Construction Contracts (England) Exclusion Order 2022

Considered in Grand Committee

Moved by

That the Grand Committee do consider the Construction Contracts (England) Exclusion Order 2022.

My Lords, I beg to move that the draft Construction Contracts (England) Exclusion Order 2022, which was laid before the House on 11 May 2022, be approved.

These regulations exclude two specific types of construction contract from the provisions of Part 2 of the Housing Grants, Construction and Regeneration Act 1996, often referred to as the construction Act. Both contract types form part of a new procurement delivery model developed by Ofwat, known as direct procurement for customers or DPC, for the finance, design, building, operation and maintenance of high-value water and sewerage infrastructure. Before I set out the details of this exclusion order, it might perhaps be helpful to touch on the legal context for construction contracts.

Specific construction payment and dispute resolution legislation has now been in place for more than 25 years. Part 2 of the Housing Grants, Construction and Regeneration Act 1996 creates a framework for fair and prompt payment through the construction supply chain and a resolution procedure for disputes. The aim is to improve cash flow and provide the right to the quick resolution of disputes through adjudication.

Generally, the Construction Act requires the legal framework to be implemented through the construction contract. Where a construction contract omits to deal with an issue, or does so in a way that does not meet the requirements of the Act, a fallback provision is required. This is provided for by the scheme for construction contracts—“the scheme”—which is implied in the contract. The Construction Act has always prevented pay-when-paid clauses, which were often used as a way to delay payments to the supply chain. They are clauses whereby party B will not pay party C unless party B itself has been paid by party A.

In addition, a loophole was closed by the Local Democracy, Economic Development and Construction Act 2009 which introduced new Section 110(1A) into the 1996 Act. This provision prevents any term in a contract which makes payment conditional on the performance of an obligation under another contract or a decision by any person as to whether obligations under another contract have been performed. This legal framework has played an important role in improving payment practices in the construction industry.

However, the Construction Act also confers powers on the Secretary of State to disapply the provisions of the Act in limited circumstances. These powers have been used only twice before, for construction contract exclusion orders in 1998 and 2011. In both cases the orders excluded contracts under the private finance initiative. This was due to the unique nature of the contractual design and financing arrangements of the PFI contracts.

It is for the same reason—the distinctive financing arrangements and design of contracts—that this exclusion is sought for two specific contract types under the new infrastructure procurement model known as direct procurement for customers. Direct procurement for customers is based on a regulated water and sewerage provider competitively tendering for a third party—a competitively appointed private sector provider, or CAP—to finance, design, build, operate and maintain an infrastructure asset that would otherwise have been delivered by the incumbent utility provider. The CAP will be likely to be a special purpose vehicle, commonly including a construction company, a funder and a service provider.

The CAP will enter into a series of subcontracts for the design, construction and maintenance of the relevant assets. These contracts are typically drafted to be co-extensive with the main CAP contract, in particular relying on performance of obligations under the contract between the utility provider and the CAP to determine payment to the tier 1 subcontractor. Payment to the CAP by the incumbent water provider is via a unitary charge, which commences only when the asset or part of the asset is capable of operating.

However, the CAP agreement and first-tier subcontracts fall under the definition of a construction contract. Such a classification means that the contracts must include Act-compliant payment processes and adjudication arrangements. If not, the scheme for construction contracts is deemed to apply to the agreement, which would then take precedence. This would adversely affect the structure and operation of these DPC project contracts and would threaten the whole viability of the procurement model.

This draft instrument is limited to the specific DPC procurement model and excludes only two types of construction contract from the provisions of the Construction Act: first, DPC competitively appointed provider—CAP—contracts are excluded from all requirements of Part 2 of the 1996 Act; and, secondly, DPC first-tier subcontracts are excluded from Section 110(1A) of the 1996 Act. This will allow payments to first-tier DPC subcontracts to be conditional on obligations being performed in other contracts. All remaining construction contracts through the supply chain of the DPC project, in particular for SMEs, will remain subject to all the provisions of the Construction Act.

Application of this instrument is within England only, as construction is a devolved matter.

Of course, we consulted on this: as part of the development of the statutory instrument we carried out a targeted consultation with relevant construction industry and water sector stakeholders. It was confirmed that the specific contracts would be disproportionately affected by the provisions of Part 2 of the Construction Act. The majority of respondents were in favour of the exclusion, although some concerns were expressed regarding the impact on first-tier contractors.

However, the tier 1 construction subcontractor or its parent company will typically be part of the main CAP. This provides good knowledge of the funding structure, contract terms and risk allocation of this particular procurement model. This means that the contractor is in a good position to assess and price the risk, in contrast to the general position with more traditional construction projects.

So DPC is a competitive delivery model focused on increasing and accelerating investment in improving water and sewerage infrastructure. There is a pipeline of potential projects—

Oh!

Yes—very good. There is a pipeline of potential projects that could adopt this model, and the Government believe that its use will deliver benefits to consumers. Through increasing competition in the delivery of strategic infrastructure, it will ensure that the cost of this infrastructure is market tested and therefore fair for water and sewerage customers. I apologise for the complicated nature of the explanation and I commend this instrument to the House.

I am sure that we are all very grateful to my noble friend for presenting this document. I am sure that he will be aware of the vexed issue of sustainable drainage systems—SUDS—in relation to the provision of water and sewerage services. So I ask very specifically whether the implementation of SUDS will be affected and enhanced by the exclusion in this regulation.

Paragraph 7.3 of the Explanatory Memorandum says:

“The instrument is limited to a specific procurement model for high value infrastructure assets in the regulated water and sewerage sector ... There are two projects under active development and a further 18 strategic water resource schemes are being progressed ... across the next 2-3 price review periods”—

so we are looking at a period of 15 years. As we are told that the significance and the business impact of this is estimated at £54,000, how will this enhance the ability to introduce SUDS and other larger water infrastructure projects if it is such small beer? That is the only issue that I will raise; otherwise, obviously I approve this instrument.