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Construction Contracts (England) Exclusion Order 2011

Volume 730: debated on Wednesday 7 September 2011

Considered in Grand Committee

Moved By

That the Grand Committee do report to the House that it has considered the Construction Contracts (England) Exclusion Order 2011.

Relevant document: 26th Report from the Joint Committee on Statutory Instruments

This instrument and the Scheme for Construction Contracts (England and Wales) Regulations 1998 (Amendment) (England) Regulations 2011 are being made using powers in the Housing Grants, Construction and Regeneration Act 1996. I should like to set out the context for these instruments.

Part 2 of the 1996 Act regulates construction contracts and has two key aims: to improve cash flow and to facilitate the quick resolution of disputes through adjudication. The 1996 Act has played an important role in improving payment practices in the construction industry. It works by requiring contracts to make certain provisions on payment and on adjudication. Where a contract fails to meet an effective provision, a safeguard is needed. The Scheme for Construction Contracts (England and Wales) Regulations 1998 (Amendment) (England) Regulations 2011 provide that safeguard.

The Department for Business has engaged in an extensive review of the construction legislation with the industry. This identifies a number of weaknesses and regulatory burdens in the 1996 Act. After two formal consultations with the industry and a further consultation on draft Bill clauses, a package of measures was introduced to reduce these burdens and fix weaknesses. These measures were included in Part 8 of the Local Democracy, Economic Development and Construction Act 2009. The measures improve access to adjudication and reduce costs, and improve the exchange of information relating to payment to enable better cash flow management and remove administrative burdens. We now need to mirror these changes by amending the scheme for Construction Contracts (England and Wales) Regulations 1998 (Amendment) (England) Regulations.

There are three main areas of change: adjudication costs, the slip rule—that is, the adjudicator’s ability to correct simple errors or slips—and payment notices. The 1996 Act was silent on the cost of adjudication. Some in the industry have chosen to exploit this by drafting contract clauses that use the cost of the adjudication process as a barrier to adjudication. Such clauses, which are commonly referred to as Tolent clauses, can require one party to bear all the costs, including both parties’ legal costs, irrespective of who initiated the process and regardless of the outcome. To prevent such onerous contract terms the 2009 Act will make agreements on adjudication costs ineffective, except in two cases. These are: where it is an agreement in writing in the contract that allows the adjudicator to allocate his fees and expenses between the parties; and where it is an agreement, whether concerning the adjudicator’s or the parties’ costs, made in writing after the notice of intention to adjudicate had been issued.

As a consequence, it is necessary to amend the scheme. The consultation exercise showed strong support for this amendment. The 2009 Act will require construction contracts to provide that the adjudicator has the power to correct a clerical or typographical error in his decision—the so-called slip rule. The scheme currently contains no such provision. It is therefore being amended so that the adjudicator has the power to make such a correction within five days. The consultation exercise showed unanimous support for this approach.

The 2009 Act will make changes to the statutory payment notice framework. In particular, it will remove restrictions on who can issue a payment notice, which removes a burden, and require it to be issued even when the amount owed is zero, which will improve communication. As a consequence, amendments to paragraphs 9 and 10 of part 2 of the scheme are required. Most respondents to the consultation agreed that no further amendments were required to the payment schedule. Apart from a minor change to cure an ambiguity, no further changes are being made.

I turn now to the Construction Contracts (England) Exclusion Order. The 1996 Act prevents the use of “pay when paid” clauses. A practice has emerged whereby some contracts make payment—its timing, amount or both—dependent on the issue of a certificate, such as a valuation of the work by the client’s agent, under the superior contract. In effect, this creates the same effect as a “pay when paid” clause. The Local Democracy, Economic Development and Construction Act 2009 therefore closes this loophole. It states that the requirement for a contract to have an adequate mechanism for determining what will be paid and when is not met if it makes payment conditional on obligations being performed under another contract. This provision, contained in what will become Section 110(1A) of the Act, will adversely affect PFI projects to an unwarranted degree.

