Construction and Property Law
Newsletter Issue #3 2016

SCHLIMME SITTEN, GUT GESETZ – STATUTORY ADJUDICATION OF CONSTRUCTION CONTRACTS IN THE UK

Adjudication is a form of dispute resolution procedure which is now very familiar to the UK's construction industry. It can be described as a “pay now, argue later” mechanism which seeks to maintain cash‐flow during construction projects by providing a cost effective and speedy means of determining disputes on a binding, but not final basis. In practice an adjudication award is very often the final resolution of a dispute.

Adjudication became a legal right in relation to construction contracts in the UK when legislation known as the Construction Act1 came into force in 1996. The right was introduced to address concerns that unfair payment practices in construction contracts were contributing to a high level of insolvency in the construction sector. Those practices included payment terms which made subcontractors' payment dependent upon the main contractor receiving payment, provisions which prevented payment of amounts 'in dispute' but then postponed the resolution of disputes to arbitration, and simple non‐payment on the basis of spurious disputes. The Construction Act provides a statutory framework for payment provisions in construction contracts and a statutory basis for adjudication to resolve disputes. This kind of statutory intervention into the freedom of parties to agree their own contract terms is very unusual in the UK.

A key aspect of the Construction Act is that access to adjudication is a statutory right for parties to a “construction contract” and parties cannot contract to avoid or postpone this right. The parties are free to agree their own procedure, provided that it complies with the basic requirements for a valid adjudication process as described in the Construction Act. If the parties have not agreed an adjudication procedure, or the procedure that they have agreed does not satisfy the requirements of the Construction Act, then an adjudication process established by secondary legislation, known as the "Scheme for Construction Contracts" will apply.

What is a construction contract?

In order to have a right to adjudicate under the Construction Act, you must be party to a construction contract. This is defined as a contract for the carrying out of "construction operations" in the UK. A number of operations are excluded by the Construction Act, for example the installation of machinery in a power plant is excluded but the construction of concrete foundations for that power plant is not. Difficulties can arise when a contract concerns a project that has some work that falls within the scope of the Construction Act and some that does not (known as a hybrid contract). Such difficulties were illustrated in the recent English case of Severfield (UK) Limited v Duro Felguera UK Limited2 where the High Court ended up splitting the payment and dispute resolution mechanisms in the contract into two separate parts, one part for the works covered by the Construction Act and another for the works that fell within an exclusion from the Construction Act.

The exclusion of certain activities from the Construction Act was the result of successful lobbying on behalf of affected industries and has caused difficulties in the application of the Construction Act in the UK. Other jurisdictions should learn from this mistake.

How does it work in practice?

The adjudication procedure under the Construction Act provides for a very tight timetable, with the adjudicator aiming to reach a decision within 28 days of receipt of a referral notice. Whilst the timetable can be extended, this is only to a limited extent, and in our experience adjudications rarely last much more than 6 weeks. Whilst time starts from service of a referral notice, it is imperative that any recipient of a notice of adjudication acts immediately without delay.

Once the adjudicator has made a decision it has “temporary finality,” in the sense that it is binding unless and until it is overturned by litigation, arbitration or by agreement, unless the contract provides otherwise. This provides some certainty for parties and a quick and cost effective means of resolution.

However, a consequence of the tight timetable is that the parties can be left with insufficient time to fully investigate the dispute or provide all the evidence and argument they would like to present to the adjudicator. The responding party has a limited window in which to instruct legal representatives, assemble the project team and gather the relevant information. The responding party may only have 7 or 14 days to prepare its response and supporting documents to defend the claim. Consequently, there will be an intense period of activity for the responding party, which will likely divert the project team's resources. We have experienced adjudications where the responding party has been faced with an extremely tight timescale in which to review hundreds of new documents, including witness statements and expert reports at the same time as coordinating a response, when in reality the dispute would be more appropriate for litigation or arbitration.

Indeed, whilst adjudication was originally developed to solve cash‐flow issues as part of the interim application for payment process, its flexibility has led to it being adopted by parties to resolve other types of dispute such as breach of contract and professional negligence. This expansion looks set to continue.

Furthermore, the tight timescales of the adjudication procedure may mean that an adjudicator is rushed into making a rough and ready decision on complex issues of law or fact. Commentators have suggested that this can lead to 'rough justice' and possibly duplication of legal costs if it becomes necessary to challenge the decision through court proceedings to correct the injustice. Parties to a construction contract are well aware of this and the inherent risk of ambush in the adjudication procedure. However, this can also mean that the threat of adjudication can work as an effective tool to bring matters to a head and force a party to engage in resolving a dispute before any formal resolution procedure is commenced.

A point of much discussion within the construction industry in the UK currently is the rise of the "smash and grab" adjudication as a result of changes to the Construction Act which became effective in 20113.

A "smash and grab" adjudication arises in the context of a payer wishing to pay less than the amount applied for by the payee, but failing to issue a pay less notice as required under the Construction Act (as amended). This failure on the part of the payer (and subsequent failure to pay the full amount due by the final payment date) means that the payee becomes entitled to the sums applied for as a result of a procedural failure by the payer regardless of the legitimacy of the sums claimed. Consequently, the payee can use the adjudication procedure to recover the sums due, as the adjudication is bound to succeed purely on the procedural failure of the payer. This is a potent weapon in the payee's arsenal. However, whilst there is no mechanism by which the adjudicator can investigate the legitimacy of sums claimed by the payee, the payer can usually initiate a second adjudication to provide for an investigation and decision as to the true value of the work carried out. Whilst this second adjudication renders the first adjudication somewhat redundant, it does perhaps create a fair outcome overall.

So, does adjudication work?

Adjudication was initially introduced into the construction industry allegedly as a form of punishment, whilst other industries, such as the power generation industry, were excluded on the basis that they had not experienced the dispute and payment problems of the construction industry. However, as the Honourable Mr Justice Coulson noted in Severfield v Duro, "far from being a 'punishment', [adjudication] has been generally regarded as a blessing by the construction industry" and consequently it should perhaps be conferred on the currently exempt industries.

Indeed, despite some negative aspects noted above, adjudication achieves its main purpose of protecting the cash flow on which projects and contractors depend. It has been for almost 20 years "an effective and efficient dispute resolution process" (Mr Justice Coulson) and one which is now firmly entrenched within the construction industry in the UK.

1 Housing Grants, Construction and Regeneration Act 1996, mit nachfolgenden Änderungen.
2 [2015] EWHC 3352 (TCC)
3 Teil 8 des Local Democracy, Economic Development and Construction Act 2009 hat den Construction Act mit Wirkung vom 1. Oktober 2011 in England und Wales und 1. November 2011 in Schottland deutlich abgeändert.

Alex Hirom, Partner, Bond Dickinson LLP, +44 207 788 2358, Alex.Hirom@bonddickinson.com