Payment terms in construction contracts: Do they comply?


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For further information, please contact Alan Woolston, Partner, Fladgate LLP (awoolston@fladgate.com)


 

Introduction

A number of common law countries in the Asia Pacific region have introduced security of payment legislation for construction contracts.  Such legislation can present a number of pitfalls for the unwary, particularly where payment arrangements are concerned.

There are two main approaches to payment terms in construction contracts.  These differing approaches are considered below.

Liberal approach

Many countries adopt a relatively relaxed approach to payment terms in construction contracts, whereby the parties are generally free to agree the payment arrangements between them.  This is the case in Korea where there are no statutory or other legal procedures regulating how an employer is to pay a contractor.  As such, issues relating to payment are typically decided between the parties and are set out in the contract.  A not dissimilar approach exists in China, where the construction contract payment structures are generally subject to mutual agreement.

This liberal approach to payment terms is reflected in many standard form contracts.  A typical construction contract payment procedure comprises a number of basic steps:

  1. following completion of certain works or at the agreed interval, a contractor submits a statement to the employer showing the amounts to which he considers himself entitled;
  2. payment becomes due within an agreed period; and
  3. the employer pays the amount set out in the contractor’s payment application less retention (where applicable) and any amounts with which the employer has expressed his disagreement.

This general approach is followed in FIDIC  contracts, which are widely used on international construction projects.  The short form FIDIC Green Book, for example, provides for interval payments with the employer paying the amount applied for less disputed items.   The standard contract drafting imposes few requirements concerning the paperwork (if any) that parties are required to put in place.   The Employer is not required to object to disputed items in a particular manner.

Prescriptive approach

Legislation regulating construction contracts has been introduced in a number of Asia Pacific common law countries such as New Zealand,  Singapore  and Malaysia.   In Australia, each state has its own security of payment legislation governing the construction industry  with terms differing between states.  What such legislation has in common is that it introduces more prescriptive arrangements regarding payment terms in construction contracts.  Whilst there are differences between the legislation in each of these countries and states, insofar as the issue of payment is concerned a number of general principles apply:

  1. pay-when-paid provisions are prohibited, with a contractor having an entitlement to progress payments on relevant contracts;
  2. minimum requirements for payment terms.  A mechanism must exist that makes clear what payments are due and when.  Where a contract does not comply with minimum standards, whilst the contract will not be unenforceable the legislation will imply compliant payment terms which supersede those written into the contract.  In such cases parties may find they are required to comply with timescales that differ from those set out in the contract; and
  3. a contractor’s payment claim must be responded to in a particular manner and within a set period.  The format of this response will differ but will usually comprise a written notice satisfying minimum requirements.  Whilst parties are generally free to agree the actual period within which payment is to be made, this will not always be the case.  Changes to the relevant legislation in New South Wales  introduced, from April 2014, a maximum 15 business day payment period.

An important feature of all security of payment related legislation is that it is not possible to contract out of the arrangements.  The legislation generally applies to construction contracts for relevant works being carried out within the country or state regardless of the parties’ contractual choice of law.  For non-construction related contracts or contracts that do not concern construction operations, it may not be necessary to comply with the statutory requirements.  This could mean that different payment terms apply to different suppliers working on the same project.

Summary and practical advice

There are a number of different approaches to payment terms in construction contracts across the Asia Pacific region but, by following the above framework and being aware of the issues, the potential pitfalls can be avoided.  In terms of practical advice:

  • it is important to appreciate that no one size fits all regarding payment terms in construction contracts.  Where no security of payment legislation is in place, the parties have greater freedom to adopt standard form payment terms;
  • although differences exist between security of payment legislation in each country or state, there are a number of common principles.  In particular, tight time constraints apply in the management of payment claims which identify what steps an employer is required to take and when.  In such cases, it is important to ensure that the necessary paperwork is put in place when required, as failure to do so may provide a contractor with various statutory entitlements, such as adjudication or suspension; and
  • where contractual payment terms do not comply with local legislation, parties might find that alternative payment terms are implied into the contract.  Incorporating compliant payment terms into a contract from the outset will make it easier for the project team to administer it.

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