The Court of Appeal considers milestone payments in construction contracts and the requirement for an adequate payment mechanism

09 September 2019

In July 2018, we reported on the first instance decision in CIMC MBS Ltd (formerly Verbus Systems Ltd) v Bennett (Construction) Ltd [2018] in which the Technology and Construction Court (TCC) held that certain milestone payment provisions in a contract did not comply with the requirement that "construction contracts" as defined by the Housing Grants, Construction and Regeneration Act 1996 as amended (the Construction Act) must contain an adequate payment mechanism.

The decision was appealed by the main contractor Bennett (Construction) Ltd (Bennett) and the Court of Appeal (CA) has now handed down its judgment overturning the decision of the TCC - we analyse the key points below.



Summary of background

Bennett was appointed as main contractor to design and build a new hotel in London. CIMC MBS Ltd (CIMC) was appointed as a specialist design and install sub-contractor of prefabricated modular bedroom units based on JCT Design and Build Sub-Contract 2011 wording with amendments (the Sub-Contract). Notably, the standard JCT provisions for interim payments were deleted and replaced by bespoke milestone provisions.

Milestones 2, 3 and 4 each provided for a payment of a percentage of the contract sum on 'sign-off' of a 'prototype room', 'snagging items' and 'units' respectively.

A dispute arose following suspension of the Sub-Contract works over non-payment.

Following an adverse adjudication decision, CIMC commenced TCC proceedings contending that payment provisions relating to Milestones 2, 3 and 4 in the Sub-Contract were non-compliant with S110(1) of the Housing Grants, Construction and Regeneration Act 1996 as amended (the Construction Act), which includes the requirement that every construction contract must provide an adequate mechanism for determining what and when payments become due under the contract, and provide for a final date for payment in relation to any sum which becomes due.

TCC decision

The TCC reviewed the Sub-Contract as a whole and held (in summary) that:

  • Milestones 2 and 3 did not comply with s.110(1)(a) because those bespoke payment provisions included a specified "sign-off" process which was unclear in terms of the criteria and date for sign-off. It was not open to the court to re-write the payment provisions to make them compliant i.e. an adequate payment mechanism.

The counter argument on behalf of Bennett (rejected by the TCC) was that the trigger for payment was clear - it was when the relevant work was completed in accordance with the Sub-Contract.

  • Milestone 4 was compliant with the Construction Act as it was more specific in requiring sign-off of units 'in Southampton' and that was viewed as if it simply required proof of delivery of the units, rather than, for example, confirmation the units had not been damaged as a condition for sign-off.

HHJ Waksman QC considered that it was impossible to alter only Milestones 2 and 3; he therefore ordered that paragraphs 2, 4 and 5 of Part II of the Scheme were to be incorporated into the Sub-Contract, replacing Milestones 2-5 in their entirety.

The result of the TCC judgment was that Bennett had to make interim payments by reference to the value of the work carried out, rather than as specified in the bespoke provisions for Milestones 2 and 3.

Court of Appeal decision

Bennett's grounds of appeal were:

  1. whether a regime requiring payment of a percentage of the contract sum on "sign-off" of a particular stage of the works complies with the Construction Act; and
  2. if it does not, what is the mechanism by which the Construction Act (and the Scheme for Construction Contracts, which it introduced) is incorporated into the contract in order to 'save' the bargain which the parties made.

Issue 1 - did Milestones 2 and 3 comply with the Construction Act?

On issue 1, the CA overturned the TCC decision and held (in summary) that the Sub-Contract (including the provisions relating to Milestones 2 and 3) did provide an adequate payment mechanism.

The CA considered that the key point of interpretation related to the "sign-off" requirement in Milestones 2 and 3 - "[is] it a generic reference to the satisfactory completion of a particular stage, to be assessed objectively ("the objective interpretation"), or is it a reference to the date on which the sign-off actually occurred ("the subjective interpretation")?" [emphasis added]

In his analysis of the TCC's first instance decision, Lord Justice Coulson referred to 3 elements of the Judge's conclusion in favour of CIMC:

  1. the TCC favoured the subjective interpretation i.e. that Milestones 2 and 3 required an actual sign-off;
  2. the criterion for sign-off was uncertain and vague;
  3. the Judge appeared to suggest that the payment mechanism was inadequate because no date for payment of the relevant percentage was set out in the Sub-Contract.

Conversely, the view of the CA on these points was as follows:

  1. the requirement for "sign-off" was to be assessed objectively i.e. if the Sub-Contract works had reached a stage where a particular element could be signed off, Bennett could not avoid liability for payment simply because the relevant document had not actually been signed-off;
  2. the only relevant criterion was compliance with the contract specification, to be viewed objectively;
  3. the fact that there was no express date for payment does not matter as the sum was payable when the relevant completion was achieved.

Issue 2 - if Milestones 2 and 3 did not comply, what was the correct mechanism of replacement?

Technically, Issue 2 fell away as the appeal on Issue 1 had been successful. On an obiter basis however, Lord Justice Coulson considered the arguments relating to Issue 2 because of its wider importance for the construction industry.

Lord Justice Coulson confirmed that it is settled law that the payment provisions in Part II of the Scheme for Construction Contracts are only incorporated if and to the extent that the contract is non-compliant, as provided in s110(3) of the Construction Act. (This contrasts with the Part I provisions of the Scheme relating to adjudication which applies on an "all or nothing" basis and cannot be incorporated on a piecemeal basis.)

