This article was written by Lucinda McPhee, Christopher Seaman and Stephanie Hsu.
Security of Payment ("SOP") regimes have been enacted via legislation in numerous jurisdictions around the world, as a means of ensuring that construction industry participants working in those jurisdictions are paid on time, and accordance with their contractual rights. SOP legislation is recognised as being a relatively effective way of ensuring that contractors and sub-contractors can maintain healthy cash flow.
The Hong Kong construction industry has been considering implementing SOP legislation for over 10 years now. Recently the Hong Kong Government took its biggest step yet by releasing Technical Circular (Works) No.6/2021 ("Circular") that has the effect of introducing mandatory SOP provisions into Public Works Contracts. Whilst we still do not have an indication of when the long-anticipated SOP legislation might be enacted, the introduction of these provisions is intended to be a trial run before the Government enacts that legislation.
Depending on the type of Public Works Contract, these changes will come into effect for contracts for which the tender invitations are issued after 31 December 2021 or 1 April 2022.
2 The Key Changes
2.1 SOP Framework
While the specifics of the SOP legislation that the Government intends to enact are still being finalised, the Circular relevantly includes, in Annexure A, a "Security of Payment Framework" ("SOP Framework") that gives a good overview of the key mechanisms that are intended to be implemented in the SOP legislation, when it is enacted.
The four mandatory requirements of the SOP Framework, that parties will not be able to contract out of when the SOP legislation is implemented, are:
- Due dates: a Respondent will have 30 days following receipt of a Payment Claim to serve a Payment Response, and 60 days to pay the admitted amount.
- Conditional payment provisions, or "pay-when-paid" clauses will be rendered unenforceable.
- Referral to adjudication: a Claimant may refer a dispute about payment to adjudication, and the Adjudicator must determine the dispute (and the amount payable to the Claimant) within 55 days of being appointed.
- Suspension / go-slow rights: a Claimant that has not been paid an amount which the Respondent admits is due, or an amount the Adjudicator has decided is owing, may suspend work or reduce its rate of progress.
2.2 ACC and SCC Provisions to be Incorporated
The Circular also includes, in Annexures B to H, Additional Conditions of Contract ("ACC") and Special Conditions of Contract ("SCC") that are intended to implement "the spirit of the SOP legislation" (in line with the SOP Framework).
These ACC and SCC will be incorporated into contracts and sub-contracts for Public Works projects tendered from 31 December 2021, onwards.
The most significant ACC and SCC provisions can be found in Annex B and Annex C of the Circular.
3 Features of the Adjudication Process
The most significant features of the adjudication process that are foreshadowed in the SOP Framework and incorporated in the key ACC and SCC provisions are set out below.
3.1 The Reference Date and the Payment Claim
A reference date is the date from which a Claimant is entitled to make a Payment Claim to commence the adjudication process. A Claimant will be entitled to submit a single Payment Claim for each reference date, which will generally arise at the end of the month, or at the end of a milestone period. There are strict rules that apply to the Payment Claim; it must:
- be in writing;
- identify the construction work or related goods and services to which the payment claim relates;
- state the amount of the progress payment which is claimed to be payable; and
- not include any amount that is the subject of an ongoing adjudication.
Interestingly, there is no requirement for a Payment Claim to be specifically endorsed as such for the purpose of the SOP regime: a requirement in many other jurisdictions. This is important. It means that those receiving documents that could qualify as Payment Claims, at all tiers, should treat each claim for payment as possibly engaging the SOP regime, and act on it accordingly.
Relevantly, Payment Claims under the SOP regime can include contractual claims for payment for extensions of time. The Circular addresses this issue in some detail.
3.2 The Payment Response
After receiving a Payment Claim, the Respondent has 30 days (or an earlier agreed timeframe) to serve a "Payment Response". Again, there are strict formal requirements which must be followed, and the Payment Response must:
- be in writing and identify the Payment Claim;
- state the amount accepted as due and the basis for the calculation;
- state the amount disputed as due, the grounds for the dispute and the basis for the calculation;
- state the amount, the grounds for and the basis of the calculation of any amount to be set off or withheld; and
- state the net amount to be paid and the calculation of the amount.
It is critical that the Respondent submits the Payment Response and provides any reasons for non-payment at this stage. This is because a Respondent cannot raise any set-off claim later in the adjudication proceedings if it has not submitted a Payment Response.
3.3 The Payment Dispute
A central feature of the SOP Framework is the concept of the "Payment Dispute"; the right to refer a dispute to adjudication hinges upon the existence of a Payment Dispute. A Payment Dispute will generally arise when:
- a Payment Claim is disputed (in whole or in part) through a Payment Response;
- the Respondent has admitted the amount claimed is due, but has failed to make payment; or
- the Respondent has failed to serve a Payment Response by the due date (30 days, unless an earlier date is agreed).
Although this sounds straightforward, the position is complicated in that a Payment Dispute will not arise in relation to that Payment Claim until the "claim handling procedure" under the contract has been complied with. Broadly speaking, this means that the contractual process for assessing claims must be completed before any further steps can be taken. Ambiguities about whether and when the claim handling procedure has been complied with could present an obstacle for parties wanting to move forward with the adjudication process. This is an unusual feature of the SOP Framework and one we expect to be carefully considered as part of drafting of contracts and sub-contracts.
3.4 Referral to Adjudication and the Adjudication Submission
The next step in the adjudication process involves the disgruntled Claimant referring the Payment Dispute to adjudication. To do so, a Claimant must serve a "notice of adjudication" on the Respondent and the adjudicator nominating body within 28 days of when the Payment Dispute arose.
