Bell & Scott Construction Update, February 2007

Welcome to the February 2007 issue of Bell & Scott’s Construction Update.

In this issue we comment on the changes to the Construction Industry Scheme and cases concerning Notices of Withholding.

This update is edited by the head of our Construction Team, Brandon Malone, a solicitor advocate, accredited by the Law Society of Scotland as a specialist in Construction Law.

For advice, guidance or information on construction law issues contact Brandon Malone on 0131 226 6703 or by email at b.malone@bellscott.co.uk.

Recent Decisions

To Pay or Not to Pay.....
Two recent cases regarding the issue of Notices of Withholding

The demise of Melville Dundas Limited has produced a couple of interesting decisions from the Court of Session. In the first, the company sued George Wimpey (UK) Limited for payment under an interim certificate. On 15 December 2005 the appeal court decided that it was necessary to serve a Notice of Withholding upon a company in receivership, before sums which had become due for payment could be retained, even if the construction contract provided otherwise. The issue was again considered by the court, in resolving Melville Dundas’ dispute with the owners of the Sheraton Hotel in Edinburgh. On 7 September 2006, the court found that (in the circumstances of this dispute) a Notice of Withholding was not necessary.

Section 111 (1) of the Housing Grants, Construction and Regeneration Act 1996 provides that unless notice of an intention to withhold payment is given to the contractor, money falling due under the terms of a construction contract must be paid. This has caused concern to employers who are fearful that if an overpayment is made to a contractor in financial difficulty, there will be little prospect of recovering the excess sums at a later date. The JCT/SBCC Standard Form Contracts allow the employer to withhold further payment until completion of the works and the making good of defects, when the contractor becomes insolvent.

Melville Dundas Limited (In Receivership) v. George Wimpey UK Limited 2006 S.L.T. 95

In Melville Dundas v. George Wimpey, the employer refused to make payment under an interim certificate because the contractor had since gone into receivership. Melville Dundas’ position was that in the absence of a Notice of Withholding, George Wimpey had to make payment. On Melville Dundas’ appeal against the first decision of the court (which went against it), the Court ordered George Wimpey to pay the sums due under the certificate. An application for payment had been made, certified and the final date for payment had passed. The obligation to make payment had already arisen. No Notice of Withholding had been served, so the employer had to pay. The obligation to serve a Notice of Withholding, before retaining sums otherwise due to the contractor, will continue even after determination of the contractor’s employment due to its insolvency. Over-ruling the earlier decision, the court took the view that the effect of the insolvency provisions in JCT/SBCC was not to determine the contract but only the employment of the contractor. The final date for payment could not be altered retrospectively. The court commented:

“Inevitably, where a contractor becomes insolvent, there will not be enough money to go round and losses will have to be borne. In our opinion Parliament has provided quite clearly that… the losses should be borne by… the employer…”

Highlighting earlier judgements, the court did confirm that service of a Notice of Withholding is not a condition precedent to disputing that the contractor is entitled to the payment he would receive under the relevant certificate.

Melville Dundas Limited v. Hotel Corporation of Edinburgh Limited

Here, the hotel had contracted with Melville Dundas to fit out the spa. Previous contractors had undertaken the shell works. Defects emerged. In particular, major areas of cracking appeared in the external glazing around the spa area. The parties disputed who was responsible. A number of other matters, such as the final account, had still to be resolved. Following appointment of receivers to Melville Dundas, meetings took place between its representatives and representatives of the hotel. An agreement was reached which was then recorded in an exchange of emails. The agreement dealt with the value of the final account, the rectification of accepted defects, and the subsequent release of the agreed retention. Responsibility for the cracked glazing was not resolved. The parties agreed that £90,000 would be held back by the Hotel pending further investigations. If not before, the money would be released to the contractors in a year’s time, subject to the extent to which it was shown that Melville Dundas were liable.

