Are milestone payments a sufficient mechanism for payment in construction contracts?
In the recent case of Bennett (Construction) Limited v CIMC MBS Limited (formerly Verbus Systems Limited)1 the Court of Appeal considered whether milestone payments in a construction contract constituted an adequate mechanism for payment in terms of the Housing Grants, Construction and Regeneration Act 1996, as amended (“the Act”). Martin Ewen explains more.
The facts
Bennett contracted to Verbus the design, supply and installation of 78 prefabricated modular bedroom units for a new hotel in London. The units were to be made in China and then shipped to Southampton. The contract price was just over £2 million. The contractual terms incorporated the standard form JCT contract. However, the standard JCT provisions for interim payments were deleted in their entirety and replaced by five bespoke “Milestone” provisions:
Milestone 1: 20% deposit payable on execution of contract;
Milestone 2: 30% on sign-off of prototype room in China;
Milestone 3: 30% on sign-off of all snagging items in China;
Milestone 4: 10% on sign-off of units in Southampton;
Milestone 5: 10% on completion of installation and any snagging.
Importantly, the contract did not contain a specific definition of the term “sign-off”.
Verbus produced a prototype of the unit in China but Bennett said it did not comply with the contract. Despite that dispute, Verbus went on to produce the 78 bedroom units in China. Before they left the factory, there was also a dispute as to whether or not these units complied with the contract. Bennett alleged that there were numerous defects. In consequence, there was no actual sign-off of either the prototype or the units themselves, nor any agreement that the prototype or the units had ever reached a stage of completion in which they could have been signed off. In the end, the whole contract came to an end following the liquidation of the developer and the units were scrapped.
The adjudication
A dispute as to payment arose. Bennett refused to pay for the units and relied on the lack of “sign-off”, whereas Verbus complained that the “sign-off” requirement did not comply with the requirements of the Act. The decision in the adjudication went in Bennett’s favour.
Decision at first instance
Verbus continued to complain that the Milestones, or at least Milestones 2, 3 and 4, did not comply with the requirements of the Act. The Court agreed with that proposition in respect of Milestones 2 and 3, although not of Milestone 4. The Court concluded that it was impossible to alter just Milestones 2 and 3 and that “for reasons of workability and coherence the only approach on the facts was to incorporate Paragraphs 2, 4 and 5 of Part II of the Scheme for Construction Contracts to supplant Milestones 2 to 5 as a whole”.
The commercial effect of the Court’s conclusions was stark. Prior to the proceedings the principal dispute was whether or not the prototype units had been completed, in a condition in which they could have been signed off as complete. Verbus said they had while Bennett said they had not. On Bennett’s case, until that was resolved Verbus was not entitled to payment of Milestones 2, 3 or 4 (or part thereof). However, following the Court’s decision Verbus became entitled to interim payments by reference to the value of the work which they had carried out. Verbus became entitled to payment, regardless of whether or not the prototype or the units themselves had reached a stage of completion at which they could have been signed off.
Bennett appealed against both elements of the judge’s conclusions.
The appeal
The Court of Appeal said that two particular issues arose. The first was whether a payment regime requiring payment of a percentage of the contract sum on “sign-off” of a particular stage of the works complies with the Act; the second, if it does not, concerns the mechanism by which the Act (and the Scheme for Construction Contracts, which it introduced) is incorporated into the contract in order to “save” the bargain which the parties made.
Issue 1: did Milestones 2 and 3 comply with the Act?
Section 110 of the Act requires every construction contract to contain “an adequate mechanism for determining what payments become due under the contract and when”. Verbus contended (and the Court at first instance agreed) that the “sign-off” requirement envisaged an actual signing off of the works, and that due payment could be circumvented by a deliberate decision not to sign off or prevent others from signing off the prototype or the units. Verbus also argued that the contract offered no clear criteria for sign-off, because it envisaged the involvement of third parties with no status under the contract at all. For these principal reasons, they contended that Milestones 2 and 3 did not comply with the Act.
Bennett contended that “sign-off,” meant simply the date on which completion of the identified stage of the work (the prototype for Milestone 2 and the units from China for Milestone 3) was achieved (and so was capable of being “signed off”). Bennett argued that the trigger for payment was when the relevant work was completed in accordance with the contractual requirements. Bennett said that Milestones 2 and 3 complied with the Act.
Verbus did not, rightly in the Court’s view, challenge Milestones 1 to 5 on the basis of section 109. This is because the contract complied with section 109. Verbus’ challenge relied on section 110(1)(a), on the basis that there was no adequate mechanism for determining what payments became due and when. Verbus accepted that there was no difficulty about the amount of each instalment: that was each of Milestones 1–5, expressed as a percentage of the contract sum.
