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CHAPTER 2: ADJUDICATION FRAMEWORK

1. Removing the requirement that the Construction Act should only apply to contracts in writing

Background

Currently the Construction Act only applies to contracts in writing. This requirement is defined broadly to include an agreement "recorded in any form". As interpreted by the courts ⁴, the requirement is applied to all the non-trivial terms of the agreement. This creates grounds for the adjudicator's jurisdiction to be challenged.

The effect of this can be as follows.

A dispute is referred to adjudication under the Act and one of the parties alleges that a contractual provision is not in writing (or that the contract has been varied by an oral agreement).

The adjudicator can then either decide that:

• the contract is in writing and he has jurisdiction, or
• that not all the agreement is in writing and he does not have jurisdiction.

Where the adjudicator decides he has jurisdiction he will continue with the adjudication. His decision however will not be enforced on an application for summary judgement if the court considers that the adjudicator did not have jurisdiction or that there is an arguable dispute as to his jurisdiction.

Where the adjudicator decides he has no jurisdiction, the adjudication of the dispute will come to an end.

Either outcome involves time and expense, not least the consideration of the challenge itself.

Current legislation
Section 107 has the following structure -
Section 107(1) - Restriction of the application of the Act to contracts in writing. Any other agreement is also only effective for the purposes of the Act if agreed in writing.
Section 107(2) - Definition of an agreement in writing (Section 104 states that a construction contract is an agreement). The courts have found that all three of the possible ways in which an agreement might be in writing must apply to the whole agreement ( i.e. all of the contract terms must be in writing, agreed in a written exchange or "evidenced" in writing).
Section 107(3) - An agreement by reference to written terms is an agreement in writing.
Section 107(4) - An agreement recorded by a party or third party with the consent of the parties is an agreement evidenced in writing.
Section 107(5) - An agreement alleged by one party and not denied by the other in adjudication, arbitration or court is an agreement in writing for the purposes of the application of the Act subsequently.
Section 107(6) - An agreement recorded by any means is in writing.

Proposal

We are proposing to remove the restriction of the application of the Construction Act to contracts in writing. The effect will be that the Act will apply to construction contracts which are agreed wholly in writing, only partly in writing, entirely orally or varied by oral agreement.

Certain important contractual provisions required by the Act, such as provisions relating to a contractual adjudication scheme, will continue to need to be in writing. Where this is not the case, the relevant provisions of the Scheme will apply. The contract will still be a 'construction contract' for the purposes of the Act.

The Scheme

We believe that the various references to 'agreements', whether written or oral, between the parties in the Scheme, will be understood to refer to any agreement following the amendments proposed above. We will therefore specify in the Scheme that agreements must be made in writing. We consider the agreement of an adjudicator under Part 1 paragraphs 2 and 5(2) must be made in writing.

The references in the Scheme to written notices and notices in writing are unhelpful and we propose to remove them. Section 115 makes clear that notices under the Construction Act are intended to be in writing, whether or not this is specified explicitly.

Discussion

The practical difficulty of agreeing a full written contract has acted as a barrier to the referral of disputes. Our proposal extends the application of the Construction Act to oral and partly oral construction contracts. Large numbers of construction contracts contain orally agreed terms. Adjudication is strongly supported throughout the industry and increasing access to it is a clear benefit of our proposal.

This proposal is not intended to encourage more oral or partly oral contracts, nor is it likely to do so. There are wider business benefits to contracting on a clearly recorded basis which act as a clear incentive to do so.

The incidence of jurisdictional challenge is reducing the effectiveness of adjudication and increasing its cost. Glasgow Caledonian University's August 2005 report on adjudication found that challenges to the adjudicator's appointment featured in 40% of adjudications. Of these, 3% related specifically to whether the contract was in writing. A further 7% relate to unspecified challenges to the adjudicator's jurisdiction which are likely to include challenges alleging an oral agreement. Many of these then lead to enforcement proceedings.

The annual reports of the Technology and Construction Court for 2005 and 2006 suggest that on average approximately 10 claims for enforcement of adjudications are submitted in Scotland each year. The Technology and Construction Solicitors Association has found that 15% of enforcement cases they considered related to whether the construction contract was in writing. Improving Payment Practices in the Construction Industry found that the median cost to the parties was £12,500. The total approximate average annual cost to the parties in the dispute is therefore 10 x 15% x £12,500 = £18,750.

2. Prohibiting agreements that interim or stage payment decisions will be conclusive

Background

Prior to the introduction of adjudication under the Construction Act it was rarely possible to resolve payment disputes via litigation or arbitration during the project. As adjudication is a quick form of dispute resolution, interim or stage payment disputes can now be resolved before the project has come to an end. However, construction contracts often provide that a payment decision will be conclusive of the amount of an interim or stage payment. The effect of such clauses is to prevent the referral of disputes relating to an interim or stage payment decision to adjudication since the payment decision arrived at under the contract has already concluded the matter.

