What Payment Terms Are Parties Not Allowed To Agree for a Construction Contract?

In an ideal world, all parties to a construction contract would agree on clear terms — particularly those related to payment and dispute resolution — and stick to them. 

If only life were that simple!

If a construction contract is silent or unclear about payment terms, legislation can imply terms to oil the wheels.

Even in situations where a written contract exists, parties to a construction agreement are prohibited by English and Welsh law from including certain payment terms. 

The key statutory provisions relating to payment terms in construction contracts are included in Part II of the Housing Grants, Construction and Regeneration Act 1996, also known as the Construction Act 1996.

Parties to a construction contract cannot exclude these terms or override them with a contractual provision in contravention of the Act and subsequent case law.

If any payment terms are non-compliant with the law, they will be ineffective and unenforceable.

‘Pay When Paid’ Clauses

A ‘pay when paid’ clause is designed to protect the contractor from having to pay a subcontractor until the employer pays them. 

The effect of ‘pay when paid’ is to pass the risk of default onto subcontractors further down the line for payment.

‘Pay when paid’ clauses created vast amounts of disruption in the construction industry during the 1980s and 1990s and, as a result, prompted an alteration in the law to limit their use.

The change to this situation is governed by s113 of the Housing Grants, Construction and Regeneration (HGCR) Act 1996. This provision prohibits ‘pay when paid’ clauses unless there is an insolvency further upstream in the construction chain.

For reasons of clarity, the Act defines what constitutes insolvency for the purposes of this provision.

Payments Conditional on the Performance of Obligations under Another Contract

The Local Democracy Economic Development and Construction Act (LDEDC) 2009 introduced further changes to the law. The revisions apply to construction contracts entered into on or after 1 October 2011.

The 1996 Act banned ‘pay when paid’ clauses but did not forbid ‘pay when certified’ clauses. The LDEDC 2009 addresses this.

The LDEDC prohibits a term or provisions in a construction contract which make payment conditional upon the performance of obligations under a different agreement. The law prohibits making payment contingent upon completion of work under a separate contract or a decision by any person on whether obligations under another contract have been performed.

This means a contractor cannot make payments to subcontractors conditional upon the employer or project owner certifying the primary contractor’s payments as being due under the main contract.

The Wider Picture

The prohibition of specific clauses is set against a backdrop in which the law envisages that construction contracts should contain payment provisions that are fair to all parties, transparent, and regulate most, if not all, scenarios.

Implied terms under legislation help rectify situations where the contract is unclear, inadequate or simply silent. Consequently, there is a general premise that an agreement will not be allowed to contain clauses which are in contravention of the law and/or in direct opposition to the implied terms of the Scheme without categorically defining every prohibited term.

The implied framework under s110 (1A) of the Housing Grants Construction and Regeneration Act 1996 is a good reference tool to guide contracting parties on whether the contract payment terms are generally reasonable.

Conclusion

Establishing whether a contract’s terms and provisions regarding payment are fair, reasonable and legal is essential both pre-signing and in the event of a disagreement or dispute.

Expert legal advice can help avoid the pitfalls associated with poorly drafted agreements. 

Two things are always certain with construction contracts: first, construction law is complex and second, it is always evolving, with the courts constantly providing updated rulings and clarity on payment terms.

Taking up-to-date and prompt expert advice is essential. Helix Law can supply this with their expert construction team. We’re here to help clarify and negotiate contracts, resolve disputes, and protect your business from delayed or absent payments.