BUILT ENVIRONMENT JOURNAL

Understanding the complexity of hybrid construction contracts

Comment: As hybrid contracts often cause confusion it is important to read the relevant definitions in the Housing Grants, Construction and Regeneration Act carefully

Author: David Greenwood

25 May 2021

Shaking hands over contract

Q: We entered into a construction contract, where the subcontractor had to repair and extend an existing building and also repair an internal wall mural. The subcontractor submitted a payment application splitting the sums between the building works and the work they did on the mural. Can we just assess the overall amount due or do we have to split the sums up in the payment notice?

A: So-called 'hybrid' contracts often cause confusion, particularly around how payment notices should be set out and how payments should be administered. Failure to issue a valid payment notice can have very serious consequences, potentially leading to the payee being entitled to the full sum in its payment application – therefore it is crucial the paying party gets its payment notices right.

Hybrid contracts arise when a construction contract includes:

  • some works which are construction operations, such as construction, alteration, repair, maintenance, extension, demolition or dismantling of buildings, for example, and therefore come within the ambit of the Housing Grants, Construction and Regeneration Act (the Act)
  • some works which are non-construction operations, such as extraction of oil or natural gas or the making, installation and repair of artistic works, for example, and therefore not caught by the Act.

Definitions

It is important to read the definitions in the Act carefully, as many contracts for works which, on any sensible definition, are construction operations, were excluded from the ambit of the Act. Based on the facts in the present question, the building works are 'construction operations' so would be caught by the Act. The repairs to the internal mural are non-construction operations.

The Court of Appeal recently shone some light on this tricky area. In C Spencer Limited v MW High Tech Projects UK Limited [2020], C Spencer challenged the validity of MW's payment notice stating that it had failed to distinguish between construction and non-construction operations. The Court of Appeal upheld the decision of the Technology and Construction Court, finding that MW's payment notice was valid as where a contractual payment mechanism is compliant with the Construction Act, it is unnecessary for a payment notice to separately identify the sums due in relation to construction operations and those due for non construction operations.

Subcontract terms

Applying this to the question at hand, the first thing to do is check the terms of the subcontract to see whether the payment terms meet the minimum requirements of the Act.

If the terms are compliant with the Act, you should then check whether there is any wording in the contract which expressly requires payment notices to be separated into construction operations and non-construction operations. If there is no express provision in the contract requiring separation, then a payment notice issued assessing the overall amount is likely to be valid.

If the terms are not compliant with the Act, then a dual payment regime may apply. This is where it can get confusing. The works which are caught by the Act may be subject to new terms implied into the contract to make the payment terms compliant with the Act, whereas the works which are non-construction operations will still be governed to the original payment terms. This was the case in Cleveland Bridge UK Ltd v Whessoe-Volker Stevin JV [2010] and also in Severfield (UK) Limited v Duro Felguera UK Limited [2015]. The effect of this is that a payment notice issued in these circumstances will need to clearly distinguish between construction operations and non-construction operations for it to be valid.

In summary, where some works are caught by the Act but other works are not, this can result in two separate payment regimes, confusion and mistakes.

Until the Act is amended to do away with these unnecessary distinctions, the courts have to do their best to resolve this confusing situation. Fortunately those involved in power generation and other areas where hybrid contracts are common have in practical terms done their best to manage the difficulties through the contracts that they enter into and their payment practices but the CSL v MW case indicates that complicated issues can still arise.

'The first thing to do is check the terms of the subcontract to see whether the payment terms meet the minimum requirements of the Act'

David Greenwood a senior associate at Pinsent Masons
Contact David: Email

Related competencies include: Contract practice, Legal/regulatory compliance

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