Adequate payment mechanisms and implied payment terms under the Construction Act

Bennett (Construction) Limited v CIMC MBS Limited (Formerly Verbus Systems Limited) [30.08.19]

This Court of Appeal (CoA) case provides helpful guidance on how to imply payment terms under the Scheme for Construction Contracts (the Scheme).

Background

Bennett sub-contracted Verbus to design, supply and install prefabricated modular hotel units, to be manufactured in China and shipped to Southampton. The contract contained a milestone payment system as follows:

Milestone payment system

  • “Milestone 1: 20% deposit payable on execution of contract;
  • Milestone 2: 30% on sign-off of prototype room by Park Inn/Key Homes [the developer/operator of the hotel]/Bennett in China;
  • Milestone 3: 30% on sign-off of all snagging items by Park Inn/Key Homes [the developer/ operator of the hotel]/Bennett in China;
  • Milestone 4: 10% on sign-off of units in Southampton;
  • Milestone 5: 10% on completion of installation and any snagging.”

Disputes arose as to whether the units complied with the contract at various stages, and no actual sign off occurred. A payment dispute ensued.

First instance decision

At first instance, the court held that Milestones 2 and 3 did not constitute an “adequate payment mechanism” under the Housing Grants, Construction and Regeneration Act 1996 (the Act), on the basis that the concept of “sign off” in this context was too vague and uncertain. When addressing the question of how the Scheme should be implied to repair the defective mechanism, the judge decided that it was not possible to mix and match the Scheme with the milestone system. For “reasons of workability and coherence”, the judge concluded that Milestones 2 to 5 must be replaced in their entirety by paragraphs 2, 4 and 5 of the Scheme.

In practice, this meant that Verbus was entitled (by virtue of the Scheme) to interim payments based on the value of works done. This was a significantly different payment regime from that originally agreed between the parties, and Bennett appealed.

Appeal decision

The CoA overturned the first instance decision, holding that the milestone payment regime did constitute an “adequate payment mechanism”. The CoA decided that “sign off” in milestones 2 and 3 simply referred to the point at which the works were capable of being signed off. It did not matter whether they were actually signed off or not – just that they had reached the stage at which they could be (i.e. they were objectively in compliance with the contract).

In addition, the CoA decided that the absence of dates in the mechanism did not render it inadequate, stating that “the courts expect the parties to adopt business common sense to the arrangements for invoicing and payment”, and that the sum was payable when completion of the relevant stage was achieved.

However, given that it was an issue of some wider legal importance, the CoA went on to give guidance on what payment terms would have been implied if the mechanism was not adequate. The CoA disagreed with the lower court that the mechanism required wholesale replacement with the provisions of the Scheme.

The CoA decided that paragraph 2 of the Scheme was not relevant. Even though the milestone mechanism was a stage payment mechanism, it was not of the kind referred to in paragraph 2. Paragraph 2 refers specifically to stage payments based on the value of the work done. The milestone regime in these circumstances was not based on the value of works done. Accordingly, paragraph 7 of the Scheme (referring to “any other payment”) was the only relevant paragraph. The payment mechanism could be repaired by the implication of paragraph 7, which states that payment is due seven days following completion.

Comment

This case is interesting for a number of reasons.

The CoA’s comments on the absence of any dates in the mechanism

One of Verbus’ arguments was that the payment mechanism contained no provision for an invoice, no due date and no final date for payment. On this basis the mechanism must be inadequate. However, Lord Justice Coulson stated as follows:

I do not consider that such details were necessary for a contract of this type. Parties are always free to agree interim payments by reference to percentages of completion. Thereafter, the courts expect the parties to adopt business common sense as to the arrangements for invoicing and payment…the fact that there was no express date for payment does not matter”.

At first glance, this appears to be at odds with section 110(1) of the Act, which requires every construction contract to:

(a) provide an adequate mechanism for determining what payments become due and when, and

 (b) provide for a final date for payment in relation to any sum which becomes due.”

The milestone mechanism did not provide any such final date for payment.

One interpretation of Coulson LJ’s comments is that they must be read as applying only to section 110(1)(a) and not 110(1)(b) – i.e. the final date for payment of that sum. This is supported by the final section of the judgment, where Coulson LJ addressed which paragraphs of the Scheme should be implied – referring only to paragraph 7 (implied due date) and not paragraph 8 (implied final date for payment). This distinction is not however spelled out expressly in the judgment, and may cause confusion.

The CoA’s analysis of paragraphs 2 and 4 of the Scheme

Coulson LJ clarified that the reference in paragraph 4 to “any payment of a kind mentioned in paragraph 2” means not simply “any stage/periodic payment”, but effectively “any stage/periodic payment based on the value of works done”. If you are dealing with any other kind of stage payment that is not value-based, the relevant paragraph of the Scheme is not paragraph 4, but paragraph 7. A technical point, but an important one for those wanting to utilise the Scheme correctly.

The parties’ original agreement

Finally, this case provides a further example of the courts adopting an approach in contractual interpretation cases that seeks to respect the parties’ original agreement. Coulson LJ commented that the court should reach a conclusion that “does the least violence to the agreement between the parties”. Further, that save in exceptional circumstances, the Act was not designed to “delete a workable payment regime which the parties had agreed, and replace it with an entirely different payment regime”.

Read more in Construction and Engineering Brief - November 2019