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Construction operations or non-construction operations? That is the question2 April 2020

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In C Spencer Limited v MW High Tech Projects UK Limited[1] the Court of Appeal recently confirmed that payment notices issued in relation to construction contracts under the Housing Grants, Construction and Regeneration Act 1996 (“the Construction Act”) which do not distinguish between construction and non-construction operations are valid and do not contravene the provisions of the Act. The judgment provides helpful clarity to both contractors and employers, and should ensure that parties are not subject to unnecessary costs and complexity when dealing with payment issues.

""Hybrid contracts" arise where the relevant contract provides for both construction operations and non-construction operations."

LEGAL BACKGROUND

The Construction Act set out to:

  1. Improve cash flow in the construction industry by way of a system of interim payments and payment notices; and
  2. Streamline the dispute resolution process in the construction industry by introducing a compulsory adjudication scheme.

Part II of the Construction Act contains the provisions relating to adjudication and payment, and section 104(5) provides that “Where an agreement relates to construction operations and other matters, this Part applies to it only so far as it relates to construction operations.” Construction operations are defined at section 105(1). A narrow but important list of non-construction operations is set out at section 105(2) and includes:

(a) Drilling for, or extraction of, oil or natural gas;

(b) Extraction of minerals or construction of underground works for this purpose;

(c) Assembly, installation or demolition of plant or machinery, or erection or demolition of steelwork for the purposes of supporting or providing access to plant or machinery, on a site where the primary activity is:

(i) nuclear processing, power generation, or water or effluent treatment; or

(ii) the production, transmission, processing or bulk storage (other than warehousing) of chemicals, pharmaceuticals, oil, gas, steel or food and drink.

(d) manufacture or delivery to site of:

(i) building or engineering components or equipment,

(ii) materials, plant or machinery, or

(iii) components for systems of heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection, or for security or communications systems, except under a contract which also provides for their installation.

The distinction between construction and non-construction operations has led to the development of “hybrid contracts”, which arise where the relevant contract provides for both construction operations (within the ambit of the Construction Act) and non-construction operations (excluded from the Construction Act).

"CSL argued that the payment notice was invalid because it did not distinguish between the sums due in relation to construction and non-construction operations."

FACTUAL BACKGROUND

MW High Tech Projects Limited (“MW”) was engaged as the main contractor to design and construct a power plant, capable of processing refuse-derived fuel produced by commercial and industrial waste. Under a sub-contract (the “Sub-Contract”), C Spencer Limited (“CSL”) was appointed to design and construct the civil, structural and architectural works. The Sub-Contract works comprised both construction and non-construction operations.

Initially the parties operated the payment provisions of the Sub-Contract without distinguishing between construction and non-construction operations. However, in 2018 a dispute relating to an interim payment application was referred to adjudication. MW challenged the adjudicator’s jurisdiction, contending that since the adjudicator could only deal with disputes in relation to construction operations and CSL had not distinguished between construction and non-construction operations in the adjudication notice, the adjudicator lacked jurisdiction. In light of this argument, CSL withdrew its adjudication claim.

In February 2019, CSL issued an application for interim payment, and this time the application drew a distinction between the sums allocated towards construction and non-construction operations.  In response, MW served a payment notice on CSL in which it contended that in fact monies were due to MW chiefly as a result of claims for delay it had against CSL. In its payment notice MW did not distinguish between sums due in relation to (i) construction operations and (ii) non-construction operations. CSL argued that the payment notice was invalid because it did not distinguish between the sums due in relation to construction and non-construction operations. CSL therefore contended that they were entitled to the sum claimed in their application for interim payment. MW challenged this point.

"Parties can contract in to the Construction Act by agreeing payment terms which comply with the Construction Act in relation to both construction and non-construction operations."

At first instance, O’Farrell J found in favour of MW. In summary, it was held by the judge that MW’s payment notice was valid. For a detailed note of this judgment, please click here.

