Cash flow is king May 2016

By GERHARD RUDOLPH, MICHELLE WRIGHT AND STEVE ABRAHAM, Published in Construction Law

What is changing and why?

South African law is about to go through a step-change development in relation to two of the most common issues that affect construction projects:

  1. The ability of contractors and sub-contractors to obtain payment promptly; and
  2. The effective resolution of disputes.

During the course of 2015, the South African Ministery of Public Works notified the public that it intends to amend the 2004 Regulations under the Construction Industry Development Board Act, 2000. The Proposed Amendments aim to introduce requirements in relation to prompt stage payments and fast-track dispute adjudication to address constraints to effective infrastructure development by ensuring proper cash flow for contractors.

The period for public comment ended in August last year. However, a recent enquiry directed to the Construction Industry Development Board (CIDB) indicated that it had escalated a number of changes to the Minister's office for further consideration. At the time of writing, nothing further has been made publically available and it is difficult to estimate when the Proposed Amendments will come in to force.

What are the key points to note?

If promulgated, the Proposed Amendments will apply to construction contracts where a person has carried out construction work, as well as any goods or services rendered under a construction works contract or a construction works related contract.

The Proposed Amendments will apply to oral and written contracts in both the public and private sectors. Importantly, they do not apply to home building contracts contemplated in the Housing Consumer Protection Measures Act, 1998. The Proposed Amendments do not seem to have retrospective effect. They also do not apply to any contract entered into before the proposed commencement date. They will have statutory force which cannot be contracted out of, even by agreement between sophisticated parties. In essence, what will be required is:

Prompt payment

  • A person who has carried out construction work or supplied goods or services is entitled to progress pay ments.
  • A contractor can submit monthly invoices if the contract does not provide for progress payments at regular intervals.
  • Payment cannot be withheld from a contractor or subcontractor without a notice stating reasonable grounds.
  • No construction contract may provide that a payment is conditional on payment being received from a third party – the so-called "pay when paid" clauses.
  • The date of payment will be the date provided for in the contract. This date must not be later than 30 days from the submission of an invoice.
  • Notices under the contract must be served in accordance with the terms of the contract. If no provision is made for service, the Proposed Amendments provide for how effective notice can be given.
  • Where payment is withheld without proper notice, performance of obligations under the contract can be suspended without prejudicing the contractor's other rights. The right to suspend performance ends once payment is made in full, but notice of the intention to suspend must be given stating the grounds for suspension.
  • A failure to comply with the Proposed Amendments will not invalidate a contract but a provision excluding the application of them will be void.

Dispute resolution

  • A party has the right to refer a dispute to adjudication at any time.
  • Every construction contract must provide for an adjudication procedure in line with the Proposed Amendments and a failure to provide for adjudication means that the provisions of the Proposed Amendments will likely apply.
  • An adjudicator must be appointed within seven days of the referral to adjudication.
  • The adjudicator's decision must be handed down within 28 days of the dispute being referred, or a maximum period of 42 days if both parties agree.
  • The procedure must allow the adjudicator to take the initiative in ascertaining facts and law.
  • The Proposed Amendments envisage that the CIDB will accredit adjudicator nominating bodies.
  • The adjudicator must act impartially, avoid unnecessary expenditure, and apply the rules of natural justice.
  • The adjudicator will be able to make a number of requests to the parties and decide on matters of procedure. Non-compliance with the adjudicator's requests, procedure or timetable, means the adjudicator can proceed with the matter and impose penalties.
  • Parties can be assisted by advisers during adjudications.
  • An adjudicator must keep all information confidential.
  • The adjudicator must provide reasons for their decision if requested and the parties must give effect to the adjudicator's decision within 10 days. The decision will be regarded as a “liquid document" and a relatively quick enforcement procedure is available in the high court. The magistrates courts can enforce smaller awards.
  • A party who is dissatisfied with an adjudicator's decision has the right to refer the matter to arbitration or review on the grounds stated in the Promotion of Administrative Justice Act, 2000.

What will parties need to do differently?

A fundamental change in mindset will be required from the construction industry in order to deal with payment issues and dispute resolution in accordance with the Proposed Amendments.

  • All standard form contracts will need to be re-visited to assess the extent to which they are compliant with the Proposed Amendments, and amendments drafted where required. Payment provisions in particular may require substantial amendment.
  • New projects will need to be tendered on a Proposed Amendments compliant basis. The Proposed Amendments will need to be brought to the attention of lenders.
  • Parties will need to pay particular attention to the warning signs of potential claims and disputes. Contractors will need to learn how to make effective use of adjudication to pursue their entitlements. Employers will need to gear up for defending adjudications at extremely short notice.
  • Parties will need to become familiar with a new regime for dealing with payment applications. In particular, employers who intend to make deductions against sums invoiced by contractors will have various requirements to fulfil under the Proposed Amendments.
  • Sophisticated parties who become familiar with the Proposed Amendments will need to deal appropriately with counter-parties who may not be aware of the details of the Proposed Amendments or how to comply with them. This issue will be particularly acute for contractors or sub-contractors engaged by employers or main contractors who do not deal with interim payments as envisaged by the Proposed Amendments.

