The Business Contract Terms (Assignment of Receivables) Regulations 2018 and the construction industry

Stephen Rockhill, partner in the construction and engineering team at Stevens & Bolton, considers what impact the Business Contract Terms (Assignment of Receivables) Regulations 2018 (the Regulations) could have on the construction industry if passed into law.

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What are the draft Regulations?

The Regulations were published on 6 July 2018 and approved by the House of Commons on 11 September 2018 (they are currently pending approval by the House of Lords). If passed, the Regulations will invalidate restrictions on assignments of receivables in certain types of contract. The Regulations nullify a term of a contract that either prohibits the assignment of a receivable (a right to future payments) under the contract, imposes a condition on or otherwise restricts the assignment. The Regulations also nullify the effect of any clauses that have the effect of preventing a party from ascertaining the value of the receivable and its enforceability.

The types of contract that are not subject to the Regulations are set out in regulation 4. There are several types that are not subject to the Regulations, but those of greatest interest to construction are likely to be:

  • contracts for financial services
  • contracts for land
  • contracts for the sale of shares or a business

These exclusions could potentially cover a myriad of construction related contracts—especially those relating to an interest in land.

There are also exclusions in regulation 3, which are dependent on the status of the supplier of the goods or services to which the right to receivables relate. Generally speaking, the Regulations will not apply if the supplier is a large enterprise or special purpose vehicle, although the Regulations go into some detail as to the types of enterprises that will not satisfy these two definitions.

How are the Regulations relevant to construction projects?

The Regulations apply to business contracts for the supply of goods, services or intangible assets under which the supplier is entitled to be paid money, so they will apply to contracts for construction works and agreements for other relevant services or materials.In the majority of cases, payment under a construction contract is subject to a process that, by design, creates a period of time between a payment becoming due to the supplier and payment having to be made. Even with tools such as adjudication, the party awaiting payment (normally a sub-contractor) may have a reasonable expectation of receiving payment, but less control as to the timescale. In the meantime, the sub-contractor has, in theory, already incurred the cost of performing its own obligations.

 

The difference in time between of each party’s performance of its obligations is detrimental to the sub-contractor, who needs cash flow to maintain its business. As a result, it has long been common practice for a sub-contractor to assign its receivable to another party for payment or as security on a loan (factoring). Without this facility, it is likely that many more construction businesses will have failed in the past.

However, contracting parties will prefer to have certainty as to who it is they owe their obligations. The concept of assignment has always butted against the legal principle that parties should not be brought into contract against their will. From a construction standpoint, an employer may want assurance that payments made to its contractor are passed down to its sub-contractors and prohibitions against assignment assist in this regard. Consequently, most construction contracts start from a position that neither party may assign the contract or any rights thereunder. Where assignment is permitted, it is usually subject to conditions and restrictions.

The status of the employer/purchaser is, interestingly, ignored for the purpose of the exemptions in regulation 3, even though it is conceivable that an employer/purchaser would also enjoy a right of payment under a construction contract—for example, when there has been an overpayment during the course of works. It would appear that a clause seeking to restrict the employer/purchaser from assigning its right will always be ineffective unless the contract is caught by regulation 4.

Given that most construction contracts contain restrictions on assignment, awareness of the new Regulations for construction clients, contractors, sub-contractors and suppliers is of great importance. Parties that provide goods and services will on the whole welcome these Regulations while employer/purchasers may find the loss of the freedom to agree contractual terms unsettling.

What type of assignment provisions would breach the Regulations?

Essentially, in certain circumstances, clauses which prevent assignment of a receivable in a contract between businesses will be unenforceable. In addition, where a clause prohibits or restricts assignment of other (non-receivable) rights, the prohibition/conditions would still be valid in the context of the assignability of other rights but not in respect of the right to receive payment. The wording of regulation 2 causes a term to have ‘no effect to the extent’ that it restricts assignment of a receivable—many parties may therefore elect not to amend their standard terms. However, it should not be difficult to amend existing clauses so as to be compatible with the Regulations.

Take the following standard clause as an example:

Neither the employer nor the contractor shall without the consent of the other assign this contract or any rights thereunder.