JUDGMENT

CSL appealed the first instance decision, arguing that the phrase “only so far as it relates to construction operations” in s.104(5) of the Construction Act had to be read into every section of the Act, including those dealing with payment. CSL argued that it followed that, in relation to hybrid contracts, a failure to stipulate within the overall sum notified in the payment notice the amount relating to construction operations, was a failure to comply with the Construction Act.

Coulson LJ noted that dealing with this issue was not entirely straightforward. However, he ultimately dismissed the appeal and concluded that O’Farrell J had been correct to reject CSL’s argument.

In reaching his conclusion, Coulson LJ noted as follows.

  1. The Construction Act identifies minimum standards which construction contracts must adhere to. Therefore, any analysis must start with the contractual terms to see if they comply with the Construction Act. If the terms comply, then the Construction Act is no longer of any direct relevance to the rights and obligations of the parties. It was further noted that parties can contract in to the Construction Act by agreeing payment terms which comply with the Construction Act in relation to both construction and non-construction operations.
  2. There is nothing in the Construction Act which requires, in hybrid contracts, for payment terms to provide a separate notified sum in respect of solely construction operations. If such a distinction was of importance, then the Construction Act could have provided for this, but it did not. If such a distinction was required, then it would give rise to two notified payment sums (one for construction operations and one for non-construction operations). It followed that the Sub-Contract complied with the Construction Act because there was no requirement to break down sums due in relation to construction operations.
  3. CSL’s argument that the phrase “only so far as it relates to construction operations” in s.104(5) of the Construction Act had to be read into every section was rejected. Coulson LJ held that the Construction Act can be construed perfectly well without reading these words in and it was neither necessary, nor appropriate to read in the phrase to the other sections.
  4. The parties were at liberty to extend the statutory payment provisions to non-construction operations. However, this did not require the parties to differentiate between different aspects of the works under the Sub-Contract as proposed by CSL.
  5. The distinction between construction and non-construction operations only arises when there is a dispute, because only construction operations can be referred to adjudication (unless the parties amend this position via agreement). It was noted that the Sub-Contract drew a distinction between construction and non-construction operations in the adjudication clause. However, no such distinction was drawn in the contractual payment mechanics. The parties could have made such a distinction but chose not to do so, thereby indicating that they were happy to rely on the payment provisions derived from the Construction Act.
  6. O’Farrell J’s decision was in accordance with the existing authorities and the purpose of the Construction Act (that being certainty and transparency of stage payments). If the parties were required to undergo two separate processes for both construction and non-construction operations, that would add a level of unwanted uncertainty, complexity and cost.
  7. Lastly, Coulson LJ noted that some reliance was placed on Jackson LJ’s comments in S&T (UK) Limited v Grove Developments Limited where it was suggested that section 111 of the Construction Act not only overrode any contractual provisions which provided otherwise but was also the principal source of the obligation to pay the notified sum, even if the contract said the same thing. The correctness of the latter part of this statement was doubted but this point was not explored further as it was not relevant for the purposes of the appeal.

"This decision is particularly relevant for those involved in the power generation sector, where works will often be conducted under hybrid contracts."

COMMENT

Coulson LJ’s judgment provides welcome clarity to contractors and employers issuing payment applications and notices. A requirement that parties separate payment notices into construction and non-construction operations for the purposes of complying with the Construction Act could well lead to uncertainty and potential disputes over the sums allocated towards each category. This decision is particularly relevant for those involved in the power generation sector, where works will often be conducted under hybrid contracts involving both construction operations (e.g. site clearance) and non-construction operations (e.g. erecting steelwork for the purposes of supporting machinery on a site where the primary activity is power generation).

The decision also emphasises the importance, when drafting payment provisions in construction contracts, of complying with the minimum requirements as set out in Construction Act. If terms fail to meet these requirements, then the Scheme for Construction Contracts will automatically apply. It is therefore recommended that parties consult their legal advisors prior to entering into construction contracts, to ensure that the terms are compliant and therefore there are no unexpected changes imposed on the contract as a result of the operation of the Construction Act.

Trainee James Burgess also contributed to this article.

[1] [2020] EWCA Civ 331

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