How will the construction industry be affected by the report of Sir Michael Latham (“Constructing the Team”) if that report is implemented?
Since the last war, technological and organisational change in the construction industry has been dramatic. This has been characterised by:
(i) significant developments in materials and pre-fabrication;
(ii) environmental requirements for low-energy buildings and environmentally conscious construction;
(iii) significant changes in building services and control systems, development of intelligent buildings, IT and use of computers and telecoms;
(iv) increasing content of services in buildings to the extent that services can be more than half the cost of a building.
This process of change will continue to evolve over the coming years at an ever-increasing pace with a greater need for more adaptable buildings and for better environmental control and energy efficiency. Much of this change will be specialist and manufacturer led.
The industry’s procurement systems and contracts have simply not kept pace with these changes and tend to represent an outdated concept of the way in which the industry actually operates. There still exists the perception that all design is done by architects and engineers and that building work is carried out by the large main contractors. The various participants in the construction process still tend to operate in isolation rather than as a team. Self protectionism is all-important. There is often a mismatch of contractual documentation and con ditions of engagement.
Of even greater concern has been the emasculation of productivity in the industry by constant conflict between the different players, particularly main contractors and subcontractors. Much of that conflict has been generated by under-resourced main contractors (often supported by the banks), keen to pass on as many risks as possible down the contractual chain. The industry has become bedeviled by commercial and contractual malpractice and abuse and costly disputes, which result in reduced performance and a poor image.
A questionnaire sent out by the Specialist Engineering Contractors’ Group in April 1994 to companies in membership of its constituent associations asked the following question:
Over the immediately preceding twelve months please estimate the percentage of contracts in which there have been disputes over moneys owing.
A total of 171 companies (including high turnover mechanical and electrical engineering companies) responded. The results of the survey revealed that there were disputes over payment in 40% of contracts. In 13% of contracts, moneys were withheld without justification.
It was against this background that the review of the construction industry’s procurement and contractual practices was established. Sir Michael Latham’s report has already generated an acceptance of the need for change and the arguments in the implementation process are probably more to do with how changes are brought about rather than with the principle of change.
Payment abuse
Specialists keenly awaited Sir Michael’s recommendations on reducing payment abuse and enhancing payment security because:
(i) Payment chains are long in the construction industry with money flowing from funding institutions, clients, and main contractors to subcontractors, sub-subcontractors and suppliers. Credit risks are much more concentrated. Substantial capital is invested in individual contracts with the result that moneys are often at considerable risk as they pass down the payment chain;
(ii) Forms of contract, particularly the non-standard ones, do not provide machinery for enabling easy ascertainment of the timing and amounts of payment, which are crucial in pricing and in obtaining redress for late or non-payment;
(iii) Extras and variations constitute as much as 30-40% of the contract price. Payment for variations is rarely obtained until well after completion of the works;
(iv) Retentions are generally at risk and are rarely repaid until after completion of the contract. A survey recently carried out by the Heating and Ventilating Contractors’ Association suggested that the average delay on repayment of the final part of retentions was, on average, three years;
(v) Forms of contract fail to recognise the fact that more and more construction work is fabricated off site, but they do not enable payment to be made, as of right, for off-site production;
(vi) Discounts are a feature of most subcontracts – both standard and non-standard – and are intended as an incentive for prompt payment. Unfortunately, main contractors simply deduct discounts irrespective of when payments are made.
Recommendations
Not surprisingly, Sir Michael Latham in his interim report, Trust and Money, published in December 1993, acknowledged that if the payment problems in the industry were to be overcome, the solutions to many other problems would probably fall into place: “It is absolutely fundamental to trust within the construction industry that participants should be paid for the work which they have undertaken” (final report).
Therefore, in recommendations 9 and 10 it is proposed that industry standard forms reflect the principles listed in para 5.18 of the report, which are Sir Michael’s vision of what a modern contract should contain. These offer greater payment protection to all parties and recaste the contracts, thus providing for equality of treatment of all parties, and thereby encouraging team work. Foremost among the proposals is the objective of producing total procurement systems for all procurement routes, including standard consultants agreements, main contracts, subcontracts, sub-subcontracts and tender documentation.