Different circumstances apply in PFI contracts from those that exist in traditional contracting. For instance, it is frequently a feature of PFIs that the construction contractor has a shareholding in the special purpose company. It will therefore be intimately aware of the project agreement and the terms of funding. Even where the construction contractor does not have a shareholding in the special purpose company, it will be a term of its first-tier subcontract that it has full knowledge of the project and funding structure. The first-tier contractor will invariably take legal advice when agreeing its contract, unlike more traditional contracts. The construction contractor will therefore have full knowledge of the funding arrangements and project contract. Further, in PFI projects it is, in practice, the construction contractor itself that performs the construction obligations contained in the head contract with the authority. This means that it is in a good position to assess and price the risk, in contrast to the general position with more traditional construction projects. Recognising these important differences, the exclusion order will mean that the special purpose company can continue to make payment to the first-tier PFI subcontractor, conditional on obligations, although not payment obligations, being performed under another contract—the head contract. The exclusion extends no further than the specific contractual relationship. That is, it will not affect any contracts that the construction contractor has with its supply chain.

The various consultation exercises have demonstrated significant support in the industry for the 1996 Act. Almost everyone believes that its adjudication provisions have played an important role in improving contractual relations, although it is fair to say that sentiment about the payment provisions is more mixed, with views largely determined by where firms sit in the supply chain. The Local Democracy, Economic Development and Construction Act 2009 made some important amendments to the 1996 Act to ensure its more effective operation. Before those changes begin to bite, they need to be reflected in the mirroring secondary legislation, the scheme for construction contracts. I commend these orders to the Committee.

The two orders are being taken together. I am entirely happy with the first one, which seems to be a very sensible tidying-up of the situation. On the second one, which basically deals with PFI, I am sure that the Minister will be aware that PFI is a highly controversial topic at the moment, not only with Private Eye but with House of Commons committees. It would not be beyond the wit of man if, as we speak, HM Treasury was looking at the details of PFI to see how it could be improved.

PFI contracts normally contain three elements: the management of the project, the finance and the construction. One of the issues here is that the construction element is to some extent being brought into the financing, and the arguments for this order go to how PFI contracts are financed. I am happy to support the order, but it would be helpful if the Minister could assure us that when HM Treasury completes its review of existing PFI contracts and the future procedures for PFI, this will be on the table again so that, if it is necessary as a result of that exercise to look again at this issue, that will be done. This does not have to be the end of the story. It may well be that that is not necessary, but if there is currently a review—not only by Private Eye, as I say, but by a more salubrious body—this should still be on the agenda if necessary.

My Lords, I welcome the comprehensive statement read by the Minister. We do not see this as a matter of controversy; its origins lie before the 1997 election and it continued until the 2009 legislation. We do not see the proposals as controversial and we do not intend to oppose them. I tend to agree with the noble Lord, Lord Razzall, on PFI contracts. If I had one other comment to make, it would be to ask whether there would be an impact regarding the participation of SMEs in these contracts, something that I know the Government see as desirable. With those comments, I await the Minister’s response.

I thank noble Lords for their patience in listening to the great amount that I had to say on the order, but I felt that we could not cut it shorter because it is important stuff. Clearly, the private finance initiative is something that generates strong feelings. I have experience myself in business of a PFI contract. The noble Lords, Lord Razzall and Lord Young, have referred to PFI, but the exclusion order that we are debating today is simply a technical exercise to acknowledge the fundamental differences between private finance construction contracts and traditional construction contracts. It does not concern the wider policy landscape. I asked the same questions myself, and it does not, so I can reassure noble Lords on that. Of course, we will look at it again if circumstances change.

The noble Lord, Lord Young, mentioned SMEs. Measures to help SMEs by promoting cash and simplifying dispute resolution are under consideration anyway, as the noble Lord would have expected. As he rightly said, the Government are very concerned about SMEs and their future. I thank both noble Lords very much for their interventions; I am grateful. I hope that I have dealt with the key points that they made and I commend the order to the Committee.

Motion agreed.