Hybrid contracts and the payment provisions of the Construction Act

United Kingdom

The Construction Act contains a limited exemption for certain specified activities in relation to power generation projects and other specified engineering facilities, to which its payment and adjudication requirements will not apply. Contracts for such projects often involve a mix of operations, some of which will be caught by the Construction Act and some of which will fall within the exemption. This can lead to disputes over contract payment mechanisms as a recent TCC decision illustrates.

The power generation exemption

The Housing Grants, Construction and Regeneration Act 1998 (the “Construction Act”) applies to “construction operations” carried out within the United Kingdom, subject to a certain narrow set of exemptions provided for by section 105, which include the:

“assembly, installation or demolition of plant or machinery, or erection or demolition of steelwork for the purposes of supporting or providing access to plant or machinery, on a site where the primary activity is … power generation”

The exemption also applies to certain other engineering projects such as nuclear processing and sewage treatment plants.

There have been a number of cases over the years which have explored the width of this exemption:

  • generally speaking, a narrow approach is to be taken to the exemption, the intention being not to exempt the whole of these projects from the Construction Act, but only those activities concerning plant, machinery or supporting steelwork;
  • some latitude is allowed in the interpretation of the words “plant” and “machinery” – so long as individual items of work play some part in the overall process carried out by the plant or machinery (such as conduits or electrical wiring necessary for its operation), they will fall within the exemption; and
  • only the specified activities in relation to plant, machinery or supporting steelwork are excluded, so a contract involving the design, fabrication and installation of supporting steelwork would fall within the Construction Act insofar as its design and fabrication elements are concerned, but not insofar as erection of the steelwork is concerned.

The rationale for such a narrow exemption has been often criticised by the judiciary. One former TCC judge described it as “uncommercial, unsatisfactory and a recipe for confusion” and not “thought through”, and the judge in the case described below referred to it as having an “illogical and uncommercial impact”.  Parties can be caught out if they overestimate the width of the exemption and wrongly assume that the Construction Act does not apply to their contract, as was the case in Severfield (UK) v Duro Felguera UK (for our Law-Now on that case please click here).

In this case, conversely, the parties were aware (at least at the time of the dispute) that their contract was a hybrid contract consisting of both construction and non-construction operations, and the issue before the Court was how the requirements of the Construction Act should be applied in those circumstances.

C Spencer Limited v MW High Tech Projects UK Limited

This case involved a Waste-to-Energy plant in Hull. MW was engaged as main contractor and appointed CSL to design and construct civil structural and architectural works on the facility.

The subcontract included construction operations (for the purposes of the Construction Act) as well as non-construction operations – being the assembly of plant and erection of steelwork to provide support or access to plant and machinery.

A payment dispute arose after CSL issued a payment application which split the amounts applied for into construction operations and non-construction operations. MW’s subsequent payment notice, however, did not distinguish the two amounts, but just assessed the overall amount due. CSL challenged its validity on the basis that it failed to identify that part of the amount assessed as due in respect of construction operations (as defined by the Construction Act), and the basis on which that amount had been calculated.

The court found that whilst it was correct that the Construction Act only applied insofar as works were construction operations, the parties were free to agree that the payment terms could apply equally to all operations under the contract.

That was the case here where the parties had incorporated Act compliant payment terms which could apply equally to all operations. This differed to the situation in the Severfield case mentioned above where the contractual payment terms were not Act compliant. In that case the Construction Act implied the Scheme provisions in respect of the construction operations, but did not have the reach to do so in respect of the non-construction operations, meaning that two separate regimes operated in parallel.

The court held that whilst in a case where separate regimes apply, an applicant had to identify what part of the sum was claimed in respect of the works covered by the Construction Act, that did not preclude parties agreeing a single payment (or adjudication) regime that was Act compliant and applied to all parts of the works under the contract. In that case a “… payment notice that does not separately state the sums due in respect of the construction operations is capable of constituting a valid notice for the purposes of sections 110A and 111 of the Act …” and that to comply with Section 110(2) of the Act, “… the sum considered due must include, but is not expressly limited to, such sum in respect of construction operations”.

Conclusions and implications

As we concluded in our earlier Law-Now on the Severfield case (see here), in the case of a hybrid contract it remains the case that the parties will often be best advised to ensure that Act compliant provisions are drafted to apply to the whole of the works. Otherwise, they could face the prospect of having to operate two separate payment mechanisms together with the pitfalls that can bring.

This latest case has now confirmed that if parties adopt Act compliant mechanisms they can avoid those risks. It should be noted that had MW’s payment notice not been valid (which might have been the case if there was no Act compliant payment mechanism), it would have been liable to pay the amount applied for by CSL as all of its alternative defences failed.

The same point applies to adjudication. The Construction Act provides a right of adjudication in relation to construction operations only, giving rise to the potential for parallel dispute resolution procedures and jurisdictional challenges in the absence of jurisdiction being conferred on an adjudicator contractually in relation to non-construction operations. That is exactly what happened earlier in the history of the present case when CSL abandoned an adjudication in response to a jurisdictional challenge by MW that no right to adjudicate non-construction operations had been agreed in the subcontract.

References:

C Spencer Limited v MW High Tech Projects UK Limited [2019] EWHC 2547 (TCC).