The following recommendations will help to overcome the concerns about payment abuse:
(i) pre-pricing of variations with disputes dealt with by adjudication;
(ii) phasing out the measure and value basis of interim payments and replacing it with milestones, activity schedules and payment schedules;
(iii) clear periods to be set out in which interim payments are to be made and interest at a suf ficiently heavy rate to deter late payment;
(iv) replacement of the retention system by retention bonds reducing in value as each milestone section of the work is completed, but secure trust funds for retentions if a cash retention system is retained;
(v) there should not be any need for discounts – payments should be on time;
(vi) the establishment of mandatory trust funds to secure payment: see recommendation 27;
(vii) all disputes to be referred to an adjudicator whose award should be implemented immediately: see recommendations 26.1-26.5;
(viii) incentives for exceptional performance;
(ix) provision, where appropriate, for advance mobilisation payments to be bonded if necessary.
Taken together, the principles embodied in para 5.18 are designed to encourage a new philosophy in contract drafting – one which seeks to place the emphasis on encouraging proper performance and on seeking solutions by team work rather than one which is negative by assuming poor performance. This will clearly require the joint contracts tribunal and the conditions of contract standing joint committee (producers of the civil engineering forms) to consider whether a fresh approach is required for their forms. In any event, this will be required by the need to have the contracts drafted in easily comprehensible language.
A construction contracts Bill
The recommendation which has attracted the greatest interest of specialists is recommendation 25, which is that parliament should introduce a construction contracts Bill in the 1995-96 parliamentary session. The Bill will provide statutory reinforcement for the changes to be made to the standard forms. It will make it clear that when standard forms are used, amendments or deletions relating to times and con ditions of payment should be unfair and invalid.
The Bill will also include provisions which are to apply to all forms of contract whether standard or bespoke. These include:
(i) denial/frustration of immediate adjudication;
(ii) refusal to implement adjudicator’s decisions;
(iii) restrictions on right set-off;
(iv) prohibition of “pay-when-paid” provisions (bespoke contracts only).
The Bill clearly needs to define the right of immediate adjudication and set out the essential requirements relating to adjudication: see recommendation 26.1-26.5 and paras 9.5, 9.6 and 9.7. Similarly, it would be necessary to define “pay-when-paid” provisions.
Recommendation 25 proposes that the actions listed therein should be declared unfair or invalid. It would be far easier for a court to declare an offending clause invalid so that the only judgment it would need to make was whether the clause in question contravened the Act.
Para 8.11 in recommendation 25 proposes that clients set up secure trust funds and, by way of elaboration of this proposal, recommendation 27 makes clear that statutory provisions should ensure that the trustee is legally em powered to make payments direct to contractors or subcontractors for work done and ma terials supplied. This would prevent an insolvency practitioner of the failed participant being allowed to divert such moneys to other creditors.
In accordance with the need to ensure equality of treatment for all participants in the construction process, both contractors and subcontractors should be treated as beneficiaries of the trust funds. The expectation must be that pay- ments will be made directly out of the trust fund to the main contractor and subcontractor.
A duty to trade fairly
In para 5.18 Sir Michael suggests a specific duty to deal fairly and, perhaps, this should have been embodied in the proposals for legislation – a statutory duty to trade fairly. In this context, it is useful to refer to the recent DTI further consultation document on implementation of the EC directive on unfair terms in consumer contracts (93/13/EEC).
It is proposed that:
An unfair term in a contract concluded with a consumer, by a seller or supplier shall not be binding on the consumer.
Furthermore:
A contractual term which has not been individually negotiated shall be regraded as unfair if, contrary to the requirement of good faith, it causes a significant imbalance in the party’s rights and obligations arising out of the contract, to detriment of the consumer.
In determining whether there has been good faith it is proposed that the court should have regard to:
- the strength of the bargaining position of the parties,
- whether the consumer had an inducement to agree to the term,
- whether the goods or services were sold or supplied to the special order of the consumer, and
- the extent to which the seller or supplier has dealt fairly and equitably with the consumer.
An interesting proposal is that the director-general of fair trading should have a statutory duty to consider complaints about contract terms drawn up for general use. If he considers that a contract term is unfair, he may bring proceedings for an injunction against any person using or recommending use of such a term in contracts concluded with consumers.
Since English jurisprudence will have to accommodate this directive it is arguable that the principles therein could be applied to all contracts. It is a paradox that the United States, perceived as the Mecca of the free-enterprise culture, has always led an array of legislation affecting commercial activity by addressing the inequality of contractual relationships. Perhaps the most notable is section 2-302 of the United States uniform commercial code. Under this section, any contract or clause deemed to be “unconscionable” by a court may be modified or declared void. The code has been widely adopted in statutes in the individual states. Some courts at state level have interpreted this power very liberally and in certain cases the courts have even ruled that the contract price was “unconscionable”.