Considering paragraphs 1-7 of Part II of the Scheme, the CA preferred the approach put forward on behalf of Bennett describing it as achieving "a common sense result that, when applied to this case, does no significant violence to the parties' original agreement".

Key points

  • This case is not concerned with s109 of the Construction Act - it is concerned with s110 which provides (in summary) that where s110 applies and there is no adequate payment mechanism, the relevant provisions of paragraph 4 to 7 of Part II of the Scheme shall apply.
  • Paragraphs 4, 5 and 6 of Part II of the Scheme[1] are not relevant in this case as it does not relate to:
    • "any payment of a kind mentioned in paragraph 2" - instalments or stage payments - paragraph 4; or
    • a final payment or a payment under an excepted contract (paragraphs 5 and 6).
  • Lord Justice Coulson noted that whilst superficially, the milestones in this case could be said to be instalments or stage payments, he did not consider milestones 2 and 3 to be payments of the kind mentioned in paragraph 2 of Part II of the Scheme (and as referenced in paragraph 4) - "[m]ilestones 2 and 3 were not payments based on the value of any work performed. They were based solely on completion of a particular stage of the works".
  • Lord Justice Coulson stated that, by a process of elimination, paragraph 7 of Part II of the Scheme applied in this case and indeed was the "'catch all'….the only provision that could apply to these Milestones". In his view, this approach made "commercial sense" - where a mechanism is inadequate due to there being no agreement as to timetable for payment, the timetable is provided by paragraph 7 (7 days after completion). This would resolve any concern about the sign-off provisions in the Sub-Contract as payment is to be made after completion which is an objective test.
  • The counter argument put forward on behalf of CIMC was that the analysis must start with paragraphs 1 and 2 of Part II of the Scheme. Dealing with this contention, Lord Justice Coulson stated that if that were correct, in the CA's view, the same conclusion would result in any event - both approaches are resolved "in straightforward fashion by the implication of paragraph 7. In that way, the payment in respect of Milestone 2 would be 7 days following the completion of the prototype in accordance with the contract. For Milestone 3, it would be 7 days following the completion of the units in accordance with the contract. Milestones 1, 4 and 5 would remain wholly unaffected."

CA's general views on the interpretation of Part II of the Scheme

Lord Justice Coulson went on to set out factors that should be central to the court's considerations when dealing with Part II of the Scheme:

  • The "right replacement option ……. does the least violence to the agreement between the parties";
  • "…. the [underlying] purpose of the Act was to provide for certain minimum, mandatory standards so as to achieve certainty and regular cash flow. Save in perhaps exceptional circumstances, it was not designed to delete a workable payment regime which the parties had agreed, and replace it with an entirely different payment regime based on a radically changed set of parameters. It seems to me that that could only happen where the regime which had been agreed was so deficient that wholesale replacement was the only viable option. That is plainly not this case." [emphasis added]

Commentary

Whilst in part obiter, this decision of the CA is of key importance to the parties to construction contracts as it makes clear the courts' commitment to seek to honour the payment regime actually agreed between those parties.

Mr Justice Coulson described the commercial effect of the first instance decision as "stark" effecting "a significant reapportioning of the commercial risk which the parties had agreed." He went on to say that "it would take very clear words in the [Construction] Act in order to bring that about.." and the CA's judgment makes it clear that the Construction Act does not contain such words.

As set out above, Lord Justice Coulson's stated view was that "Part II of the Scheme is badly drafted". It is clear from this decision that the courts' approach to interpretation will favour an emphasis on the commercial payment framework agreed by the parties and they will seek to uphold a workable payment regime.

At the point the contract is being negotiated and drafted, ensure that the payment provisions are entirely clear and that they reflect the deal you have agreed. The Construction Act provisions provide a backstop default position but the CA has made it clear that when interpreting Part II of the Scheme at least, there will be a focus on the apportionment of commercial risk agreed between the parties. In the CA's view, the Construction Act does not contain the clear words that would be needed to bring a reapportionment of that risk.

The expansive approach adopted and promoted by the CA in this judgment is bound to be met with some level of resistance. We await any steps to appeal this decision with interest.

If you have any queries on these cases or any construction issue, please get in touch with the team.

Footnote

[1] Scheme for Construction Contracts (England and Wales) Regulations 1998/649

Para 4

Any payment of a kind mentioned in paragraph 2 above shall become due on whichever of the following dates occurs later:

(a) the expiry of 7 days following the relevant period mentioned in paragraph 2(1) above;or

(b) the making of a claim by the payee.

Para 5

The final payment payable under a relevant construction contract, namely the payment of an amount equal to the difference (if any) between:

(a) the contract price;and

(b) the aggregate of any instalment or stage or periodic payments which have become due under the contract,

shall become due on:

(a) [the expiry of ]130 days following completion of the work;or

(b) the making of a claim by the payee,

whichever is the later.

Para 6

Payment of the contract price under a construction contract (not being a relevant construction contract) shall become due on

(a) the expiry of 30 days following the completion of the work;or

(b) the making of a claim by the payee,

whichever is the later.

Para 7

Any other payment under a construction contract shall become due

(a) on the expiry of 7 days following the completion of the work to which the payment relates;or

(b) the making of a claim by the payee, whichever is the later


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