced adjudication and payment provisions into written

construction contracts. The payment provisions dealt with parties’ rights to
stage payments, procedures for serving notices of sums due and sums to be
withheld, a right to suspend work for non-payment and (save in cases of
insolvency) a prohibition on pay-when-paid clauses. It was designed to
promote best practice and secure fairness and balance between parties to
construction contracts. But did the Act achieve its purpose?

A review of the Act was undertaken by Sir Michael Latham who presented his
report on 17th September 2004 to the then Construction Minister Nigel
Griffiths. The report identified key issues and suggested improvements to
both the adjudication and payment provisions. Following this, the DTI drew
up consultation proposals on improving the Act to enhance the delivery of
minimum standards in the contracting process as the construction industry
moved towards integrated construction supply teams and more collaborative
approaches to project delivery.

The consultation period ran from 22nd March until 21st June 2005. The 356
responses from the construction industry were considered and on 16th January

1 The Consultation Document, Improving Payment Practices in the Construction Industry,

Department of Trade & Industry, March 2005, can be found (together with the related
documents referred to below) at www.dti.gov.uk/construction/hgcra/hgcralead.htm.
2006 an Analysis2, including new Government proposals aimed at improving
payment, was published.

The new proposals include:

1. introducing a requirement that certification of the sum due, by one
of the contracting parties or a third party, becomes an essential
feature of contractual payment mechanisms;
2. removing the section 110(2) requirement for a payer notice;
3. introducing a right to apply for payment where a certificate is not
issued by the due date;
4. making certain payment mechanisms, including pay-when-
certified clauses, ineffective;
5. enhancing the existing right of suspension under the Act to allow
the suspending party to claim for loss and expense;
6. prohibiting the use of trustee stakeholder accounts for awards
made by adjudicators;
7. making ‘final and conclusive’ clauses unenforceable where they
apply to decisions under the contract that are of substance to
interim payments only; and
8. taking forward the Government’s existing commitment to make
contractual agreements on adjudication costs unenforceable and to
provide a statutory framework for allocating them, including cases
where adjudicators resign in response to a challenge to jurisdiction.

The post-consultation conference was part of the next step in the process,
which sees the Government working with the construction industry over the
coming months to ensure that when amendments to the Act are published for
further consultation, they are based upon a clear and thorough understanding
of all the issues and reflect the needs of the construction industry and its
clients.

One hundred and forty six key figures in the construction industry
(representing, amongst others, the Specialist Engineering Contractors’ Group,
the National Specialist Contractors’ Council, the Construction Confederation,
the Technology and Construction Solicitors’ Association, the Construction
Industry Council, the Construction Clients’ Group and the Society of
Construction Law) got together in one room to listen to some eminent
speakers discuss a variety of topics, including the future of business in the
construction industry, how the Act has been viewed by the Courts and how the
changes to be made to the Act will be implemented by using a relatively new
vehicle to reform legislation, the Regulatory Reform Order.

2 See the publication Improving Payment Practices in the Construction Industry – Analysis
of the consultation on proposals to amend Part II of the Housing Grants Construction and
Regeneration Act 1996 and Scheme for Construction Contracts (England and Wales)
Regulations 1998, Department of Trade & Industry, January 2006.
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Against this background, attendees participated in debates on specific
Government proposals in small groups, each group then reporting back their
findings and views on the issues. It is the participation in the debates and the
feedback from them which will help reform the Act. The discussion topics,
and a summary of the feedback received at the conference, are set out below.

The payment proposals

The question was: should there be a requirement that certification of the sum
due, by one of the contracting parties or a third party, becomes an essential
feature of contractual payment mechanisms? This was the only issue, in my
opinion, where there was considerable polarity in the views expressed by
different players in the construction industry.

The current problem is that Section 110(1) of the Act does not go as far as was
intended in providing certainty about what sums are due under a construction
contract and when. The Act states that every construction contract shall
‘provide an adequate mechanism for determining what payments become due
under the contract, and when, and provide for a final date for payment in
relation to any sum which becomes due’.3 It is left to the parties to each
construction contract to agree an ‘adequate mechanism’ and incorporate it.

