Milestone Payments - an adequate mechanism for payment

In a Court of Appeal decision handed down last week the court considered whether milestone payments in a construction contract constituted an adequate mechanism for payment in terms of the Construction Act.

The decision arose out of an appeal in the case of Bennett (Construction) Limited v CIMC MBS Limited (formerly Verbus Systems Limited).

The Facts

The main contractor (Bennett) engaged subcontractor (CIMC) to design, supply and install pre-fabricated bedroom units for a hotel it was constructing. The sub-contract incorporated the JCT standard form terms but replaced the standard provisions for interim payments with five "Milestone" payments. Milestones 2, 3 and 4 provided for payments on "sign-off" of the bedroom units at various stages (sign-off of a prototype room, snagging items and completed units respectively). The parties disagreed over what "sign-off" meant. Bennett argued that the prototype of the rooms did not comply with the contract specification and that there were defects in the units produced. It therefore did not consider that "sign-off" had taken place. CIMC argued that the milestones which linked payment to "sign-off" did not comply with the requirements of section 110(1) of the Construction Act 1996 for an adequate payment mechanism.

In the first instance, the Technology & Construction Court held that Milestones 2 and 3 were not compliant with the Construction Act and should be replaced with paragraphs 2, 4 and 5 of Part II of the Scheme for Construction Contracts 1998. The commercial effect of this was that Bennett had to make interim payments by reference to the value of the work carried out, irrespective of whether it had reached a stage at which it could be signed off.

Appeal

The Court of Appeal allowed Bennett's appeal and concluded that the sub-contract did provide an adequate mechanism for payment. The court rejected the subjective interpretation contended for by the sub-contractor that "sign-off" only took place when the prototype and units were actually signed off. Instead sign-off was to be assessed objectively and, when the contract was viewed as a whole, it was clear that parties intended for the milestone to be paid, on completion of the relevant stage in accordance with the contract. If actual sign-off was required, the contract would have said so. The Court of Appeal also rejected the argument that the payment mechanism was inadequate because no date for payment of the relevant percentages was expressed in the contract. Such details were not necessary in a contract of that type. The contract contained an adequate mechanism for determining what payments became due under the contract and when.

Although the court allowed the appeal on the basis of the above, because of the wider importance of the issue, it also considered the second ground of appeal; if Milestones 2 and 3 did not comply with the Construction Act, what was the replacement mechanism? The court held that paragraph 7 of the Scheme (which provides for payment seven days after completion) was intended as a catch-all provision and was the only one in the Scheme that could relate to the milestones here. The proposition also made commercial sense. It meant that, in the event that the agreed mechanism was considered inadequate because there was no agreement as to timetable for payment, such a timetable was provided by paragraph 7. It followed that, in a case where parties did not agree a payment arrangement by reference to interim valuations of the work done, Part II of the Scheme did not impose such a regime. On the assumption that the mechanism in respect of the date and criteria for payment was inadequate in some way, both could be resolved by the implication of paragraph 7. The court considered that this inflicted the "least violence" upon the agreement between the parties, which was central to the court's considerations.

Implication of the Scheme...but only where necessary

The court reiterated that the underlying purpose of the Construction Act was to provide for certain minimum, mandatory standards to achieve certainty and regular cashflow. It was not designed to delete a workable payment regime which the parties had agreed and replace it with an entirely different payment regime, based on a radically changed set of parameters. That could only happen when the agreed regime was so deficient that wholesale replacement was the only viable option.

It is clear from this decision that, where a construction contract's payment provisions do not comply with the Construction Act, Part II of the Scheme will be implied, but only to the extent that such implication is necessary to achieve what is required by the Construction Act.

This decision raises a potentially significant issue around cashflow in the context of stage or milestone payments if a dispute arises between the parties as to whether and when a payment falls due. Best practice remains to ensure that payment provisions are clear and unambiguous, leaving parties in no doubt as to how and when payments are to be calculated and made.