Digital processes can reform payment practices in UK construction

Out-Law Analysis | 11 Feb 2020 | 12:55 pm | 3 min. read

The digital transformation of the UK construction industry provides the opportunity to re-think poor payment practices that have become all too common, thanks in part to the industry's unique characteristics.

Harnessing the full benefits of digitalisation will require greater collaboration and integration amongst the project team so there is commonality of process, purpose and direction.

The benefits of digital transformation are most likely to emerge where every party contributes to the long-term success of the project, as has been the experience of the likes of building information modelling (BIM) and the industry-led 'Project 13' initiative. Success will require an end to parties working in hierarchical silos, protecting their own interests and holding onto the money – often at the expense of the other parties working on the project.

The problem

The UK construction industry suffers from high fragmentation, low margins, low investment – at least in relative terms – and a 'cards close to the chest' mentality. These characteristics make the sector unique, but also encourage poor payment practices such as elongated payment terms and unjustified delays to payment.

David Greenwood

David Greenwood

Senior Associate

Harnessing the full benefits of digitalisation will require greater collaboration and integration amongst the project team so there is commonality of process, purpose and direction.

Leaving aside the moral aspect, poor payment practices like these heighten the risk of smaller companies becoming insolvent, and thus the risk that the main contractor will have to deal with added delays, costs and complication as a result.

Current initiatives

The Construction Act

The Housing Grants, Construction and Regeneration Act (Construction Act), introduced following a landmark report by Sir Michael Latham, introduced certain minimum standards and safeguards. More recently, the Act was amended to create statutory, obligatory regimes for interim payments and adjudication.

Leading judge Lord Justice Jackson praised the statutory regime in 2018, as part of his judgment in the Grove case, a significant case on payment notices and adjudication. He said: "Overall the payment regime and the adjudication regime have been successful".

However, the minimum standards set quite a low threshold and the time between the works being carried out and payment can still be significant without infringing the Act. Additionally, adjudication has become a costly and at times protracted, unsatisfactory process.

Project bank accounts

Project bank accounts (PBAs) continue to divide opinion. Despite some fairly significant criticism of PBAs and their effectiveness, they retain the support of the UK government and they are used on a number of public sector projects, particularly those of Highways England. They have also been mandated for projects of a certain size by the procurement authorities in Scotland, Northern Ireland and Wales, and they are growing in popularity in Australia as well.

The principle behind PBAs is a straightforward one: the money is held in a central account and then all members of the supply chain are paid simultaneously, to avoid delays and deductions as the money flows down the chain. They also take away the risk of upstream insolvency, which could deprive those lower in the chain of the money which they are owed.

However, critics say that PBAs complicate matters. Fair payment practices, together with well drafted contracts and security documents, ought to provide the necessary protections already. In addition they can be costly to set up and administer, the contractor loses control of the funds and they have no bearing on a payer's assessment and certification of the sums due to their supply chain, so don't really tackle the underlying problem.

Retentions

Retention refers to the common practice of the paying party holding on to a percentage – typically, 5% - of each interim payment, with half released when the works achieve practical completion and the remaining half released at the expiry of a defect rectification period.

In essence, retention involves holding back money due to the supply chain as a form of security in case they fail to perform. However, in practice, the retention is often not released at all, due to a set-off for contra charges or some alleged defect rectification costs. The payee will then find itself in the frustrating position of having to pursue sums which should already have been released.

UK standard form contracts could add a statement confirming that all subcontractors will be paid the sums due to them – as in the US – and say it must be paid within 30 days with some contractual penalty if the statement is proven to be false.

Both the industry and politicians seem torn between resolving this by ring fencing retention funds in a trust, abolishing retentions altogether and maintaining the status quo. The main blocker to absolute abolition seems to be finding a viable alternative. Although bonds are often cited as an obvious alternative, this may prove impractical if smaller businesses are unable to access bonding facilities within paying a significant premium.

Lessons from other jurisdictions

Looking to other jurisdictions which are tackling similar problems, some ideas may be worthy of adoption in the UK.

In France and Australia, there are regulations in place which enable subcontractors to seek direct payments from the employer in circumstances where the main contractor is in default. The lack of third party contract rights in English law prevents this here, although collateral warranties do often include 'step-in' rights to allow an employer to step in, and sometimes pay and instruct a subcontractor directly, in circumstances where the main contractor becomes insolvent. It may be that wider payment provisions could be added to collateral warranties to allow payment for other defaults too.

To improve attrition of cash flow, the UK could legislate to make 30 day payment terms mandatory. This could be backed up either by a short form adjudication process as is used in Australia, or through government-imposed penalties like in Japan. Alternatively, the UK standard form contracts could add a statement confirming that all subcontractors will be paid the sums due to them – as in the US – and say it must be paid within 30 days with some contractual penalty if the statement is proven to be false.