Are there any problems or uncertainties with the Proposed Amendments?
There are indeed. Both the prompt payment and adjudication provisions give rise to a number of potential problems. Beyond this, the scope of the Proposed Amendments in terms of what contracts and projects are caught by them is unclear.

First, the Proposed Amendments may be said to affront certain administrative requirements of legality and reasonableness. The mandate of the CIDB is, in our view, limited to policy development, the promulgation of industry standards and the promotion of best practice. Save on a strained expansive interpretation, the CIDB's empowering legislation does not envisage the promulgation of far reaching, binding machinery such as the implementation of prompt payment and mandatory construction adjudication, binding both the public and private sector. There are aspects of the Proposed Amendments which curtail fundamental freedoms and, as such, are more appropriately introduced by parliament.

Second, many of the provisions are vague and uncertain in their effect. This is likely to create confusion, generate disputes and may also render the Proposed Amendments subject to review if promulgated in their current form.

By way of example:

Scope

  • The Proposed Amendments are based on similar UK legislation (the Housing Grants, Construction & Regeneration Act 1996, as amended). The UK Act has been largely successful since its implementation, primarily due to the support adjudicator's decisions have received from the UK courts. There are differences in that, for example, the UK regime applies only to construction operations which are carried out in England, Wales or Scotland irrespective of whether the laws of England, Wales or Scotland apply to the contract.
  • This territorial limitation is not reflected in the Proposed Amendments. To avoid confusion and jurisdictional conflicts where, for example, a Zimbabwean-based project is subject to South African substantive law, it would be sensible to specify whether the regulations apply to South Africa-based project only. Conversely, it is unclear whether parties can subject a contract performed in South Africa to a foreign governing law and thus take the contract outside the scope of the Proposed Amendments. If that is possible, it will be interesting to see how widely such a practice may be adopted, and whether steps would be taken to close that loophole.

Adjudication

  • The South African regime appears to envisage accredited nominating bodies – there is no such requirement under the UK regime. It is uncertain whether the accreditation of nominating bodies is a necessary or appropriate level of oversight by the CIDB.
  • Further, the South African regime requires the referring party to request the contractually specified person to act as adjudicator/the nominating body to select a person so to act within five days of the notice of adjudication being given – the UK regime does not have such a prescriptive time limit (although it does require the referral to be made to the adjudicator within seven days of the notice of adjudication). The capacity of contractors, employers, nominating bodies and adjudicators to comply with this time limit is unknown. In particular, it may be difficult to get nominating bodies to act with this degree of speed.
  • In the South African regime, the 28 days afforded to the adjudicator to make his decision can only be extended to 42 days if all parties agree. In the UK, this election is made by the referring party only. Also, under the proposed South African regime, 42 days cannot be exceeded, even by agreement. In the UK, if all parties agree, 42 days can be extended to whatever date.
  • The Proposed Amendments envisage a mechanism for review of an adjudicator's decision, which we submit is inappropriate in the context of adjudication. The statutory reference to arbitration is also confusing and is it unclear whether a separate contractual arbitration agreement would also be needed or whether the parties can litigate rather than arbitrate. It would be more appropriate to adopt the UK approach, whereby any subsequent proceedings (be they in litigation or arbitration, depending on the parties' contract) deal with the underlying dispute de novo, rather than acting as an appeal or review of the adjudication decision.
  • The CIDB proposes to keep a record of all adjudication decisions, without indicating how it may guarantee confidentiality for adjudicating parties.

Project Finance

Industry has expressed concern that the proposed overhaul of project payment regimes will make it more difficult to secure funding for infrastructure projects, and may instead cost jobs and compromise industry growth. The vague definition of staged payments at “regular and reasonable" intervals; the punitive interest regime in the face of non-payment; an employer's ability to withhold payment on vague notions of “reasonable" grounds; and the contractors' corresponding ability to suspend work in the event of non-payment have all been identified as areas ripe for dispute. This introduces substantial risk for investors.

Becoming familiar with the Proposed Amendments and knowing how to comply with them is only the start. Sophisticated parties will want to get ahead of the curve to understand how to take strategic advantage of the Proposed Amendments and to adapt their usual practices, habits and documentation in order to look after their commercial interests. This will require the issues to be understood at board level and also by those responsible for managing projects on the ground. Industry participants should not wait until they are promulgated to grapple with the effect of the amendments. It will be preferable to have assessed the impact of the proposals on your business ahead of the amendments becoming effective, and to hit the ground running once they are.

Rudolph is a partner, Wright an associate and Abraham a candidate attorney with Baker & McKenzie.