The question of what amounts to an ‘adequate mechanism’ is a hurdle which

parties find hard to address. Not only are construction contracts failing to
provide a mechanism which offers certainty of what is due and when, but
responses to the consultation process indicate concern about the failure of
many contractual mechanisms to bring about effective communication of what
is due and when.

The proposal is for Section 110(1) to be amended so that certification of the

sum due becomes a contractual requirement. Where a certificate is not issued
(resulting in non-compliance with the contract), the payee would have the
right to issue an application stating the sum due. The date of the application
would then act as the due date, as it does under the Scheme for Construction
Contracts. The proposal is intended to create a clear understanding of what is
meant by the ‘sum due’ for the purposes of enforcing the requirement for
withholding notices under Section 111 and exercising the right of suspension
under Section 112 of the Act.

Many felt that to incorporate such a requirement into a contractual payment

mechanism prevented parties to a construction contract from being able to
freely negotiate their own terms. Many were also concerned that if, in the
absence of a certificate, a payee could apply for the sum due, the payee might
inflate the sum due and require payment of an incorrect amount. To counter
this argument, though, some said that if an interim payment was incorrect, it
could easily be adjusted at the next payment date after the work carried out
had been properly valued.

3 Section 110(1).
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Those against a statutory requirement to address this issue (by imposing on
parties clear obligations on how to deal in their contracts with certification of
the sum due, with the fallback position being that if parties fail to deal with
the issue in their contracts in the way which is prescribed by statute then the
Scheme for Construction Contracts (in an amended form) will apply), wanted
the current position under the Act to remain, with guidance covering best
practice, as opposed to legislation, which the industry could follow.

Those in favour of a statutory requirement to oblige certification of sums due

argued that this was the only way to provide certainty in respect of such an
important issue. Guidance was not something that people would necessarily
follow. The general feeling amongst this group was that there was a lack of
trust between parties and security of payment was not being offered in
contracts.

Sir Michael Latham commented that there had been considerable

improvement since the passing of the Act, and the way forward was to find a
solution which addressed the fact that it should be a proper amount which is
paid on time rather than an amount which someone demands as due or thinks
is due.

In addressing the issue of payment, the Government also proposes that the
requirement for a Section 110(2) notice under the Act is removed. It is
suggested that this notice is unnecessary because if a payer does not believe
he should pay what is due under the contract he can utilise the mechanism in
Section 111.

This proposal also caused concern. Many construction contracts adopt the
position under the Act whereby a payment may be withheld without a Section
111 notice being issued if the Section 110(2) satisfies certain criteria, thus
becoming effective as a notice of intention to withhold payment. However,
this arrangement depends on a Section 110(2) notice being issued. From a
timing point of view, the construction industry seems to prefer the issue of a
Section 110(2), which can also act as a withholding notice, rather than doing
away with this notice and relying solely on the service of a Section 111 notice
to determine what payment is to be made and how much is due.

Why? Because a Section 110(2) notice must be given ‘not later than five days
after the date on which a payment becomes due ….’4 This means that the
payee receives notice at the beginning of the payment process of what is
payable, how the amount is calculated, and (where the notice is capable of
acting as a withholding notice) how much is being withheld and on what
grounds. If a period between the due date and the final date for payment is
stipulated in the contract as being, for example, 30 days, the payee receives
his notification within the first 5 days of such period and has time to consider
if he agrees what is proposed and raise any issues with the payer.

4 Section 110(2)
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If the Section 110(2) notice is done away with and the issue of a withholding
notice is relied on to determine what is paid and when, reliance is being put on
a notice which can be issued ‘not later than the prescribed period before the
final date for payment’.5 The parties are free to decide what the prescribed
period is and in many contracts I have seen, the payer may issue a withholding
notice up to two days before the final date for payment. This is terrible news
for the payee as he may be working to budgets and cash-flow forecasts which
depend on him receiving money at certain times. If a payee only has two days
notice of what is being paid, this may not give him enough time to ascertain if
he agrees with the payment offered and raise any queries with the payer. It
also means that he can only refer the matter to adjudication if the amount is
disputed towards the end of the payment process – which will delay the
opportunity to receive money even further.