From there, the hotel’s quantity surveyor issued an interim certificate which was paid less the £90,000. In the year that followed the meetings no liability by Melville Dundas for the cracked glazing was established. It therefore sought payment of the £90,000. The hotel claimed Melville Dundas’ had not rectified some of the accepted defects, and that latent defects had materialised. It claimed that it was entitled to withhold the money in respect of rectification of these. The contractor sued under the agreement recorded in the exchange of emails. Amongst other arguments, Melville Dundas suggested that before the hotel could retain any sums it required to serve a Notice of Withholding, which it had not done. In resolving the dispute the court confirmed a number of principles:

• In resolving a dispute the court must give effect to the parties bargain rather than substituting a different bargain. A contract must be interpreted as a whole, objectively from the view of a reasonable third party. The aim is to find its commercial purpose. The contract should therefore be given a commercially sensible construction, which is the most likely to have been intended by a reasonable businessman. The circumstances in which the contract is concluded may be looked at. However, regard may only be had to matters known or which ought to have been known to the parties to the contract. The discussions of the parties are relevant only in determining their knowledge of the circumstances. Beyond that what is said in negotiations cannot be considered. Nor is consideration of alternative wording relevant.
• The employer’s right to withhold (or retain) sums due under a contract, as a result of the contractor’s breach, can be excluded by agreement. This agreement can be expressed in the contract or it can be a “clear” implication of the terms of the contract.
• Following insolvency of one of the parties, the right of balancing of accounts may be excluded by agreement or clear implication. This right may not be excluded prior to insolvency.
• The balancing of accounts on insolvency cannot be undertaken in respect of money which has been ear-marked for a particular purpose.

Having regard to these principles, the court decided that the effect of the parties agreement (as recorded in their exchange of emails) to set aside the £90,000 pending resolution of the glazing dispute, was to wit-hold that money for a specific purpose. The rights of retention and of balancing of accounts on insolvency were therefore excluded. A self-contained compromise deal had been agreed which was separate from the agreement about value of the final account, rectification of accepted defects, and subsequent release of the agreed retention. Because the time limit for holding the £90,000 had passed, the court ordered payment of this money to Melville Dundas.

Against this background, the court again looked at section 111 of the 1996 Act. Relying on one of the judgements the court had considered in the earlier case, the contractor argued that a Notice of Withholding was necessary before the hotel could retain the £90,000. The hotel suggested that the separate agreementrecorded in the emails was not a construction contract so the 1996 Act did not apply. The court drew a distinction a between settlement agreement which is independent of the underlying construction contract and one which (although settling a dispute) simply determines a sum due under a construction contract. The latter is given effect to through the mechanics of the contract. It is possible that one agreement could contain both types of settlement. That was the situation in the present case. So a Notice of Withholding would be required to retain any of the sums due under the final account and the retention money. However, no Notice of Withholding was required in relation to the £90,000 set aside.

Ross Taylor, Solicitor in our Construction Team comments:

The two cases highlight the need to adopt a ‘better safe than sorry attitude’ to Notices of Withholding. That is to say that if there is any ambiguity it is better to issue a Notice of Withholding than not. The current financial position of any party to whom payment is to be made is not important, payment will still become due as per the contract.

The decisions do not however help employers fearful that they will be unable to claim back any over-payment made to a contractor in financial difficulties. This obviously leaves the employer in a precarious position, but the terms of the contract must be complied with. Failure to do so, and in particular failure to issue a Notice of Withholding, will result in payment being due on the date specified in thecontract.

Full text of Melville Dundas Limited (In Receivership) v. George Wimpey UK Limited available here

Full text of Melville Dundas Limited v. Hotel Corporation of Edinburgh Limited available here

News

Construction Industry Scheme - a Changing System: How Not to be Caught Out

The new Construction Industry Scheme (CIS) comes into force on 6 April 2007 . It brings with it many pitfalls. CIS will not only affect companies within the construction industry but also businesses, public bodies and other concerns outwith the mainstream construction industry that regularly carry out construction operations. This could mean that landlords, tenants, department stores, breweries, banks, oil companies and property investment companies find themselves being caught by the new rules.

Who will be affected?
CIS will affect any company with an average annual expenditure exceeding £1m on construction operations in the previous three years. For a large concern a modest refurbishment programme can easily exceed £1m per year. Any company meeting the £1m test will continue to be deemed a contractor until they can satisfy HMRC that their expenditure on construction operations has been less than £1m in each of three successive years. Anyone employing subcontractors to carry out work falling within the scope of CIS will need to register with HMRC.

The changes
CIS will, from April 2007, operate without any of the vouchers used in its previous guise. The annual CIS return will also be scrapped. Instead there will be a monthly return.

