Industry Watch – Payment Protection – Why the US and Other Leading Nations Need Payment Protection Legislation and What Procurement Can Do in the Meantime.

Throughout the world legislative actions are transforming the way the construction industry behaves.  These legislations are not only protecting trade contractors from unfair practices, they are protecting Owners too.

Surprisingly, some of the world’s most sophisticated markets have yet to enact similar protections.  In those parts of the world, certain common and persistent practices continue to put the supply chain and Owners at risk.

In November of 2019 a Senior Associate with Skrine Advocates and Solicitors in Malaysia published an article on Lexology where he reported on a landmark ruling from the Federal Court of Malaysia.

The ruling determined that Malaysia’s Construction Industry Payment and Adjudication Act of 2012 “does not have retrospective effect“.  This ruling meant the Act could only be applied to contracts started after the Act was adopted.  The ruling cleared up ambiguity that persisted as a result of an April 15, 2014 press release from the Kuala Lumpur Regional Centre for Arbitration (KLRCA) indicating the act would have retrospective effect.

The Act names the KLRCA as the adjudication authority, giving it a central role as the default administrative authority.  KLRCA initially announced, “the Minister of Works has approved CIPAA 2012 to apply retrospectively“.  This announcement opened the flood gates for countless cases.

Now the court of appeal has reversed this ruling and announcing, “any legislation affecting substantive rights must be given a prospective effect“.

While the effect of the court’s reversal is significant, the more impactful part of this story is the Act itself.

In 1996 the UK passed the Housing Grants, Construction and Regeneration Act.  This move was followed by Australia three years later with the Building and Construction Industry Security of Payment Act.

These jurisdictions led the way in legislation aimed at addressing the challenges of cash-flow in construction.

While the scope of the act’s vary, the common thread among them is that they entitle “contractors, consultants or suppliers in the contractual chain to receive payment due under the terms of their contract from the party higher in the chain”  The Acts also establish quick, effective, and binding methods of dispute resolution (through adjudication) and makes certain common practices (such as back to back payments) illegal.

New Zealand and Singapore have followed the example of the UK and Australia and have also adopted similar legislation.

While these countries are leading the industry in legislative protections, industry practices and legislation in other countries are lagging behind.

In October of last year I shared with you some of the common practices General Contractors use to avoid the impact of retainage terms.  One such practice being the trickling down of retainage terms onto the trades.

Later that month I cited standard AIA contract language found on the current A201-2017 that supports pay when paid practices.

In a white paper study published in 2008 by the Illinois Institute of Technology, the authors studied the reasons why construction companies fail.

Their paper, “Business Failures in the Construction Industry” concluded, “consistently negative cash flow over the course of the construction process is likely to increase the likelihood of construction company failure“.

According to Construction Business Owner.com, US Census data shows construction companies fail at a rate of more than 23% with over 36% failing after one year.  That is 3% to 7% higher than the failure rate of all other businesses combined.

Regardless of whether the Act has a retrospective or a prospective effect, Malaysia is on the right track.

Payment risks do not just impact the Contractor.

When a Contractor files for bankruptcy they cause a ripple effect that impacts everyone in the supply chain.  We are not that far removed from the spectacular failure of Carillion who’s liquidation left over £5B in debt with only £29M in cash reserves.  That happened even within a country that has Payment Protection legislation.

Not to mention the risk on Owner’s who’s properties would be subject to mechanics liens.

Closing

The rest of the world needs to catch up and recognize that the Construction Industry has a major problem.  Decades of allowing bad practices to persist have created a status quo that cannot be reversed without legislative action.  In the same way that we legislate protections for Owners, we must also legislate protections for Vendors.

In the meantime, Procurement needs to be leery and aware of the risks that unfair payment terms has on the supply chain.

Ensuring that Contractors are not allowed to use these practices is the best way to ensure a healthy supply chain and is a great way to protect Owners.

What do you think?  Are payment terms a major problem in the industry?  Is legislation the answer?  Tell me your stories.

Thanks for reading.  If you enjoyed this content, please feel free to browse my previous articles and please like, share, comment, and subscribe.  This helps promote my content and is greatly appreciated.

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