The ability of the parties to agree that such decisions are conclusive of the payment amount is reflected at paragraph 20(a) of the Scheme which provides that an adjudicator may not open up, revise or review any decision or certificate if the contract states that the decision or certificate is final and conclusive.

Current legislation
Section 108 of the Construction Act provides the right to refer a dispute under a construction contract to adjudication. The contract must provide a process whereby a party may give notice at any time of his intention to refer a dispute to adjudication.
Section 109 of the Construction Act requires all construction contracts of duration 45 days or more to provide for payment by instalments, stage payments or other periodic payments.
Paragraph 20(a) of Part I of the Schedule to the Scheme provides that an adjudicator may not open up, revise or review any decision by any person if the contract states that the decision or certificate is final and conclusive.

Proposal

We are proposing to provide that -

• An agreement that a decision will be conclusive as to the amount of an interim payment, whether an instalment, stage or other periodic payment, will be ineffective. Decisions as to the amount of a final payment (which are often governed by clauses making them conclusive after a period of time) are excluded.
• The parties may agree that a payment decision is conclusive of the amount of an interim payment after the decision of the amount of the interim payment has been taken and notified to them (an effective agreement).

• A decision as to the amount of an interim payment will include any decision which relates to work performed under the contract to the extent that it affects the amount of the payment.

This proposal reinforces the combined effects of sections 108 and 109 of the Construction Act by providing a right to stage or interim payments which are properly determined in accordance with the contract.

The Scheme

Following the above amendment, parties will no longer be able to agree that interim decisions will be final and conclusive as to the amount of the payment unless that agreement is entered into after the parties have been notified of the amount of the interim payment. We therefore propose to provide that the adjudicator's ability to "open up, revise and review a decision" applies unless the parties have made an effective agreement to the contrary.

Discussion

Following DTI's consultation on Improving Payment Practices in the Construction Industry, it has been concluded that -

• The current incidence of agreements that interim or stage payment decisions should be conclusive is high (responses to the consultation suggested 15% of contracts provide for conclusive decisions that are only of substance to interim payments).
• This can be viewed as a means of avoiding the referral of interim payment disputes to adjudication and is contrary to the intention of the Construction Act.
• The adjudicator's power to open up conclusive interim or stage payment decisions should extend to decisions about the work done in relation to the interim payment.
• Though it can be argued that some stage payments are finally decided at the completion of a stage of work, this is rare as there is often a reappraisal of the valuation of all stages at the completion of the contract.

Statistics provided by BERR suggest that 1,500 Scottish contracts are of a duration of less than 45 days and that the remaining 10,000 in the industry are therefore subject to the statutory right to interim payments. Interim payments are usually monthly so assuming that each contract provides for a final payment at its completion and an interim payment at the completion of each whole month during the contract, 44,000 interim payments are made each year across the industry in Scotland. 13% of these payments may not be referred to adjudication leaving 38,300.

The joint DTI / CIC survey ⁵ of adjudicators found that 50% of adjudication disputes relate to interim payments while the remainder relate to final payments or other matters. The survey also found that resolving payment disputes at the interim stage reduced the cost of adjudication by approximately 10%, or £2,000. This means that approximately 90 adjudications in Scotland relate to interim payments. If adjudication of interim payments was encouraged by increasing the number that may be disputed by a factor of 115/100, this would represent an additional 14 interim payment adjudications. Compared to adjudication of the final account, this would result in an approximate reduction in the average cost of £35,000 or £187 per adjudication on average. Any litigation cases that were also averted would increase this figure.

The more significant benefit resulting from the prompt payment of the correct sum following the adjudication is more difficult to quantify as the dispute may be decided in favour of either party.

3. Introduction of a statutory framework for the costs of adjudication

Background

The Construction Act provides that a party to a construction contract has the right to refer a dispute arising under the contract for adjudication.

One of the disincentives to parties to a contract in referring disputes to adjudication is the financial cost in doing so. Parties can agree in the contract that the 'loser' will pay the costs of the adjudication, or even that, win or lose, the referring party ⁶ will bear all the costs. This creates a disincentive to the party so liable for costs to refer disputes to adjudication and can conversely encourage the other party to escalate costs.

Current legislation
Section 108 provides a statutory right to refer disputes to adjudication. It also sets out the basic requirements of the adjudication scheme to be contained in the contract such as the timetable for securing the appointment of the adjudicator.