What is clear from the general views expressed at the conference, though, is
that there is consensus that the Act does not deal effectively with the question
of how and when a debt crystallises and, whatever happens, this issue must be
addressed.

‘Final and conclusive’ clauses

Should ‘final and conclusive’ clauses be unenforceable where they apply to
decisions under the contract that are of substance to interim payments only?

At the conference, a general consensus was reached on this issue. The

majority of attendees had no problem with the principle of making ‘final and
conclusive’ interim payment provisions unenforceable, thus allowing
adjudicators the right to open up such payment decisions.

However, some did mention that making such payment decisions

unenforceable would potentially impact on cases where a variation had been
instructed by the employer under the construction contract and a fixed quote
for carrying out that variation had been received from the contractor and
approved by the employer. In these cases, consideration should be given to
the fact that if an employer expects a variation to be carried out for a quoted
price, that price should not subsequently be capable of being opened up and
adjusted. This is something which will hopefully be borne in mind when the
amendments to the Act are drafted.

There was also general agreement that final payments under a contract should
continue to be capable of being ‘final and conclusive’, so that parties could
rely on some finality at the end of a project and draw the contract to a close.
However, it was felt that to promote fairness, all final payments should clearly
be marked as ‘FINAL’ by the payer (putting the payee on notice that a final
payment is being made) and that a final payment should be capable of being
challenged within a set time period prescribed in the contract. The JCT
contracts currently have a 28 day period within which a final payment can be

5 Section 111(2)
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challenged and attendees generally felt that it was sensible that a provision
along these lines was retained in all construction contracts.

Trustee stakeholder accounts

The question was: should the use of trustee stakeholder accounts for awards
made by adjudicators be prohibited? If so, this might lead to more claims in
court that the receiving party is insolvent, and the conference attendees were
asked whether they thought that the TCC’s guidance is sufficiently clear on
when it is likely to stay an adjudicator’s decision.

The general position at the conference was ‘yes’, the use of such accounts
should be prohibited. The ability of contracting parties to agree terms which
negate the effect of adjudication was a regulatory loophole that needed
closing.

The problem at the moment is that parties may contract on terms which allow
adjudicators’ awards to be paid into trustee stakeholder accounts pending final
determination of the dispute in the courts or by way of arbitration. This
prevents adjudication from being used in the way it was intended under the
Act. It may also have cash-flow consequences for the party in the dispute
which has suffered at the hands of the other.

There were limited circumstances where it was felt by some that the use of
such accounts should be accepted. These included circumstances where there
was a risk that the recipient of the award would become insolvent before the
dispute was finally determined and where an award of public money was
made.

However, it was agreed that the TCC’s guidance on when it is likely to stay an
adjudicator’s decision is sufficiently clear6 and, therefore, why should it not
be left to the courts alone to decide when a stay in enforcing an adjudicator’s
decision should be granted?

Interestingly, not many attendees had direct experience of the use of trustee
stakeholder accounts. One person who had had experience said that whilst the
contractual provision authorising the use of a trustee stakeholder account in a
dispute allowed the receipt of money into the account, there was no
corresponding provision explaining how the money would eventually be
released from the account!

‘Evidenced in writing’
The question was: is it correct that any amendment to Section 107 of the Act
on contracts evidenced in writing would need to take account of the courts’
emphasis on certainty of all the contract terms for adjudication to be
workable?

6 See Wimbledon Construction Company Ltd v Derek Vago [2005] EWHC 1086 (TCC).
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This question did not form part of the formal consultation process but the
Government is interested in the views of the construction industry and is
considering amending the Act to deal with the Court of Appeal’s decision in
RJT Consulting Engineers Ltd v DM Engineering (Northern Ireland) Ltd.7
The Court of Appeal held that on the proper construction of Section 107, it
was the terms, and not merely the existence of a construction contract, which
had to be evidenced in writing in order for the contract to fall within the scope
of the Act. The whole of the agreement had to be evidenced in writing, not
part of it, as writing provided certainty which was important when
adjudication, which would have to take place under a demanding timetable
and agreed procedure, was envisaged.

