Drafting construction contracts for modular projects – the importance of defining ‘sign off’

Alex Walmsley, solicitor in Harrison Drury’s property and construction litigation team, discusses how the outcome of a recent case may influence drafting in future construction contracts when dealing with the terms for payment.

Modular projects are becoming much more popular in the modern construction industry, particularly for hotels, where entire rooms will be constructed off site and fitted at a later date.

In these types of projects, milestone payments will often be set between the parties, where payment is triggered upon signing off a certain event, for example a certain number of rooms being completed within a hotel.

The construction industry has its own set of rules that govern how and when payment under a construction contract should be made. These rules are set out in the Housing Grants, Construction and Regeneration Act 1996 (as amended) (the ‘Construction Act’).

Defining the meaning of ‘sign-off’ for milestone payments

In the recent case of Bennett (Construction) Limited v CIMC MBS Limited, the Court of Appeal considered the issues regarding milestone payments and modular projects, as well as the wider importance of payment terms to construction contracts and how they should be defined.

Bennett was the head contractor for the construction of a new hotel in London. Bennett entered into a contract with CIMC MBS Limited to design, supply and install 78 modular bedroom units for a hotel.

In this case, the relevant payment milestones in the contract provided that a 30 per cent payment would be made on ‘sign-off’ the prototype bedroom and 30 per cent on ‘sign-off’ of all snagging items (any minor defects imperfections or omitted items).

The parties disagreed about what ‘sign-off’ actually meant and therefore could not agree when the payment was due.

In summary, the Court of Appeal considered whether the parties’ payment terms complied with section 110 of the Construction Act and, if they did not, what the correct mechanism for payment should be.

It considered whether ‘sign-off’ meant the units being in a condition in which they could be signed off, or whether they had actually been signed off and whether this was an adequate mechanism for payment as required by section 110 of the Construction Act.

If this failed to be an adequate mechanism, then these agreed payment terms would need to be replaced by Part II of the Scheme for Construction Contracts (England and Wales) Regulations 1998 (‘The Scheme’). The Scheme implies terms to ensure there are adequate mechanisms for payment in place that comply with the Construction Act.

The Court of Appeal held that milestone payments were compliant with the Construction Act and were therefore an adequate payment mechanism in these circumstances.

The court also held that Part I of The Scheme, which related to adjudication provisions, is clear in that if the relevant construction contract does not contain proper adjudication provisions, then Part I applied in full. However, where payment provisions do comply with section 109 or section 110 of the Construction Act, Part II of the Scheme applied, but only to the extent as is necessary and under the objectives of the Act.

The purpose of the Construction Act

The court clarified that the purpose of the Construction Act, in relation to payment provisions, was to provide certain minimum and mandatory standards to achieve specific and regular cash flow to contractors.

Therefore, the Construction Act is not designed to be used to delete workable payment regimes, which both parties had agreed to replace with an entirely different regime. This would only happen where the regime was so deficient that a complete replacement would be the only viable option.

Interestingly, the court did not go as far in this case to define ‘sign off’, so there remains an air of uncertainty around the lengths parties must go to in order to ensure that there can be no dispute in this regard.

The need for clarity in construction contracts

 If this mechanism is to be utilised efficiently, parties should ensure to agree and document exactly what will document ‘sign-off’ and what express criteria will have to be met in order to make ‘sign-off’ obligatory by a party. This should minimise the chances of future disputes arising.

The clear message here is that payment milestones must be clearly drafted and in terms which cannot be construed as contrary to the Construction Act. Should they fail to be clearly set out and/or provide further definition of terms to identify a trigger, then parties to a contract may find terms supplemented by The Scheme and in unnecessary disputes over the terms of payment.

If you require assistance regarding the preparation of construction contracts or to seek specialist legal advice Harrison Drury’s property and construction litigation team, please contact Alex Walmsley on 01772 258321.