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Do you need to differentiate between construction operations and non-construction operations in your payment application?22 January 2020

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In an important decision for parties to construction contracts in the energy sector[1], the English Technology and Construction Court (“TCC”) has held that a contractual payment mechanism which complied with the Housing Grants, Construction and Regeneration Act 1996 (“the Construction Act”) applied to all payments under a hybrid contract, and not just payments due in respect of works falling within the Act’s definition of “construction operations”. The decision provides a timely warning to parties operating in England, Wales and Scotland to check how their hybrid contracts work and to clarify exactly what a construction operation is.

"The distinction between construction and non-construction operations is the result of compromise and lobbying by particular industries."

Background

Section 105(1) of the Construction Act provides a detailed definition of construction operations and s.105(2) lists the types of work, including those for power generation (s.105(2)(c)(i)), which are categorised as non-construction operations. Such “non-construction operations” are interpreted narrowly.

Reading s.105 in conjunction with s.104(5) the effect of which is to restrict the parties’ statutory right to refer disputes to adjudication to those that relate to construction operations – it can be said that such a narrow interpretation of non-construction operations opens up adjudication to parties who may not have considered they had a statutory right to refer their dispute to adjudication. This may be of particular relevance to parties, such as sub-contractors, who are only involved in a small part of the overall project.

The distinction between construction and non-construction operations is the result of compromise and lobbying by particular industries. In Severfield (UK) Ltd v Duro Felguera UK Ltd[2], Coulson J stated that the legislature’s justification for excluding certain industries from adjudication was that adjudication was seen as some form of “punishment” for the construction industry from which the power generation and some other industries should be exempt, because “they had managed their affairs reasonably well in the past”. Nevertheless, according to Coulson J, “those underlying assumptions were, and remained, misconceived”. Adjudication was a “blessing” which needed to be conferred on all those industries, such as power generation, which were currently exempt; they too would benefit from the clarity and certainty brought by the Construction Act.

The dispute

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

In February 2019, CSL issued a payment application which distinguished between the sums payable in respect of construction operations and sums for non-construction operations. However, MW’s payment notice (which indicated a negative sum due to CSL) did not allocate to or divide the sums due between construction and non-construction operations and did not respond to the substance of CSL’s position regarding the appropriate distinction of the works.

CSL claimed that MW’s failure to specifically identify the amounts assessed as due in respect of construction operations in its payment notice rendered the notice invalid. CSL argued that in the absence of a valid payment notice or pay less notice, it was therefore entitled to the amount assessed as due in its application for payment. However, MW argued that its payment notice complied with the contractual payment regime between the parties and was compliant with the requirements of the Construction Act; it was, therefore, a valid payment notice.

"It is a reminder of the importance of expressly including in hybrid contracts a contractual adjudication clause as well as a payment mechanism that complies with the Construction Act."

Judgment

Mrs Justice O’Farrell DBE concluded that MW’s payment notice was valid, and that, where a hybrid contract contains a payment scheme that mirrors the relevant provisions of the Construction Act in respect of both construction and non-construction operations, a payment notice which does not separately set out the sums due is capable of constituting a valid notice:

a) Sections 110A and 111 of the Construction Act (which set out mandatory requirements for contractual payment notices and impose a statutory requirement on the payer to pay the notified sum) do not stipulate separate identification of the sums due in respect of construction operations – to comply with section 110A(2), the sum considered due must include, but is not expressly limited to, such sum in respect of construction operations;

b) Although the provisions of the Construction Act only apply to sums due in respect of construction operations, it is open to the parties to agree a payment scheme that sits alongside the statutory provisions, such that it complies with the statutory provisions in respect of construction operations and mirrors these provisions in respect of non-construction operations;

c) Section 111 could be implemented without difficulty where the same payment provisions governed both construction operations and non-construction operations; and

d) This approach to the proper interpretation of the subcontract did not undermine the purpose of the statutory payment provisions – it simply extended the cash flow benefits conferred by the Act to cover the non-construction works.

Conclusion

C Spencer is a reminder of the importance of expressly including in hybrid contracts a contractual adjudication clause as well as a payment mechanism that complies with the Construction Act.

Given that Part II of the Construction Act will only apply to construction operations, parties should carefully consider whether to include separate provisions for adjudication in respect of non-construction operations. This practice will avoid the need for two separate regimes. The same applies to payment mechanisms. It is critical for parties to understand that, if the contractual and statutory schemes work differently, then they do have to set out the sums claimed separately.

Where there are no such clear clauses, there is potential for uncertainty and dispute on the operation of two separate systems for construction operations that fall within the Construction Act and non-construction operations outside the ambit of the Construction Act.

 

Stella Stathis also contributed to this article.

[1] C Spencer Limited v MW High Tech Projects UK Ltd [2019] EWHC 2547 (TCC)

[2] [2015] EWHC 3352 (TCC)

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