It’s payback time

You may wonder where Building columnists get the stimulus for articles. I have to confess that this one is the result of a late-night discussion with Sarah Davis and Rod Pettigrew, my legal colleagues in the Electrical Contractors Association and Heating and Ventilating Contractors Association. We were talking about the meaning of “adequate mechanism” in section 110 of the Construction Act. You might think that having nothing better to do on an evening makes us sad people, and you would probably be right.

Nonetheless, the conclusion was interesting. It was that, in all probability, most subcontrac (and sub-subcontracts) do not have an adequate mechanism for payment.

Section 110 of the act states that a contract must “provide an adequate mechanism for determining what payments become due … and when”. The problems that are occurring appear to relate to three kinds of provisions:

• Pay-when-certified arrangements for interim payments
• Final payments, due following the issue of the final certificate on the main contract
• The second half of retention moneys that are stated to be due following the date of issue of the certificate for making good defects.

Pay-when-certified has the following mechanism: “Interim payments will be made to the subcontractor as and when the value of work carried out by the subcontractor is included in a certificate or equivalent notification issued to the contractor under the main contract.”

The problem here is twofold. First, a subcontractor is unlikely to be aware of the dates of issue of main contract certificates. Second, such certificates do not identify the amount that is due to the subcontractor.

There is, however, a chance that a pay-when-certified arrangement could qualify as an adequate mechanism. It may simply be a useful way of timing payments, rather than a condition of the subcontractor’s entitlement – as long as the subcontractor is in possession of the dates of issue of the certificates. But hold on a second. What happens if a certificate is not issued or is substantially delayed? The subcontractor has no rights of redress against the certifier or its employer. The mechanism has broken down. Is it adequate under the act? The answer must be no. If, however, there was a contractual fall-back mechanism, this could save the day.

If subcontractors are having problems with payments or in obtaining the second half of their retention moneys, the likelihood is that the rules of the contract can be ignored

When it comes to final payment and the release of the final half of the retention moneys, subcontract drafters appear to have forgotten that the adequate mechanism requirement also applies here. This final payment clause is typical: “The final payment shall be due 28 days after the date of the issue of the final certificate under the main contract conditions.”

Again, we have a pay-when-certified arrangement that, for the reasons already stated, is unlikely to qualify as an adequate mechanism. Most subcontractors will not know when the final certificate will be issued and it may be changed anyway. Similar considerations apply to the release of retentions: “Within 28 days of the date of issue of the defects correction certificate under the main contract; there shall be due to the subcontractor the second half of the retention moneys under the subcontract.”

The subcontractor, of course, has no control over the issue of the certificate and no redress if either the issue of the certificate is delayed or if it is not issued at all. This is not an adequate mechanism.

Further strength is given to this approach by the provisions of the act. Look at section 111 on the withholding of moneys. Moneys may not be withheld after the final date for payment of due sums unless “an effective notice of intention to withhold payment” has been given. Look at section 112. Where outstanding moneys are not paid in full by the final date for payment and there has not been an effective notice of withholding, the payee can suspend its contract.

The statutory protection in these provisions is dependent on there being certainty about the due date for moneys. If there is uncertainty or doubt about whether they will ever become due because of a failure of the mechanism under another contract, this protection becomes academic. This was not parliament’s intention.

So, what is the message? It is a very simple one; such provisions must be taken out. Therefore, if subcontractors are having problems with payments or in obtaining the second half of their retention moneys because of subcontract provisions such as those above, the likelihood is that they can be ignored as not constituting an adequate mechanism. The provisions of the Scheme for Construction Contracts will apply.

This point has greater relevance where there is a breakdown or delay in the mechanism operated under another contract – over which the subcontractor has no control – that prevents payments becoming due under contracts later.

With the exception of the statutory permission to operate pay-if-paid in the event of upstream insolvency, arrangements that link subcontractual payment entitlement and timing to activities under the main contract are generally outlawed by the act. Subcontract drafters should revisit their contracts to make them comply.