On 1 October 2022, the Construction Contracts (England) Exclusion Order 2022 comes into force. The Order will exclude contracts within the water and sewerage infrastructure industries “for the delivery of a direct procurement for customers project”, or “DPC”, from the Part 2 provisions contained in the Housing Grants, Construction and Regeneration Act 1996 (the “Act”).
At first glance, this is a somewhat paradoxical move given the purpose of those provisions is to improve cash flow by guaranteeing fair and prompt payment consistently across the construction industry, and to provide a means of quickly resolving disputes via adjudication.
The Government, however, and, in particular, Lord Callanan, who lobbied for the Order in the House of Lords in June 2022, believes that the exclusions will ultimately guarantee a more competitively priced market for bill payers.
However, as Adele Parsons of Fenwick Elliott discusses below, there are questions as to whether the Order will guarantee the Government’s desired results for consumers. Instead, the exclusion may well have the potential to open the floodgates on pay-when-paid clauses to the detriment of first tier contractors and prevent access to Adjudication, this being the industry norm for resolving payment disputes.
What is the DPC model?
DPC is a new procurement delivery method developed by the Water Services Regulation Authority, Ofwat. It involves a water or wastewater company competitively tendering for services in relation to the delivery of certain large infrastructure projects, resulting in the selection of a third-party water or sewerage competitively appointed provider (or “CAP”) to finance, design, build, operate and maintain an infrastructure asset that would otherwise have been delivered by the incumbent utility provider. The CAP will likely be a special purpose vehicle, including a construction company.
The CAP will usually enter into a series of subcontracts for the design, construction and maintenance of the relevant assets, which are typically drafted to be co-extensive with the main CAP contract, in particular relying on performance of obligations under the contract between the utility provider and the CAP to determine payment to the tier 1 subcontractor.
Regular payment to the CAP by the water provider is made by reference to actual costs incurred, which become due after one or more parts of the construction operations are completed and are capable of performing a sewerage or water service.
The government hope the DPC model will result in lower consumer bills compared to schemes delivered by regulated water companies using traditional business-as-usual models that set companies’ prices.
A clash between the DPC model and the Act?
Currently, the CAP agreement and any tier 1 construction subcontracts fall under the definition of a construction contract for the purposes of the Act. Accordingly, they could be challenged as being non-compliant with the Act given:
(i) Payment under the DPC model only commences once the asset has been completed and is operational, but:
(ii) The Act prohibits paid-when-paid or conditional payment clauses, instead requiring that payments under a construction contract to be paid by instalments or other periodic payments, otherwise the payment mechanism within the Scheme for Construction Contracts (the “Scheme”) is implied into those parts of the contract which do not comply with the Act1 .
As explained above, DPC models, by their very nature, incorporate paid-when-paid or conditional payment clauses prohibited by the Act. Therefore, any such challenges are likely to affect the operation of the projects and threaten the success of the project overall.
Consequently, it appears that the very provisions of the Act devised to ensure fair and prompt payment can undermine, if not prevent, prompt and fair payment within DPC models by affecting the operation of the project agreement as intended and the end consumer; the latter of which the Government is keen to protect
It is these unique design and financing arrangements within a DPC that led to the publication of the Order.
What does the Order exclude from Part 2 of the Act?
The Order excludes DPC contracts that meet the following criteria:
- The contract contains a statement that it is a DPC contract;
- One of the parties to the contract is a sewerage undertaker or a water undertaker;
- The construction operations are in respect of an infrastructure project that is designated by Ofwat as a direct procurement for customers’ project in accordance with the conditions of appointment of the sewerage undertaker or the water undertaker; and
- The consideration due under the contract consists at least in part of regular payments that:
- are determined in part by reference to the actual cost of the construction operations; and
- become payable after at least one part of the construction operations is completed and is capable of performing a sewerage or water service.
Practically, the Order seeks to exclude contracts in which the CAP is a party from all requirements of Part 2 of the Act. Relevant contracts do not have to comply with the payment mechanism or statutory adjudication procedure set out in the Act; nor do the parties need to be concerned that the provisions of the Scheme will be implied into their contract.
DPC first-tier subcontracts are also excluded from Section 110 (1A) of the Act only. Section 110 (1A) prevents any contract term that makes payment conditional on the performance of an obligation under another contract or a decision by any person as to whether obligations under another contract have been performed.
The Government believes that these exclusions have the potential to benefit customers in the future by way of increasing competition in the delivery of infrastructure. It is hoped that the exclusions will ensure that the cost of this infrastructure is market tested and result in better value for the average water and sewerage customer.
Practical implications – are the floodgates about to open?
In short, no. The Government is clear that the Order very much represents an exception and not the rule. All remaining construction contracts through the supply chain of the DPC project, in particular those involving SME contracts, will remain subject to all the provisions of the Act.
In addition, DPC first-tier subcontracts are only excluded from section 110 (1A) of the Act, and not Section 113, which prohibits contract provisions that generally make payment conditional on the payer receiving payment from a third party. Payments relating to these contracts will, therefore, still have to be made at agreed intervals or stages in accordance with the Act.
The limits of the exclusions do, however, mean that, while the parties to the main CAP contract do not have a statutory right to adjudication, the subcontractor and those other contracts in the supply chain still do. Arguably, this could cause imbalance within the contractual chain to the detriment of the first-tier contractor.
Although the relevant construction industry and water sector stakeholders who were consulted in respect of the Order were generally in favour of it, given the difficulties posed by the Act, concerns have also been expressed as to the impact of the exclusions on first-tier contractors as regards payment.
There are some who believe the exclusions could result in payment to a tier-one supplier being delayed until the point at which the service has been delivered, but that payments to those lower down the supply chain would not be delayed. If that is the case, there could be a significant cash flow issue for the tier-one suppliers caught in the middle of these arrangements.
The Government seems unconcerned by this on the basis that it is for the main supplier to assess and price the risk, of which the Government believes they will be fully appraised given that, typically, the tier 1 contractor or its parent company will be part of the main CAP in any event and, therefore, have a good working knowledge of the funding structure, contract terms and risk allocation involved in the DPC model.
Ultimately, if the tier one supplier wants to be paid, it needs to deliver on the contract and on the service that it is being contracted to provide. It is believed that this will act as an incentive to ensure fair value for the taxpayer and the bill payer.
It does remain to be seen, however, whether we will see a decrease in prices for the bill payer. For example, one concern raised in the House of Lords is that tier 1 contractors will increase their prices in factoring in any risk to cash flow as a means of insuring or financing the flow of cash through their business.
Practically, it will be important for those involved in these projects to be mindful of how their payment and dispute resolution provisions are drafted and the rights they have under those agreements, as there will no longer be the fallback option of the Act and Scheme in relation to these types of contract.
Adele Parsons, Fenwick Elliott
- 1Section 109(3) of the Act