Respondents during the consultation process took issue with this decision on
three grounds – with which attendees at the conference generally agreed.8

1. When construction contracts are agreed, this is usually based on an

incomplete agreement of the contract terms, with an understanding
that a full agreement will be finalised in time. This is a
consequence of the industry’s advertising and tendering process
where tenders are submitted on the understanding that a particular
standard form of contract will be used. It is only after tenders are
submitted that bespoke contract amendments are put forward for
negotiation. It is the final process of agreeing the bespoke
amendments which is often not completed, opening up grounds for
a dispute as to whether the Act applies if the contract was never
properly finalised and fully recorded in writing.

2. The drafting of Section 107 is based on Section 105 of the

Arbitration Act 1996 which requires that an arbitration agreement
between parties to an arbitration should be evidenced in writing.
In that context, it is argued that the provision makes sense as there
is no statutory fallback where all the terms of an arbitration
agreement are not properly and fully recorded. It is suggested that
this provision does not make sense when interpreted in the context
of adjudication, and that the requirement that all contractual terms
should be agreed in writing is excessively narrow.

With adjudication, if, for example, the adjudication procedure is

not fully set out in the contract in accordance with the procedure
set out in Section 108, there is a statutory fallback procedure set
out in the Scheme for Construction Contracts which can be relied
upon. Therefore, if the adjudication procedure is not agreed in
writing, or with any certainty, the legislative framework can still
be effective. By similar argument, wherever the Scheme for
Construction Contracts provides a statutory fallback position in
respect of parts of the contract which do not comply with the Act,

7 RJT Consulting Engineers Ltd v DM Engineering (Northern Ireland) Ltd [2002] EWCA
Civ 270.
8 See the Analysis referred to in note 2.
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 any parts of the contract which are not fully agreed in writing but
are covered by the Scheme should not prohibit the contract from
falling within the ambit of the Act.

3. An adjudicator’s decision about what terms of a contract are

agreed can be equally complex whether or not the whole contract
is recorded in writing at the time the dispute is referred to
adjudication. Parties can still, at this time, dispute what is finally
agreed and whether all bespoke amendments are applicable.
Where an adjudicator is deciding a dispute on a contract which is
in the course of being negotiated and agreed during the progress of
the works, the making of his decision will also be based on an
extremely complex set of facts. In every case, the adjudicator’s
decision should be based on the evidence before him and the
balance of probabilities. The Court of Appeal’s narrow
interpretation of Section 107 means an adjudicator can only make
a decision on an agreement which is fully recorded in writing.

The thrust of the argument is that unless the requirements relating to contracts
being evidenced in writing are changed, many contracts may not be caught by
the Act which undermines the Act’s intentions. Without clarity of this issue, it
may be easy for a party to argue that there are terms which are not recorded
and, therefore, the whole contract is not in writing so the Act does not apply.
Those at the conference agreed that Section 107 should be amended so that
the UK has less stringent requirements for contracts to be evidenced in
writing. Where there is a mixture of written and oral terms, or even wholly
oral terms, these contracts should not be excluded from the ambit of the Act.
All contracts, no matter what their form, should be capable of being
adjudicated.

It was suggested that the Government should look at similar legislation in

other jurisdictions (which seem to work satisfactorily elsewhere), such as that
in New Zealand. Section 9 of the Construction Contracts Act 2002 generally
applies to ‘every construction contract that relates to carrying out construction
work in New Zealand … and is written or oral, or partly written and partly
oral’.

Suspension
In relation to the suspension proposals, the following questions were asked.
Should the remobilisation period be limited to a maximum period notified in
the notice of suspension? Should the suspending party seek the payer’s
agreement to provide certain services under the contract during the suspension
period to ensure statutory obligations are met and to reduce the costs of
remobilisation? Should the Act enhance the existing right of suspension to
allow the suspending party to claim for loss and expense?