Issue 1 raised primarily a question of interpretation. Did the reference to “sign-off” in Milestones 2 and 3 mean the prototype and units being complete, in a condition in which they could be signed off, or did it mean the date on which they were actually signed off, thereby allowing Bennett to refuse to sign off the prototype or the units and deprive Verbus of payment? Was it a generic reference to the satisfactory completion of a particular stage, to be assessed objectively (“the objective interpretation), or was it a reference to the date on which the sign-off actually occurred (“the subjective interpretation”)?
The Court found that “it was plain, taking the contract as a whole, that the parties intended that, on completion of the relevant stage, the Milestone would be paid”. In other words, the objective interpretation was favoured. The Court noted that there was nothing in the contract that sought to tie in sign-off to the production of a certificate or record of any sort. Further, it noted that if actual sign-off was required, the contract would have said so.
The Court went on to say that even if it was wrong and the contract envisaged actual completion or certification of a signed off document, it would not alter the Court’s view as to the adequacy of the payment mechanism. If a unit was in a state where it could be signed off, Bennett could not avoid liability to pay simply because the document had not actually been signed off.
Accordingly, the Court could find no difficulties with the use of the word “sign-off” in Milestones 2 and 3. It denoted, in the Court’s view, the objective state the prototype and then the units had to reach before the payment was due. It did not require actual signing-off. Even if it did, that could not affect Verbus’ entitlement to be paid because, if the prototype or the units were in a state in which they were capable of sign-off, Verbus were entitled to be paid, and a failure to sign off the relevant documentation would not be a defence to Bennett.
The Court held that the Court at first instance was wrong to find that the contract did not contain an adequate payment mechanism for determining what payments became due under the contract, and when. The contract contained an adequate payment mechanism in accordance with section 110 of the Scheme.
Accordingly, the Court allowed the first ground of appeal.
Issue 2: if Milestones 2 and 3 did not comply with the Act, what was the correct mechanism of replacement?
While the appeal was allowed, because of its wider importance for the construction industry, the Court went on to consider what the correct payment mechanism would have been if Milestones 2 and 3 did not comply with the Act in terms of being an adequate payment mechanism.
Section 110(3) of the Act states that “if or to the extent that a contract does not contain” adequate mechanisms for payment, “the relevant provisions of the Scheme for Construction Contracts apply”. These provisions can be found in Part II of the Scheme. This means that a piecemeal incorporation of these provisions is permitted. Therefore, where payment provisions do not comply with sections 109 or 110 of the Act, Part II of the Scheme applies, but only to the extent that such implication is necessary to achieve what is required by the Act.
The Court said that Part II of the Scheme was “badly drafted” but nonetheless it was possible “to pilot a course through it in order to achieve a common sense result that, when applied to this case, does no significant violence to the parties’ original agreement”.
The Court considered Milestone payments 2 and 3 to be based on completion of a particular stage of the works. Upon review of the relevant paragraphs in Part II, paragraph 7 (“Any other payment under a construction contract shall become due on (a) the expiry of 7 days following the completion of the work to which the payment relates …”) was deemed the only paragraph that could relate to Milestones 2 and 3. On that basis, if the payment mechanism is inadequate because there was no agreement as to timetable for payment, such a timetable is provided by paragraph 7 (7 days after completion).
Payment of Milestone 2 would be due 7 days after completion of the prototype, and payment of Milestone 3 would be due within 7 days of completion of the units.
The Court was of the view that this also resolved any concern about the sign-off provision because it provides for payment after the completion of the relevant work.
Commentary
Where standard payment terms, such as those in the JCT standard form, are replaced by bespoke amendments as to stage/milestone payments, it is imperative to ensure that they are properly drafted. When using stage/milestone payments, it is important to define the exact requirements of each stage. Vague, undefined terms such as “sign-off” should be avoided. Ensure that payment provisions comply with the Act.
Only in very rare circumstances will the payment provisions in Part II of the Scheme replace contractual provisions as to payment in their entirety. The courts will strive to make the original contract work, with terms of the Scheme implied only to the extent necessary to make the payment provisions achieve what is required by the Act. As the Court of Appeal noted in this case, this is not a straightforward task and there is little legal authority on the point. Properly drafted payment provisions will help avoid the need to resort to the Scheme to imply terms. It will also avoid potentially costly disputes.
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- 1. [2019] EWCA Civ 1515.