When on account payments can come back to bite.
What is a payment on account ?
A ‘payment on account’ describes a situation where Party A pays to Party B a sum of money for works completed without actually knowing if Party B is owed the money or not.
This may sound like a risky business but this type of payment occurs all the time in the New Zealand construction industry, particularly the commercial sector.
To understand why we must consider how payments and payment schedules work in practice.
Re-measurable contracts and the time needed to perform a measure
Often, construction projects include schedules of quantities which require the works performed on site to be ‘re-measured’.
This can dictate a significant amount of work which needs to be undertaken before the bill payer can measure / check how much it must pay to its contractor.
The Contractor may also ‘project’ the progress of their works to satisfy the payment periods required by the contract and/or the CCA 2002. For example, the period for payment.
Other reasons for on account payments..
Re-measurable quantities are not the only reason for on account payments.
A payer may simply be under resourced, work a far distance from the project or may have access restrictions or personal issues which prevent on site checks from occurring before the payment must be made.
Payments may also be subject to overall performance. Terms of this nature may include bonuses for time performance, or failure to meet requirements of the contract where time is ‘of the essence’ (for example think of a contract to build a swimming pool to facilitate swimming contests at the Olympics, which isn’t ready for the Olympics.. and you get the idea).
The purpose of the CCA 2002 is to facilitate timely payments, and “i haven’t had time to do my own job and check you’ve done your work” is not a very good reason for non payment when approached from the viewpoint of Party A, who may have done the work it was supposed to and is fully entitled to be paid for it.
The CCA does not restrict the ability to pay ‘on account’ because the payee is entitled to ‘correct’ any prior mistakes it may have made in a previous payment schedule.
This is an obvious requirement because no one would expect an incorrect payment to be permanent, but it comes with a price.
When can’t on account payments be made?
The CCA is the legislation which prescribes how payments must be approached when the contract does not specify.
This means that if the contract provides that Party A must agree a payable amount on a permanent basis when it makes a payment, then the contract rules and this must be carried out accordingly.
Standard forms (for example NEC 3/4) which prescribe agreement of variation values prior to the work taking place are factor which essentially removes the ability for on account payments to be made in some respects.
Although these terms do not often extend to contracted works and so offer prescribed agreement in relation to variations only.
Other than that, if the contract does not require permanent agreement prior to payment, then on account payments are allowed.
So what’s the issue with on account payments?
They aren’t all bad. There certainly is benefit to both parties to have freedom to pay on account.
The disadvantages of payments on account occur due to those that apply such freedom to a level of negligence or abuse.
Put simply, if Party A can change its mind, then this comes at the cost of Party B’s confidence in its due payment. Party B may be in for a shock when Party A decides to get around to doing its assessment.
The process can be used in nefarious ways, often referred to as ‘subby bashing’.
These methods typically consist of partial payments on account before the end of the project when the claims are ‘final accounted’ in a way which deducts from the correct contractual entitlement in a way that the recipient doesn’t see coming.
The payer is able to pay just enough to retain the services of the contractor before implementing sweeping frivolous disputes at the end of the project.
A particular issue is that the payer can make impacting decisions at relatively the last minute.
In contrast to a scenario where amounts must be agreed intermittently throughout the contract, the payee may not even be aware that an issue exists when it receives a whole contracts worth of potential disputes at once.
Often the impact of such major adjustments may impact on the payees ability to litigate the matter.
A particular sharp thorn becomes apparent when Party A not only doesn’t receive their final payment, but realizes that it has spent some of the money it now must pay back.
A contributing factor to ongoing risk is the common misunderstanding that payment means agreement, it typically does not.
A case in point
I spent some time working on a major key recovery projects in Christchurch.
One particular project included a large requirement for general labour which was facilitated by several labour hire companies.
Access to the project was via personal electronic key cards.
The duration of the project was approximately 2.5 years from start to finish.
At sometime toward the end of the project the contractor decided to check total gate records vs the daywork sheets which had been provided (signed) to justify it’s monthly claims throughout the project.
It eventuated that there was a discrepancy between the gate logs and the claims, resulting in a final adjustment deduction of over $1 million excluding GST. The labour hire company was able to reach a negotiated settlement with the contractor but not without a substantial unforeseen cashflow impact.
Not only was the contractor withholding essential cashflow, it was demanding repayment of money which simply wasn’t available.
The labour hire company went into liquidation a few months following the settlement.
Needless to say, the labour hire company had for some time, believing its revenue a safe bet, reinvested in its business with vehicles etc, and had up scaled its resourcing ability.
Things must have seemed like they were going well.
Similarly, the labour hire company had paid all of its staff, most of which had moved on throughout the 2.5 year period of the project. There was 0% chance to recover this cost if indeed it was overpaid in the first instance.
We need not wonder whether the gate records or time sheets were correct. The issue is that the labour company didn’t know about any of this until 2.5 years after it began providing services and issues were able to accumulate over time.
The impact may be too much to handle
Even in scenarios where the final account position is genuinely disputed, it may not matter if the payer is able to withhold a critical amount from the expected payment.
As useful as adjudications under the CCA are, the costs may seem restrictive when struggling to keep the lights on following such a big change in cashflow in such a short period of time.
Further issues (especially for long running projects) is adjustment of revenue accounts for tax purposes. This is a blog subject in of itself, suffice to say retrospective adjustments of years worth of accounts may well be a requirement.
The CCA (and construction contracts generally) set out strict requirements.
Draconian terms regarding Form 1 & payment schedules can be catastrophic. In this respect none of us can underestimate the Act in the importance of its requirements.
When compared to the above provisions it may not be an overly onerous change for the CCA to limit the potential risk of ongoing on account payments.
The purpose of the CCA is to facilitate timely payments and as such on account payments do indeed satisfy the general ethos of the Act which is to ‘pay now argue later’.
However, it seems contrary to the general health of the construction industry to continue to enable such significant ‘ongoing risk’ where less risk is possible.
One potential process which may limit the exposure of the long term risk is to limit ‘on account’ payments to a lesser period of time, say 3 months for example.
If the CCA limited the ability to pay on account amounts to a reasonable period e.g. 3 months (note* this is subjective and may well need a ‘scale’ of ranges to choose from by election so that the security period meets the requirement of the procurement model)
This may result in security and/or increased confidence related to the expired amounts because the payee knows the payer can’t change their mind at the end of the job.
Paying parties would be imbued with the need to do their part and assess the claims ‘as construction projects progress’, rather than procrastinating the job of verification and/or measurement.
Claims would essentially have a timer attached, at the end of which whatever valuation for the payment is fixed and unable to be adjusted due to contractual review, unless by agreement.
The option to mutually agree changes to the paid amounts is essential in retaining the parties freedom to negotiate out of disputes. This ensures parties may correct mistakes beyond the mandated time out period.
There are no doubt a plethora of considerations when dealing with the potential issues and benefits related to on account payments.
For now, it is advised that parties agree a similar model for certification of claims within their own construction contracts so that the obligation to assess claims in a timely manner are binding. You may wish you had one day.