January 21, 2020

Commercial sense prevails once again in the Court of Appeal

It's always good to see the courts taking a common and commercial sense approach and seeking, as far as possible, to honour the bargain made by the parties. It's particularly encouraging in the construction industry to see this when it comes to the much disputed and discussed payment sections of the Housing Grants, Construction and Regeneration Act 1996 (the "Act") and the Scheme for Construction Contracts 1998 (the "Scheme").

That is exactly what happened recently in the Bennett case in the Court of Appeal. Milestone payments were found to be compliant with the Act and the implied payment terms in the Scheme were found to be capable of co-existing with the payment provisions of the contract (and not requiring wholesale replacement) - the two central issues to the case - thereby doing the least violence to the agreement between the parties.

The facts

Contractor, Bennett, employed sub-contractor, Verbus, to design, supply and install 78 prefabricated modular bedroom units for a hotel. The interim payment provisions of the JCT standard form contract used were replaced with a payment mechanism based on five milestone payments. Three of the milestones (milestones 2, 3 and 4) were stated to be achieved on "sign off" – being undefined and not used consistently throughout the contract - of the units at different stages of their design, build and delivery.

The validity of these milestones was challenged by Verbus as being non-compliant with section 110(1)(a) of the Act, the purpose of which is to ensure that every construction contract contains a "transparent and straightforward payment mechanism for payment … to a clear contractual timetable".

The judge at first instance held that milestones 2 and 3 were non-compliant and, because it was impossible just to alter those 2 milestones, paragraphs 2, 4 and 5 of the Scheme should replace the milestone mechanism in full. This would have the effect that interim payments would be calculated by reference to value of work done. There were 2 issues on appeal:

Issue 1 - did milestones 2 and 3 comply with the Act?  

Coulson LJ in the Court of Appeal commented that "the commercial effect of the judge's decision is stark". To replace those milestones would mean that Verbus would be entitled to payment (20% of the contract sum) irrespective of whether or not the prototype / units had "reached a stage of completion at which they could have been signed off". He went on to say that "this is a significant reapportioning of the commercial risk which the parties had agreed" and that it would take "very clear words in the Act in order to bring that about".

Coulson LJ referred found that milestones 2 and 3 did comply with the Act and referred, in particular, to 3 elements of the first instance decision, finding differently on each of them:

Sign off was to be assessed objectively – the parties intended that the milestone would be paid on completion of the relevant stage (to be interpreted objectively). If actual sign-off had been required (subjective interpretation), the contract would have said so and required a certificate or similar, but instead the term was used in various guises throughout the document.
The only criterion to sign-off was that the prototype or units had to be in accordance with the contract (to be assessed objectively). Actual sign off was not required and even if it had been, if the units were in a state where they could have been, then failure to sign off would not be a defence.
The fact that there was no express date for payment did not matter because the sum was payable when completion was achieved. Parties are free to base stage payments on completion and should adopt business common sense as to invoicing and payment arrangements.

Issue 2 – if milestones 2 and 3 did not comply with the Act, what was the correct mechanism of replacement?

The judge addressed the second issue on an obiter basis (technically the issue fell away following the successful appeal on issue 1). The payment provisions in Part II of the Scheme are implied where the contractual provisions are non-compliant "but only to the extent such implication is necessary to achieve what is required by the Act". It follows, therefore, that they can co-exist with the payment provisions of the contract and the Act does not require wholesale replacement of a workable payment regime agreed by the parties, unless what had been agreed was so deficient that that was the only viable option.

The judge found that despite Part II of the Scheme being badly draft, it was possible to "pilot a course through it in order to achieve a common sense result that … does no significant violence to the parties original agreement". By process of elimination - whether the mechanism was deficient in respect of just the date for payment or the criteria and date for payment - the catch all provision in paragraph 7 of Part II would be the correct mechanism for replacement then. Therefore, either way, the date for payment would be 7 days following completion of the prototype or units(as the case may be), retaining the position agreed by the parties that payment would be triggered by completion and adding that payment should be 7 days later.

Take away

Whilst, this case demonstrates that the courts will take a common and commercial sense approach and seek, as far as possible, to honour the bargain made by the parties and to uphold a workable payment mechanism, it does still highlight the importance of ensuring that payment mechanisms are expressed in clear and specific terms.