Don’t let milestone payments become a millstone around your neck

Milestone payment in an off-site contract

Bennett (Construction) Limited v CIMC NBS Limited (formerly Verbus Systems Limited) [2019] EWCA Civ 515

In a timely exercise in a commercial sense, the Court of Appeal has given guidance on the correct interpretation of milestone payment drafting in an off-site contract, though better drafting of the payment terms could have avoided some expensive litigation.

In an increasingly typical scenario, a large portion of a new hotel in Woolwich, London, was to be constructed with 78 prefabricated bedrooms with the bedroom units sourced under a JCT sub-contract.

The modular units were to be manufactured in China by Verbus, the sub-contractor to Bennetts. As is commonplace in a manufacturing process, this was to be against an agreed specification, by reference to the construction of a prototype, signed off by Bennetts, the Employer and the future owner of the hotel, before delivery and installation in the UK of the balance of the rooms by reference to the prototype sample.

The JCT payment provisions did not fit the commercial risk and payment profile of the off-site manufacture, so they were deleted in their entirety to be replaced with

• Milestone 1: 20% deposit payable on execution of contract

• Milestone 2: 30% on sign off of prototype room by Park Inn/Key Homes/Bennett in China

• Milestone 3: 30% on sign off of all snagging items by Park Inn/Key Homes/Bennett in China

• Milestone 4: 10% on sign off units in Southampton

• Milestone 3: 10% on completion of installation and any snagging

“Sign off”, notably, was not defined.

Underlying dispute

The sub-contractor, Verbus, failed to obtain sign off of the prototype but proceeded to manufacture and import the 78 modular units in any event. Perhaps unsurprisingly, Bennett refused to pay for the defective units, relying on the wording of the milestone payment schedule. Following an adjudication in which Bennetts were successful, the sub-contractor received the support of Judge Waksman QC who decided that milestones 2 and 3 did not comply with the requirements of the Housing Grants, Construction and Regeneration Act 1996 (as amended) (the “Act”) given (a) the lack of definition of “sign off”, (b) the “sign off” being by persons not party to the sub-contract’; (c) lack of dates for sign off and (d) lack of dates for the payments following sign off.

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Judge Waksman decided that paragraphs 2, 4 and 5 of Part II of the Scheme for Construction Contracts should apply. These imply the monthly payment regime against the value of works done. Bennett was suddenly left owing a significant sum of money for the value of 78 defective bedrooms it had never approved and had never signed off for manufacture, let alone installation.

Court of Appeal

Lord Justice Coulson, in a robust commercial decision, agreed and expressed concern that the High Court decision materially changed the parties’ bargain. Pointing to the normal process for stage payments, including the invariably used model of the retention release, he felt that a milestone sign off process for determining if and when payment fell due was compliant with the Act.

This contract had criteria, being the specification, which, even if it was to be assessed by a third party, was objective; the sub-contractor had a means by which they could seek a declaration that the milestone had fallen due (and when) by proving that their units complied with the contract criteria. They weren’t at the whim of a third party.

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It was his view that the relevant completion date of the prototypes and units was, therefore, the date on which the payment of milestones 2 and 3 became payable. The fact that there was no express date for payment did not matter. With regard to the lack of dates for when payment was to be made, again he did not consider this to be a problem. It was his view that the Courts would expect the parties to adopt business common sense as to the arrangements for invoicing and payment.

As an aside, it was Lord Justice Coulson’s view that, if the mechanism had not been adequate, then the correct part of the Scheme for Construction Contracts to have been applied would have been paragraph 7. He felt it exercised the least “violence” to the agreement between the parties as it related to a mechanism more suited to stage completion, or in this case, being more closely aligned to a milestone payment scenario. In his view, paragraphs 2 to 5 of the Scheme, which dealt with valuation exercises, did not reflect the intent on this contract.

Conclusion

Off-site contracts constitute the future of a large portion of construction operations. This case highlights the failure of the current suite of standard form contracts. Neither the JCT or the NEC suite of contracts have a template contract that adequately deals with the commercial risk and payment structure commonly found on large projects that include design and construction of large elements off-site.

To properly capture the terms needed (e.g. Incoterms, milestones instalments, proper testing regime and advance payments), bespoke amendments to the standard contracts will be required. If you are in such a situation, do get in touch, as we have extensive experience of adjusting the JCT and NEC drafting to deal with particular and bespoke commercial arrangements that best suit the agreement you have reached with your contracting party.