The effect of subcontractor legislation: don’t get caught out

Wes Simmons, managing director of construction software company Eque2, offers a reminder on the pitfalls of payment notices.

Despite being nearly 20 years old, the Construction Act 1996 continues to cause problems for businesses. Recent court cases have highlighted the importance of making payments according to the strict rules of the Act and changing subcontractor legislations, as businesses which make mistakes risk paying heavily.

To avoid making a mistake, particularly in cases where you want to withhold payment for non-delivery or disputes about quality, you need to properly understand your obligations. The amends made to the Construction Act 1996 apply to all contracts formed on or after October 1 2011 and demand that you:

• issue a payment notice to your subcontractors within five days of every payment due date;
• determine the due date(s) for your payment(s) by reference to the contract only;
• issue a pay less notice which outlines any intention to underpay, along with the calculations of how the sum (including nothing at all) was arrived at;
• the payment must then be paid by the final date stipulated in the contract/invoice;
• provide a date for the release of your retention.

It is essential that this subcontractor legislation is followed exactly, or you could find the dispute costs a lot more than expected.

The potential cost of getting it wrong

The case of a Devon hotel refurbishment project shows the importance of keeping paperwork in order. The building contractor issued an Interim Application (IA60) to the company commissioning the hotel project for £4m (the whole project value), which it believed was due. The hotelier saw differently, believing that they were only supposed to pay instalments, rather than the entire project cost. However, instead of following the procedure outlined above, the company behind the hotel issued neither a payment notice, nor a pay less notice. At this point the sum requested in the application ‘crystallised’, making the hotelier legally liable for the full amount immediately.

Another case between another building contractor and an Essex-based college also had a similar outcome. Again the client (the college) failed to respond to the builder’s IA60, and became liable for the full amount – £1.1m.

In both cases the law found that the clients had failed to act in accordance with subcontractor legislations and were therefore liable for the full amounts that they had been billed.

Your role in the payment process

Both these cases relate to bills between builders and the end client, but the Construction Act applies to builders and subcontractors too. Thus it is extremely important to follow the prescribed steps when handling payment demands from your subcontractors.

The way in which the amount due is determined has changed. In accordance with the latest amendments, there are three different ways:

1. The contractor is responsible for notifying the amount due using what is called a payment notice, which must be issued not later than five days after the due date or
2. The specialist Contractor is responsible for notifying the amount due using the ‘Payment Notice’ which must be issued not later than five days after the due date.
3. If the contractor is responsible for notifying the amount due but does not issue the payment notice on time, the specialist contractor can issue their own payment notice, which becomes the amount due unless the contractor issues a pay less notice before the final date for payment.

All contracts must state whether option 1 or 2 are applicable. Where they are not, option 3 can be used as a fall back position.

Although the finance manager is responsible for making payments, as the commercial manager you are responsible for assessing work completed by subcontractors and approving payment. It is vital then that you complete such assessments in a timely fashion and ensure that the outcomes are forwarded to the finance department before the five-day deadline expires.

Where work is found to be unsatisfactory, you will need to calculate how much of the sum due is to be held back. Ensure that those calculations are also forwarded to the finance team because they will need to be included with the pay less notice that is returned to your subcontractor.

And never forget, if you fail to fulfil your legal obligations and comply with subcontractor legislations, your job – if not the future of the business itself – could be in jeopardy.

Takeaways

To avoid costly problems with subcontractor payments:

• Ensure you fully understand your payment obligations under the Construction Act 1996 and changes effective from 2011.
• Keep track of subcontractor progress and document all cases where standards are not met.
• Ensure you inform the finance department in advance of any payment dates so that the relevant notice is forwarded to the subcontractor.

You can do more to avoid costly problems with subcontractors – here’s the Construction Risk Assessment Checklist: Rate Your On-Site Management of Subcontractors, so you can assess the performance and value of your subcontractors, put in place an effective process for hiring and management, and ensure you’re complying with health and safety