Reviewing the situation: Appeal Court leaves no milestone unturned

Bennett (Construction) Ltd (“Bennett”) recently appealed against a Court decision holding it liable to make three interim “milestone” payments to its subcontractor CIMC MBS Ltd (“CIMC”) in relation to prefabricated bedroom units in a London hotel.

Background

Bennett, acting as a contractor, engaged CIMC as a sub-contractor to build 78 prefabricated bedroom units (the “Units”) in China, for a London hotel for around £2m.

The Subcontract contained five milestone payments, in place of the standard time period mechanism. Milestones 1 and 5 did not require a “sign-off” as they were payable upon execution of the Subcontract and completion of the Subcontract works. Milestones 2, 3 and 4 all required sign-off, with 2 and 3 relating to the prototype room and snagging items in China, and 4 relating to the Units once they had been delivered to the site.

A dispute meant that there was no “sign-off” of Milestones 2 and 3 for the prototype or completed Units. The Main Contract was eventually terminated following the liquidation of the developer, Key Homes.

Following the termination, an adjudicator found in favour of Bennett in relation to a dispute regarding the milestone payments. CIMC then took this dispute to Court, with the Court finding that milestones 2 and 3 did not comply with the statutory requirements for payment as prescribed by the Housing Grants, Construction and Regeneration Act 1996 (the “1996 Act”).

The Court at first instance took the view that:

  1. Milestones 2 and 3 required to be physically signed-off, based on the underlying premise that the clients could refuse to sign even if the units had reached a stage of completion;
  2. The criterion to be applied to any sign-off was itself uncertain and vague, because of the use of the “clients representative” in the Subcontract; and
  3. The mechanism was inadequate because no payment date for each milestone was set out in the Subcontract.

The Court determined that it could not alter milestones 2 and 3 alone, and instead incorporated paragraphs 2, 4 and 5 of Part II of the Scheme for Construction Contracts (the “Scheme”) to wholly replace milestones 2-5. As a result, Bennett was held liable to make payments by reference to the value of CIMC’s work. Bennett appealed this decision.

The arguments

CIMC claimed that the sign-off requirement did not comply with s.110 of the 1996 Act, which requires that “an adequate mechanism for determining what payments become due under the contract and when” is provided for. In their view Bennett could deliberately refuse to sign off the works to avoid making payment. Milestones 2 and 3 requiring sign off did not comply with the Act and had to be replaced by the Scheme provisions.

Bennett contended that the relevant “sign-off” was simply the date on which the identified stage of the work was achieved in accordance with the Subcontract requirements, and on that basis provided an adequate mechanism was provided in respect of milestones 2 and 3 in satisfaction of the Act. There was no need to incorporate the terms of the Scheme.

The decision on appeal

The Court of Appeal found in favour of Bennetts, having determined two key issues arising from the original decision:

Did the payment regime requiring a “sign-off” of a particular stage of work comply with s.110 (a) of the Act?

The Court of Appeal took a different approach to the “sign off” provisions than the court at first instance.

Taking the Subcontract as a whole, the parties intended that each milestone would be paid on completion of the relevant stage. If an actual sign-off were required, the Subcontract should have mentioned the required production of a certificate or otherwise signed document. The Court of Appeal found that undue formality was incorporated into the original decision, as a failure to sign-off relevant documentation was not a valid reason to avoid paying CIMC for the completed Units.

The use of “client representatives” did not detract from the only relevant criterion - if the Subcontract specification was objectively achieved, then the works were capable of being signed-off and milestones 2 and 3 became payable regardless of signing.

Lastly, this case did not involve specific time-period payments and the payment dates are clear with regard to when payments should occur, with sums payable when completion was achieved.

The Court of Appeal reversed the original decision and found that the contract did include an adequate mechanism for payment.

Did the payment mechanism enforced by the 1996 Act in its place “save” the bargain which the parties made?

The original decision applied paragraphs 2-4 of the Scheme and replaced the existing milestone payments in full.
The Court of Appeal considered the wording of the Scheme namely: “if or to the extent that a contract does not contain [adequate mechanisms for payment] the relevant provisions of the Scheme…apply”.

It determined that paragraphs 2-4 of the Scheme could not apply in this case, as the agreed milestones were based solely on the completion of a stage of works.

In the Court of Appeal’s view only paragraph 7 of the Scheme could apply where the mechanism is considered inadequate due to the absence of payment dates. The incorporation of paragraph 7 of the Scheme would resolve the issues with milestones 2 and 3, without replacement of the entire payment provisions and leaves milestones 1, 4 and 5 unaffected.

Commentary

The Court of Appeal has clarified the underlying purpose of the 1996 Act, which is to provide a minimum standard to achieve regular cash flow and certainty of payment. The 1996 Act is not intended to replace whole parts of contractual agreements, where doing so results in radically changed parameters and an entirely different payment regime that unfairly tips the scales of risk borne from one party to another. Only where payment provisions are entirely deficient, would such replacement occur. The Court of Appeal determined that the correct option was to take the route that caused the “least violence to the agreement between the parties”, and demonstrates that Courts will attempt to maintain the parties’ original agreement, where possible.

Parties to construction contracts can therefore take solace in the fact that milestone payments have been found to comply with the 1996 Act. However, when using such provisions, one should take care that the wording is clear, especially where “sign off” is a requirement.

This article was co-written by Chris Murphy, a Trainee Solicitor within our Construction team. 

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