The major changes are:

• The engagement status of subcontractors must be checked closely. A declaration of the engagement status of any subcontractors who have received payments will be required on each monthly return. Engagement status is a complex issue which is not always as it seems, however HMRC will be assisting contractors on the issue.

• If the work being undertaken falls within the scope of the scheme the verification status of the subcontractor must be considered. Are they CIS registered? This must be done by contacting HMRC, they will then advise whether payment should be made gross or net.

• Notification must be made to the subcontractor if tax is deducted from a payment. Notification can be in any form that suits the contractor but must contain certain basic information.

Monthly returns must be made to HMRC. The monthly return must:

• Confirm that the employment status of sub-contractors has been considered;
• Confirm that the new verification process has been correctly dealt with;
• Detail payments made to sub-contractors;
• Detail tax deductions made from those payments.

Unless the worker is registered they must be paid after deduction of tax at a higher rate. If the worker is registered they are paid either after deduction of tax at the standard rate or without deduction (if registered for gross payment). 

Penalties
There is to be a minimum penalty of £100 per 50 subcontractors (or part thereof) for failure to submit a monthly return on time, with further penalties where returns are incomplete or incorrect. There will be a fine of up to £3,000 for each monthly return if contractors negligently or deliberately provide incorrect information. If compliance is not being met HMRC will have the power to withdraw gross payment status.

What to do now
Everyone who may be caught by the new regulations must check their position now. If they are to be caught by the new regulations now is the time to provide training and put in place the necessary systems to deal with the new processes.

Brandon Malone, Head of Construction comments:  
The new regulations impose a heavy administrative burden on contractors. The penalties for failure to comply with the scheme are severe, and include financial penalties and the loss of the right to be paid gross.

Regular users of construction services are in for a nasty shock if they fail to register for the scheme. Any company in doubt as to whether they might be deemed to be a contractor for the purposes of the scheme should seek legal advice.

Information on the Construction Industry Scheme is available here

Fire Safety (Scotland) Regulations 2006

The Fire (Scotland) Act 2005 received Royal Assent in April 2005; subsequently most of the Act came into force in August 2005. However, Part 3 of the Act, dealing with a new fire safety regime for non-domestic premises, came into force on 1 October 2006 . The Act contains general duties, these are joined by more specific measures contained in the Fire Safety (Scotland) Regulations 2006, which also came into force on 1 October 2006. The new legislation replaces the Fire Precautions Act 1971 and the Fire Precautions (Workplace) Regulations 1997.

The main change is that Fire Certificates are no longer required. Instead the new regime is based on the principle of risk assessment. In addition to carrying out a fire risk assessment, the new legislation also imposes the following general requirements:

• Identifying the fire safety measures necessary as a result of the outcome of the fire safety risk assessment;
• Implementing these fire safety measures using risk reduction principles;
• Putting in place fire safety arrangements for the ongoing control and review of the fire safety measures;
• Complying additionally with the specific requirements of the fire safety regulations;
• Keeping the fire safety risk assessment and outcome under review;
• Record keeping.

A ‘responsible person’ will be required to carry out the risk assessment. The responsible person will be the employer and any other person having control of the premises or any part of the premises. More than one person may be responsible. The responsibility is said to be in direct proportion to control, the more control you have the more responsibility.

Full text of the legislation is available from the Office of Public Sector Information:

The Fire (Scotland) Act 2005 is available here.

Regulations 2006 are available here.

Energy Performance of Buildings Directive

The EU Energy Performance of Buildings Directive (“the EPBD”) was published in January 2003. Member States were given three years to transpose the provisions of the Directive into national regulations. The majority of the provisions have been implemented in Scotland , however notice was given to the EU Commissioner that implementation of all provisions would not take place within the specified time limit.

The key provisions of the Directive are:

• Minimum requirements for energy performance of all new buildings
• Minimum requirements for the energy performance of large existing buildings subject to major renovation
• Energy certification of all buildings (with frequently visited buildings providing public services being required to prominently display the energy performance certificate)
• Regular mandatory inspection of boilers and air conditioning systems in buildings

The EPBD has been partially implemented in Scotland by the Building (Scotland) Act 2003 together with amendments to both the Building (Scotland) Regulations 2004 and the Building (Procedure)(Scotland) Regulations 2004. Full implementation of the EPBD is to take place by 2009.

Full text of the EPBD is available from Europa here