There is a movement in the construction industry that is gaining traction around the world and if you are in construction, like I am, you need to pay attention.
I am referring to the movement to improve payment terms for Contractors and sub-contractors.
For a long time, the construction industry has tolerated casual payment behaviors.
Tedious and lengthy corporate payment processes that take effort to navigate, coy and negligent Owners who improperly withhold approvals, and General Contractors who abuse trades are among the most prevailing problems facing the industry.
The problem has been building for a long time and it all came to a head in January 2018 when the second largest construction company in the UK (Carillion) went bankrupt.
In response, various new proposals and amendments have come before law makers all over the world. Those who neglect this issue are likely to stumble into a courtroom sooner or later.
Vague Payment Terms
In the UK a billed called the Public Sector Supply Chains (Project Bank Accounts (PBA)) Bill had it’s first reading before Parliament in January 2019. The bill is written to require public authorities to pay certain suppliers using project bank accounts.
The UK Bill follows the government of Australia’s action to pass the Queensland security of payment bill which began trials of PBA accounts in January of 2018.
You can read more about PBA’s and how they work here.
In September 2019 Gowling WLG (a law firm with offices in the UK) published an article in Lexology about a decision passed down by the Technology and Construction Court (TCC) that held certain milestone payment provisions did not meet provisions of the Housing Grants, Construction and Regeneration Act 1996.
The case between the Contractor (Bennett) and it’s subcontractor (CIMC) was over payment terms.
The terms of the agreement stated that CIMC was required to receive “sign-off” from Bennett before being paid. The Act referenced by TCC states that a contract must contain an “adequate payment mechanism”. TCC found the phrase “sign-off” as “too vague” and therefore non-compliant with the Act.
The initial decision from TCC required Bennett to make interim payments according to the value of the work rather than on “sign-off” of the complete scope.
The TCC decision was later overturned on appeal.
The overturning judge cited that the TCC decision appeared to suggest that in order for a payment provision to be complaint it must be tied to a defined date. A position the court dissented with. The court held the “sign-off” criteria was made in reference to the specifications.
The judge also stated that, “the requirement for “sign-off” was to be assessed objectively… [and that] Bennett could not avoid liability for payment simply because the relevant document had not actually been signed-off”
Despite the over-turn of the initial decision, this case shows that sensitivity to payment terms for subcontractors is growing and that lax payment terms (and the abuse of those terms) will not be tolerated.
The overturning Judge’s statement also indicates that while the Contractor can use the scope of the work as a measure of what and when to pay, using the term “sign-off” in no way allows the Contractor to withhold payment for work that has been completed.
Prompt Payment Code
The problems associated with Sub-contractor payment are not new. The act of extending payment terms, paying later than agreed, or tying payments to secondary events has been a constant and ongoing trend in construction.
In 2008 the Chartered Institute of Credit Management published a voluntary code called the Prompt Payment Code.
Signatories to the Prompt Payment Code commit to; paying suppliers on time, giving clear guidance to suppliers, and encourage good payment practices across the construction supply chain.
In another article from Lexology, Charles Russell Speechlys (a law firm headquartered in London) writes;
Although more than 2,000 organisations have signed up to the Code as at September 2018, it has fallen short in achieving its objectives. The collapse of Carillion in January 2018, a major government contractor and signatory to the Code, highlighted some of the problem. Carillion was found on collapse to owe about £2bn to suppliers, sub-contractors and other short term creditors. In March 2019, other government suppliers were warned about paying subcontractors on time or they would risk being barred from future public sector work.
Speechly’s article calls attention to the fact that the voluntary nature of the Code has done little to sway the behaviors the Code was meant to address.
Speechly’s article also calls out a number of additional measure that have recently been taken to combat this problem:
the Late Payment of Commercial Debts (Interest) Act 1998 which, among other things, establishes maximum 30 day payment terms for transactions with public authorities and 60 day payment terms between businesses, unless they agree longer terms and this is not grossly unfair to the supplier;
the Public Contract Regulations 2015 that require many public sector bodies to pay their suppliers within 30 days and to pass this payment term down the supply chain in new public sector contracts;
The Reporting on Payment Practices and Performance Regulations 2017 that require large companies to bi-annually publish certain information about their practices, policies and performance in relation to paying suppliers. The Prompt Payment Code Compliance Board regularly review this data to ensure that companies are upholding their commitments; and
The Business Contract Terms (Assignment of Receivables) Regulations 2018 nullify contract provisions which restrict invoice assignment. This took effect from 24 November 2018 and applies to contracts entered into on or after 31 December 2018. It is hoped that these Regulations will assist SME’s seeking alternate forms of finance.
The Security of Payment Act
In Australia the government of New South Wales announced changes to the Building and Construction Industry Security of Payment Act 1999 (NSW). K&L Gates (a global legal firm located in all 5 continents) tell us in an article published September 26, 2019 that changes to the law affecting the flow of payment to subcontractors will become effective on October 21, 2019.
The changes include among other things legal limits that require Contractors to make payment to subcontractors within 20 days of claim.
The law also includes harsher penalties for contractors and personal liability for contractor Executives if they provide false or misleading statements.
In recent negotiations here in the US, I encountered some payment language from the AIA that in my mind violated some of these fair payment principles.
The AIA language is found in Article 9.6.2 of A201-2017 General Conditions of Construction. It states, “The Contractor shall pay each Subcontractor, no less than seven days after receipt of payment from the Owner, the amount to which the Subcontractor is entitled, reflecting percentages actually retained from payments to the Contractor on account the of the Subcontractor’s portion of the Work”
This clause came to my attention because the Contractor initially attempted to exclude their fee and General Conditions from retainage.
In response to the Contractor’s attempt at mitigating the impact of retainage on their fee, I responded with stronger language that not only made their fee and general conditions subject to retainge, I specifically excluded them from trickling down retainage onto the subcontractors.
Of course they balked at that and we reverted back to more standard language.
In doing so the sentence above came to my attention. At first I thought this was another write-in from the contractor, but later realized this was standard language.
The phrase,”reflecting percentages actually retained from payments to the Contractor” essentially ties the Contractor’s ability to pay the subcontractor to the Owner’s retainage.
Contractors will argue that they should not be made to pay the trades unless they have been paid. A concept I don’t inherently disagree with, but we need to be mindful that retainage of payment between an Owner and his Contractor is meant to withhold the Contractors fee as a guarantee of completion. Retainage is not meant to be trickled down as a withholding on a Subcontractor’s payment so that the Contractor can take his fee.
Further, the act of withholding payment from a Subcontractor based on nothing more than the term of the Owner’s agreement with the Contractor, effectively ties the subcontractor’s payments to secondary events outside of the Subcontractor’s scope of work.
During my negotiation we struck that phrase and kept the remainder of the clause.
My rationale was that the Contractor’s payment terms with their subcontractor should not be encumbered by the Contractor’s terms with the owner, doing so ties the subcontractor’s payment to a secondary act and elevates the Owner’s risk to Liens.
It is an interesting time for the construction industry. The risks for all parties have never been higher. As we evolve into the next stage, Owners need to get smart about the pressures that impact their suppliers. They need to ensure they are set up to meet their obligations while being leery of contractor attempts at mitigating theirs.
What other signs do you see that the construction industry is changing? How do you manage Contractor payments? Tell me your stories.
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