Following a consultation by the Department of the Environment, Transport and the Regions in 2001, DTI developed proposals for a statutory framework in relation to the costs of the adjudication which:

• ensures that the parties should pay their own legal and other costs thereby providing an incentive to reduce costs unless they agree otherwise after the adjudicator is appointed;
• provides that agreements about payment of costs between the parties are only valid if made in writing after the appointment of the adjudicator; and,
• provides a statutory entitlement for the adjudicator to recover his fees and expenses.

Proposal

We are proposing to include new provisions in the Construction Act so that the following agreements are only valid if made in writing and after the appointment of the adjudicator -

• Agreements that a party should pay the whole or part of the costs of the adjudication (the legal or other costs of the parties and the fees and expenses of the adjudicator).
• Agreements that the adjudicator may make a decision that a party should pay the whole or part of the costs of the adjudication.

Where the parties have made a valid agreement described above, unless the parties have agreed what costs of the adjudication will be recoverable, the adjudicator will be required to award:

• only a reasonable amount in respect of costs reasonably incurred by the parties; and
• such reasonable amount as the adjudicator shall determine by way of fees for work reasonably undertaken and expenses reasonably incurred.

We also intend that, notwithstanding the adjudicator's contractual entitlement to his fees and expenses, the parties shall be jointly and severally liable for the adjudicator's reasonable fees and expenses (the formula above). This "backstop" is intended to ensure the adjudicator can recover his reasonable fees when he decides the dispute; or his appointment is brought to an end for reasons other than his default or misconduct.

We have considered whether the Construction Act could include a similar provision requiring the adjudicator to make an allocation of his fees and expenses between the parties. This is not possible if the parties are to be jointly and severally liable for fees. An allocation by the adjudicator appears to be no more than a statement of the proportions in which he will seek to recover them from the parties. It is not binding on him as he is not a party to the dispute.

We will provide that in general the decision of the adjudicator as to the costs of the adjudication is final and binding other than in cases where:

• the parties agree that the adjudicator shall make a decision as to their reasonable legal and other costs and he fails to do so; or
• the adjudicator claims or decides his reasonable fees and expenses under the new provisions.

In these cases it is intended that the courts will be provided with powers to determine the matter.

The Scheme

Having made full statutory provision for the costs of the adjudication in the Construction Act, we intend to remove all provisions as to the costs of the adjudication from Part 1 of the Schedule to the Scheme for Construction Contracts. These are:

• the provisions entitling the adjudicator to his fees when his appointment is revoked under paragraph 11; and
• the provisions entitling the adjudicator to his fees when he decides the dispute under paragraph 25.

We are also proposing to remove the provisions entitling the adjudicator to payment where he resigns in certain cases where he does not have jurisdiction to decide the dispute. As the Scheme does not apply in these situations, the terms of the adjudicator's appointment determine his payment in this case.

Discussion

We are creating a framework which will provide greater access to the adjudication process for those in the construction industry who would otherwise be reluctant to go through this process because of the costs involved. Our proposal will, to a degree, allow all parties to compete on a 'level playing field'.

We will provide that the parties may not agree before a dispute has arisen and the adjudicator has been appointed, that one party will be liable for all or part of the costs of the adjudication. This provision will remove a disincentive to refer disputes whilst at the same time reducing any incentive to refer frivolous disputes.

In addition, we believe we are encouraging parties to keep costs at a reasonable level by providing that, where the adjudicator is to make a decision as to who shall pay the costs of the adjudication, he shall only award a reasonable amount to reflect costs reasonably incurred. This will also encourage the parties to keep costs at a reasonable level and result in disputes being resolved more promptly.

The parties in dispute will share liability for the adjudicator's fees and expenses. This will ensure the adjudicator can secure payment of his fees and expenses and reduce the possible financial cost to him if he is not paid. This proposal will also ensure that the adjudicator's allocation is impartial because he will not be tempted to allocate his fees to the party better able to pay.

The adjudicator will also not need to ask the parties to sign an 'adjudication agreement' upon his appointment to secure their fees and expenses.

The joint DTI / CIC survey of adjudicators suggested that the parties' combined legal and other costs in an adjudication are approximately £15,000. The same survey found that the adjudicator's fees and expenses are approximately £5,000 on average. The total costs of the adjudication are therefore approximately £20,000. Statistics from the CIC in 2001 suggested that the incidence of agreements that the referring party should pay all of the costs of the adjudication arise in 3% of adjudications. Results from the DTI / CIC survey were unclear and the extent of the problem is considered as part of this consultation. If these clauses arise in 3% of the 180 adjudications conducted in Scotland each year and, in each one, on average half of the costs are unfairly allocated at a cost of £54,000 this will cost £300 per adjudication on average.

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