There is also legislation in the USA to protect cash flow and enhance payment security on federal government projects. The 1982 Prompt Payment Act lays down time-scales for payment to contractors and subcontractors. In addition, the Federal Miller Act requires main contractors to provide payment bonds to subcontractors and suppliers involved on federal government projects. The United States was also responsible for introducing the first liens legislation when the State of Maryland added the Mechanics’ Liens Act to its statute book in August 1791. Similar legislation exists in many Canadian states, which also have statutory provisions for setting up trusts to protect project funds. After much litigation on “pay-when-paid” clauses in the various states of the US, the state of Wisconsin has recently introduced legislation which declares legally unenforceable “pay-if-paid” provisions.
Legislation need not be intrusive, but will help to establish the bench-marks for commercial activity in the industry. It will shape behaviour in the industry, particularly at site level where prevailing attitudes and culture must change. Standards of commercial dealing in the industry must improve so that every participant has a real “stake” in the process. Legislation is the key to the implementation process.
Good practice
What is to be done about good practice? The National Joint Consultative Committee for building (NJCC) was set up in 1954. It has produced valuable guides and procedure notes and, on occasions, has been successful in taking up complaints of malpractice. However, it has often been criticised for lacking effective powers to deal with malpractice complaints.
The review implementation forum will have to resolve a way forward for dealing with good practice matters. In his report, Sir Michael refers to the possible appointment of a construction industry ombudsman, but was reluctant to pursue this if there was agreement to set up an agency akin to the Construction Industry Development Agency in Australia. Such an agency would exist:
to encourage the delivery of best practice and performance, and to develop teamwork, rather than to judge alleged perpetrators of bad practice. Because it would involve client representation, an agency would have much more authority throughout the construction process than the NJCC, which could be allowed to lapse.
Information about the experience of the Australian body has not been too encouraging. So far as specialists are concerned, it is important to have a mechanism which has “teeth” to deal with those who persistently offend against accepted good practice. Every team will have its prima donnas.
The concept of an ombudsman has been accepted in other industries, sometimes under the guise of regulators, assessors or compliance boards. The Latham report places great em phasis on adjudication to deal with disputes that arise during the performance of the contract. There is a need for a similar facility to deal with malpractice complaints. To be effective, the ombudsman/regulator’s authority would have to be recognised in statute. His powers could range from the right to report “offenders” to their professional bodies to imposing fines for persistent “offending”.
Recommendation 18.1-18.6 proposes a code of practice for the selection of subcontractors, which will be enforced by public-sector clients while other client organisations would encourage their members to do likewise. The code would include the following provisions:
(i) commitments to shorter tender lists and selection based on quality and price;
(ii) main contractors to confirm that the subcontract documentation complies with the para 5.18 principles and the Construction Contracts Act;
(iii) tendering procedures to be tightened up so that Dutch auctioning is minimised;
(iv) clients to be informed of the identity of all subcontractors.
Design
Specialist subcontractors now make a significant contribution to the design process and design teams cannot function without it, yet they seem increasingly reluctant to recognise this. The design process is very complex and a large proportion of a project’s drawings are originated by specialists.
The Changing Role of Specialist and Trade Contractors, published by CIOB in 1989.
Traditionally, the fashion has been for specialists contributing substantial design input to be treated as domestic subcontractors. This disadvantages clients. The insistence of many clients on having a single point of responsibility means that they divorce themselves from the key players, who can contribute to the success of a project. As Sir Michael has recognised, the predominant regime becomes one of lowest cost and quality.
The obsession with a need for a single point of responsibility has helped to create the very adversarial relationships and questionable performance which clients are seeking to avoid. Clients should seek greater direct and early involvement with specialist contractors. False economies at design stage are usually “rewarded” by substantial increases in construction costs. Sir Michael’s report recognises the vital contribution of specialists to the design process.
In practice such contribution is rarely acknowledged and often not paid for. Therefore, in recommendation 8 Sir Michael proposes separate design agreements for specialist engineering contractors involving a fee and common standard liability similar to that of consultants.
Conclusion
Specialists are the industry’s producers. Their contribution, at all stages of the construction process, provides them with a valuable insight which enables them to better appreciate clients’ expectations and provide the solutions to meet them. Therefore, most of the burden of saving the 30% in construction costs – the long-term objective of Sir Michael’s report – will fall on specialists. They must have the wherewithal to achieve this objective.