This clause could be made compatible by reference to the Regulations as follows:

  1. save for receivables neither the employer nor the contractor shall without the consent of the other assign this contract or any rights thereunder
  2. for the purposes of paragraph 1 “receivables” shall have the same meaning as in the Business Contract Terms (Assignment of Receivables) Regulations 2018

It is important to note that the Regulations do not distinguish between prohibitions, conditions and restrictions on the assignments of receivables. Therefore, clauses that seek to limit assignments to a certain number, or which prevent assignments to certain named parties will also be invalid insofar as they apply to receivables.

The explanatory note accompanying the Regulations does confirm that clauses confirming the debtor’s right to contractual set-off are unaffected. The Regulations therefore do not impinge upon the longstanding legal principle that an assignee cannot be placed in a better position than an assignor—and that regardless of whether an assignment is legal or equitable in nature the receivable is subject to the same limitations, defences and set-offs that the debtor enjoys under the contract.

Why are clauses banning or restricting assignment included in some construction contracts?

Typically, large construction companies which are sensitive about their supply chain will implement a ban on assignment within their contracts. This means that sub-contractors and suppliers cannot assign part of their contract to another business. This is usually so that companies ensure that after they have checked the necessary standards of a supplier or their supply chain, there is no change or passing out to a business they would not want to deal with.

What is the current position in standard form construction contracts?

It is usual for standard forms of contract to contain restrictions on assignment. It is common practice for employers in construction contracts to procure assignment, but in the case of contractors, it is not as common.

For example, the JCT contracts provide that no assignments are permitted by either party without the consent of the other (see, for example, clause 7.1 of the JCT Standard Building Contract 2016). There is no requirement to be reasonable.

The NEC3 family of contracts are silent on assignment, and thus the rights are freely assignable. The NEC4 Engineering and Construction Contract, however, does include a provision (clause 28.1) which restricts assignment where the assignee does not intend to act in a spirit of mutual trust and co-operation, but as this would be difficult to establish, and is not market practice, this is likely to be amended by way of a Z clause. Clause 28.1 also requires notification if a party intends to transfer its rights, which may also be an invalid restriction under the Regulations.

The FIDIC forms provide that either party may assign at the sole discretion of the other, and that either party may assign as security to a bank or financial institution its right to money due or that becomes due under the contract.

How prevalent is factoring in the current market?

Factoring for the construction industry is a niche sector of the factoring market specifically designed to cope with JCT contracts and applications for payment in order to fund sub-contractors in the construction industry. However, this type of finance is only available from a few factoring companies. Traditionally, factoring companies have been unwilling to deal with any company unless the work is complete, and the invoice raised, but more factoring companies have designed facilities that do not require an invoice to be raised as they are more satisfied with stage payments evidenced by an application for payment.

Do the Regulations give rise to any concerns?

There is an argument that these Regulations discriminate against the industrial, commercial and technology sectors because they damage the stability of project contracts by effectively interfering with freedom of contract. The intention behind the legislation was to facilitate the sale of invoices by UK small businesses to factoring finance companies and many would say that the fact that the Regulations strike at major business contracts is hugely disproportionate. The Regulations would also override clauses preventing assignment to a competitor.

What happens next and what steps, if any, should those involved in construction projects be taking now?

If passed, the Regulations will apply to contracts entered into on or after 31 December 2018 including contracts novated after this date. The act of novation brings the previous contract to an end and creates a new contract with identical terms to the original, only changing the identity of one of the parties. If the Regulations apply, a restriction on the assignment of a receivable will be ineffective. There is no necessity to alter standard forms of contract to take account of the Regulations as they will simply override the contractual provision. However, where practicable, it would obviously be prudent for contracts to reflect the underlying law. In time, it is likely that express reference to the Regulations will be made to reflect this.Prior to the Regulations coming into force, construction companies should consider the impact of these Regulations and whether or not they want to seek to exclude them by bringing their contract within one of the exemptions. One possible result of these Regulations is that employers will prefer to contract with suppliers that satisfy the ‘large enterprise’ definition. There may also be an increased preference for construction contracts that include as part of their terms, the creation of an interest in a business or land, such as some development agreements currently do. This would allow the parties to claim the contract is exempt even though the business or land interest is not the primary purpose of the contract.

 

Interviewed by Robert Matthews. The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

Filed Under: Construction

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