South African Construction Contracts – Cash Flow is King

Amendments to the Construction Industry Development Regulations  

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.

The South African Minister of Public Works has notified the public that it intends to amend the 2004 Regulations under the Construction Industry Development Board Act, 2000 (the Proposed Amendments). The proposals aim to introduce certain 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 has now ended.  The Minister may now go ahead with the Proposed Amendments as currently drafted or amend them in line with comments received from Baker & McKenzie and others in the industry.   

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 will also not 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 payments.   
• 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 7 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 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 Magistrate's 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 mind-set is 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 swiftly 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 under the Proposed Amendments?  

There are indeed. Both the prompt payment and adjudication provisions give rise to numerous potentially problematic issues.  Beyond this, the very 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 such 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 examples:  

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, for example, in that 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.

• The purpose of the home building exception in the Proposed Amendments needs some clarification. The UK Act does not apply to contracts where one of the contracting parties occupies or intends to occupy the property as his or her residence. This is to prevent a layperson from being side-lined by prompt payment and adjudication provisions about which he knows very little and which would be laborious to comply with on a minor works contract.

However, under the UK Act, this does not mean that a housing project or residential development is excluded wholesale from the regime, as seems to be the intention in the Proposed Amendments. In the UK, agreements between commercial developers and contractors would not be excluded because there is no contractual party who is or will be the occupier.  As it stands, the Proposed Amendments appear to apply in a blanket fashion to homebuilders and potentially stand to exclude a large portion of the industry.

Payment

• The South African regime provides that stage payments are due at "regular and reasonable intervals" under the contract.  There is no indication of what "regular and reasonable" means.

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 5 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 7 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.  Rather, 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.

What can be learned from the UK experience?  

The UK introduced the Housing Grants, Construction & Regeneration Act in 1996, which became effective in 1998 an was amended in 2009.  The UK has thus been through the learning curve process that South Africa will shortly be commencing.    As to dispute resolution, it is no exaggeration to say that the effect of the UK Act was revolutionary.  Domestic litigation and arbitration under contracts within the scope of the Act dried up overnight and is now a rarity.  Parties had to adjust to dealing within a 28 day period with what they had been used to taking many months if not years to argue.  Adjudication is now well established in the UK and has, broadly, become a process construction industry participants have come to know and trust.  But the journey they travelled to reach that point was not always an easy one.    The UK Act has given rise to much case law in the UK which has served to clarify the uncertainties and ambiguities.  Beyond the case law, industry practices changed to deal with the UK Act.  By way of example:

• Adjudication is now the norm for resolving disputes, no matter how complex and no matter their value.  Although parties have the right to litigate or arbitrate their dispute after it has been dealt with in adjudication (or instead of adjudicating depending on the referring party's choice and the wording of their contract), this tends not to happen. Thus, adjudication has, save in rare cases, effectively replaced litigation and arbitration as the forum in which most construction disputes are heard.  
• The UK developed a system whereby adjudicator's decisions could be enforced by the courts by way of summary judgment.  This gives adjudication real "teeth".  The exceptions to enforcement are very narrow and apply only where the adjudicator lacks or exceeds his/her jurisdiction or breaches natural justice.  
• Conversely, it was established that errors of fact and law (even if serious) are not a proper basis on which to avoid compliance with an adjudicator's decision.  
• The right to refer a dispute to adjudication "at any time" has been confirmed to mean exactly that.  There can be no fetter to a party's right to adjudicate once a dispute has crystallised.  Adjudication can therefore be commenced whenever the referring party so chooses, and most often at the most inconvenient time for the responding party.  
• Case law was developed to regulate the extent to which counter-claims can be brought in adjudication.   
• Case law was developed to clarify the extent to which a party's insolvency could affect the right to commence adjudication and to enforce the decision.  
• Case law has developed as to what is meant by "natural justice" in the context of a fast-track process which does not purport to mimic litigation or arbitration.

Although UK court judgments are not binding in South Africa, since the Proposed Amendments are based in large part on the Construction Act, it is fair to assume that South Africa will look to the UK in terms of how to regulate issues such as those summarised in this note.  

In conclusion  

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 as best possible once the changes become effective.  This will require the issues to be understood at board level but 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 them becoming effective, and to hit the ground running once they are.  

How we can help?  

We have already analysed the Proposed Amendments in detail and submitted comments to the Minister during the period for public comment.  We are able to guide you through how they will work and what we consider the main benefits and pitfalls to be for employers, contractors, consultants and sub-contractors.  Project lenders will also need to grapple with the Proposed Amendments.  Whilst they will not themselves be caught by the Proposed Amendments, project lenders will need to understand the potential cash flow implications of the new legislation on their borrowers.  We have a market-leading construction disputes practice in both Johannesburg and London, operating as one virtual team.  Our London team is intimately familiar with the law and practices surrounding these issues in the UK and has conducted a great many successful adjudications.  Our Johannesburg team is intimately familiar with the South African market and its current prevailing practices.  The Johannesburg office combines its legal expertise with close partnerships with construction industry players.  The office has established relationships with several leading construction firms, consultants, construction training institutions and construction professions.    We are ideally placed to help you adjust to the Proposed Amendments, ensuring compliance with them but also helping you obtain commercial and strategic advantage from them where possible.  We can refer you to leading training opportunities and provide you with in-house training on the Proposed Amendments and their likely effects on your projects and your business.   We would welcome an in-person discussion with you on these issues, on a free-of-charge basis.  We look forward to hearing from you and to working with you to adjust to these important changes.