Agreement on these issues was generally reached amongst attendees. The

conference decided that a suspending party should be entitled to recover loss
and expense in respect of any suspension and subsequent re-mobilisation.
This view also applied to any loss and expense suffered as a result of a
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suspended party having to return to site during a suspension in order to carry
out services to ensure that statutory obligations continued to be satisfied.

Regarding the period of re-mobilisation, it was generally felt that stipulating a

maximum period for re-mobilisation in a suspension notice was a non-starter.
Suspension is a right given to the innocent suspending party in circumstances
where the payer has not paid the sum due in full, and no effective notice to
withhold payment has been given. The payer’s breach could go on for a short
period or, in theory, indefinitely. It would really depend on how long the
breach subsisted before the suspending party would be able to indicate how
long it would take him to get back on site, following receipt of the sums due.

Where the breach is likely to go on for some time, the suspending party will
probably go off-site and secure work on another project, using and committing
his resources elsewhere, and making it harder for him to return to the site
quickly. It was felt that there is no good reason for forcing the innocent party
into a position where at the outset of the suspension, he must commit to
coming back on site within a maximum period. The only duty of the innocent
party in this respect should be to return to site as soon as reasonably possible,
ensuring that a return to site was, for the purposes of recovering loss and
expense, subject to all the usual rules of mitigation of costs.

Regarding the provision of certain services during a suspension period, it was

generally felt that this should not be done in order to reduce the costs of re-
mobilisation. Re-mobilisation costs are only going to be necessary because
the payer has committed a breach in the first place and, again, it was felt that
there is no good reason for obliging the innocent party to do anything on site
in the absence of being paid what is due to him.

However, when it came to providing services on site to ensure compliance

with statutory obligations (such as health and safety where the duties of, for
example, principal contractors and planning supervisors are on-going) the
conference decided that in these circumstances, permission from the payer to
go on site should not be sought or required at all. The suspending party
should simply have an immediate and unquestionable right to go on site at all
times when required to do so in order to comply with his statutory obligations.
The only thing the suspending party ought to do in these circumstances is
notify the payer that he is going on site to carry out services in pursuance of
such obligations.

The additional costs incurred by the suspending party in carrying out his
statutory obligations (the cost of providing these services is likely to be more
than originally priced for because labour and materials are not permanently
on-site) should be recoverable by the suspending party through a loss and
expense claim.

Shortly after the issues had been debated, the conference concluded and, I
might add, without any blood being spilt! In fact, people addressed the floor
and said that given the bad times and the bad relationships within the industry
which existed prior to the Act coming into force, it was amazing to see so
many different players in the industry get together in one room, quite

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amicably, to discuss the future of the UK construction industry. Certainly my
impression from this exciting event, which was probably the best conference I
have been to in my career to date, was that the industry is keen to resolve its
differences and that, in respect of the issues raised at the conference, the
players are not necessarily too far apart in their views to make this an
impossibility.

It now comes down to submitting amendments to the legislation which are

realistic enough to be passed. If we are to go forward with a Regulatory
Reform Order (and it is hoped that legal clearance on the text of a Regulatory
Reform Order could be obtained as early as this Spring) to amend the
legislation we need to show qualitative and even anecdotal evidence in
support of the changes. Ultimately, it will be Parliament which finally
determines the desirability of a Regulatory Reform Order on the basis of the
evidence and the arguments put to it. Let’s make sure we achieve changes
which will make our construction industry an industry to be proud of.

Anna Rabin is head of construction at Jeffrey Green Russell, solicitors.

March 2006

© Anna Rabin 2006.

The views expressed by the author in this report are hers alone, and do not
necessarily represent the views of the Society of Construction Law or the editor.
Neither the author, the Society, nor the editor can accept any liability in respect of
any use to which this paper or any information or views expressed in it may be put,
whether arising through negligence or otherwise.

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