In 2009 the Local Democracy, Economic Development and Construction Act was quietly passed into law. Part 8 of this act concerns construction contracts. Its purpose was to amend the statutory payment rules which were first introduced to construction contracts by the Housing Grants Construction and Regeneration Act 1996, together with a statutory right to adjudication of disputes. Whilst the 1996 act was initially of benefit to contractors in securing payment both pre- and post-insolvency, the benefit was eroded by clever lawyers, vested interests and the courts.

In particular, if the contractor was insolvent, Bouygues v Dahl Jensen (2007) and Straw Realisations v Shaftsbury House (2010) scuppered the usefulness of an adjudicator’s decision, making it a ‘chocolate teapot’ – nice to have, but pretty useless for the purpose intended.

An earlier case which had see-sawed its way to the House of Lords was Melville Dundas v Wimpey (2006), which invalidated the notion that, in the absence of a withholding notice, payment was all but a certainty. Their Lordships confirmed that it was not necessary to give a withholding notice to an insolvent contractor; the client could withhold payment from the insolvent contractor and apply its cross-claims and set-offs. Under the 2009 act, withholding notices are a thing of the past, as is the necessity to spell out in detail the reasons and amounts making up the withholding.

The significance of the 2009 act is that it has to some extent codified the ‘Melville Dundas rule’ and at the same time made payment more certain provided its procedures are followed. The significance to a contractor on the brink of insolvency cannot be under-estimated. In brief, the procedure under the 2009 act is as follows:

  • Contractor submits its application for payment.
  • Client gives a payment notice setting out the amount to be paid.
  • Client may give a pay-less notice setting out a lower amount to be paid.
  • The client pays the lower amount.
  • If the client neglects to give an effective payment notice and an effective pay-less notice, the contractor’s application for payment becomes the default payment notice and is indisputably due.
  • This procedure applies to all construction contracts from 1 October 2011, hence is increasingly commonplace when looking at contractors in or on the brink of insolvency

So, how can this change in the statutory payment rules benefit recovery?

Insolvency of the contractor usually permits the client to terminate the contract by written notice. However, whether or not it terminates, most standard forms of contract contain a provision to the effect that the client need not make any further payment until after contract completion; expiry of the rectification period; rectification of all defects and the eventual certification of the completion of making good of defects – which I call the ‘mañana’ clause. In the case of sub-contracts, the mañana period will extend to completion of all remedials by all sub-contractors on the job, such that the main contractor can secure its certificate of making good of defects.

It therefore becomes imperative to implement recovery before payment is put on ice for a year or two, after which wresting payment will become difficult if not impossible. This is where the 2009 act can come in handy.

In my experience, the majority of contractors and sub-contractors are either not aware of, or fail to properly implement, the new statutory payment rules. Many do not reflect the new rules in their contracts, and those that do lack training as to their proper use. It is commonplace to see bungled and non-compliant contract drafting which leaves the door ajar for recovery of an indisputably due sum.

However, it is imperative to identify those instances where the payment rules have not been properly adhered to prior to triggering the mañana clause by a formal insolvency appointment, and act on them to suspend and/or terminate the contractor’s employment. If a failing contractor can successfully terminate its employment under a contract prior to insolvency, then the prospect of cross-claims and set-off for non-completion, delays, et cetera, will subside, leaving the door now wide open for payment of the un-disputable sum. Of course, if the threat of termination encourages the client to pay the outstanding amount, so be it, although it is technically better to achieve a termination thereby entitling the contractor to payment of WiP and release of retention.

Whilst I am not suggesting for a minute that the strategy suggested above is straightforward, with a short injection of pro-activity prior to insolvency it is certainly possible, and may have a significant impact on the outcome, potentially changing a zero into a hero.

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