An Adjudicator will then be appointed within 5 working days. Once an Adjudicator is appointed, the Claimant will have only 1 business day to serve an "Adjudication Submission". This is, in essence, the Claimant's case, and needs to include the submissions and arguments relied upon as well as any supporting documents and evidence. This is an incredibly tight time frame, given we expect a contested Adjudication Submission in relation to a complex construction project to include legal submissions, witness evidence and possibly expert evidence.
3.5 The Adjudication Response
After it has received an Adjudication Submission, the Respondent has 20 working days to serve its "Adjudication Response". In a similar way to the Adjudication Submission, the Adjudication Response must include the submissions and arguments relied upon as well as any supporting documents and evidence. This is another incredibly tight frame and it will be fundamental to deploy the necessary resources quickly and to the right areas to maximise the use of time. Any delay here will be costly.
3.6 The Adjudicator's Powers and the Adjudication Process
The SOP Framework and the key ACC and SCC provisions set out the rules for how the adjudication is to be conducted, and what powers the Adjudicator will have in deciding how much is payable to the Claimant. The Adjudicator will not be bound by the same rules of evidence as would apply to court proceedings; they will have broad powers including the ability to call a conference and question any of the parties.
Our experience in other jurisdictions is that the adjudication process is often carried out "on the papers". This means that there will be no hearing and the adjudicator will decide the issue on written submissions only. However, it remains to be seen whether the practice of conferences will be adopted in Hong Kong.
3.7 What about costs?
With respect to costs, unlike court or arbitration proceedings, it is not possible to recover legal costs of the adjudication. This means each party is responsible for its own costs. The Adjudicator will charge a fee and can determine to apportion those costs in a manner which he/she sees fit.
3.8 The Adjudication Decision
The Adjudicator has 55 working days to deliver an Adjudication Decision to the parties, which must determine:
- the amount to be paid to the Claimant;
- the due date for payment; and
- the proportion of Adjudicator's fees payable by each party.
3.9 What happens if a party is unhappy with the Adjudication Decision?
It is almost inevitable that from time to time, an unhappy party will want to challenge an Adjudication Decision.
Because the SOP Framework that is incorporated in the key ACC and SCC provisions is a creature of contract, and not statute, parties will not be entitled to apply to the Court to overturn or enforce Adjudication Decisions (as they are in other jurisdictions where SOP legislation has been enacted).
Under the ACC and SCC provisions, an Adjudication Decision will be final and binding, on an interim basis, until the Payment Dispute is resolved in writing between the parties, or the Payment Dispute is decided by the dispute resolution mechanism set out in the main contracts/sub-contracts. Parties trying to enforce an Adjudication Decision are limited to making claims for direct payment or exercising their rights to suspend work.
Although the Circular does anticipate that the SOP legislation will allow the Claimant or Respondent to apply to the Court to set aside the Adjudication Decision within 14 days of delivery of the Decision, no guidance has been released so far as to what grounds either party would have to mount such a challenge.
4 Procedural Requirements
The SOP Framework that is incorporated in the key ACC and SCC provisions also introduces several procedural / administrative requirements that contractors and sub-contractors will need to be aware of.
4.1 Mandatory Sub-contract Conditions
The main contractor will be required to ensure that the mandatory SOP provisions in Annex D of the Circular are contained in relevant sub-contracts and must also take all reasonable steps to ensure that sub-contracts at lower tiers (i.e. sub-sub-contracts) contain the necessary provisions. Sub-contractors have similar back-to-back obligations.
4.2 Additional Reporting requirements
The main contractor is required to submit copies of its construction sub-contracts to the Employer's Representative. It is envisaged that a technical audit could be carried out by the responsible Works Department for the purpose of ensuring all contract documents comply with the SOP regime.
Throughout the course of a project, the main contractor will also be required to report on a monthly basis to the Employer's Representative as to whether any notices of adjudication have been served, and the status of payment or settlement of any adjudicated amounts.
4.3 Directing Payments from the Employer
Where a party at any of the contracting tiers is successful in obtaining an adjudication decision from its counter-party, and the whole or part of the adjudicated amount is not paid, the aggrieved party can request for the Employer to make direct payment of the outstanding amount. There is also a right to direct payment from the Employer where a subcontractor at any higher tier to the Claimant has an insolvency event occur to it. Where the necessary conditions for payment have been met, the Employer will make payment to the lower-tier sub-contractor and charge that amount to the contractor.
4.4 Requirement to Display Site Notices
To ensure transparency and accountability at all contracting levels (and to allow lower-tier sub-contractors to properly engage in the process of directing payments from the Employer), a Contractor will be required to display a Site Notice in an approved form (found in Annex H of the Circular) that contains information including the contact details of the Employer and the Main Contractor.
5 What can you do to prepare for these changes?
The mandatory contractual provisions will require careful consideration by contractors, of all tiers, working on Public Works projects that are tendered after December 2021. It will be important to ensure that sub-contracts are compliant and that contract administrators are prepared to handle adjudication claims, and comply with various notice requirements. It is also crucial that parties are aware of their rights to suspend works and make and defend claims for direct payment.
King & Wood Mallesons has extensive experience in dealing with SOP regimes in other jurisdictions and can guide you through the technical and legal minefield to ensure you receive the best possible outcome. We would be happy to discuss the process, and what support we can offer to your business.