What Makes Construction Suffer? Brexit, the Housing Market and Adjudication

The construction sector was disproportionately affected since the recession of 2008 and with the industry being easily impacted by surrounding events, we speak to Ian Reid, Partner in the Construction Department at Trowers & Hamlins Solicitors LLP about the challenges which remain.

From urban regeneration schemes, to the impact of Brexit and adjudication, Ian shares how the housing market is constantly changing, and how this affects his clients and those in the construction industry.

Can you share more about your experience working on the major urban regeneration schemes in London’s Docklands?  What challenges did you come across?

A common feature of these major urban regeneration schemes is the procurement model often used, namely “Construction Management”.  This form of procurement does present some challenges.

Under this form of procurement, the developer client, rather than engaging one “Main Contractor”, instead engages a “Construction Manager” who is something of hybrid between a consultant and a contractor.  The Construction Manager’s role is to divide the work on the project into a series of “Trade Contract Packages” and then to manage a number of “Trade Contractors” who bid for each package.  Each Trade Contractor then enters into a “Trade Contract” directly with the client (and not with the Construction Manager).

During a boom, contractors can be choosy about the work they want to do, and they are often reluctant to undertake major projects on procurement models which involve them in assuming a lot of risk.

A significant feature of Construction Management procurement is that the Construction Manager is not usually responsible for the defective design or construction of the Trade Contractors.  This is in marked contrast to the way a Main Contractor is responsible for the design and construction of its sub-contractors.

This procurement route certainly does have a number of advantages attached to it which I go on to discuss below, however, during the boom years in the British construction sector when many of these major urban regeneration projects began, developers could often find themselves forced down the Construction Management route by market conditions.

During a boom, contractors can be choosy about the work they want to do, and they are often reluctant to undertake major projects on procurement models which involve them in assuming a lot of risk.  This is a feature of “Design and Build” procurement involving one Main Contractor.  During the boom some developers were experiencing difficulty in getting contractors to even respond to tenders which were based on Design and Build contracts, or if tender responses were received, then the prices offered by the Main Contractor for assuming the intended risks could be so inflated as to make the project unviable from the developer’s point of view.  As a consequence, to take forward these large urban regeneration schemes, clients had to look at alternative procurement routes such as Construction Management which were more appealing to contractors.

The typical advantages of Construction Management as a procurement route include:

• a very early start on site is possible because the design and construction phases can overlap and the Trade Contract Package for the groundwork can be tendered and let before the roof package is even designed;
• individually tendered Trade Contract Packages may achieve cost savings because each package may be competitively tendered and more competitively priced;
• the independent design advice for the client from the directly engaged consultants (akin to traditional contracting) is maintained;
• the Construction Manager’s exposure to risk is limited, given he is not directly responsible for the design and construction of the Trade Contractors. This can lead to a lower cost for the client because whereas a Main Contractor would have priced for the risk of carrying out the job under say a Design and Build Contract that risk and that price may no longer be a consideration for the Construction Manager.

The typical challenges posed by Construction Management include:

• since there is no single Main Contract, the overall cost for carrying out the project cannot really be known with any certainty at the outset. The cost can only really be known when the last of the Trade Contracts is let, which is often well into the project;
• design and construction liability is very diffuse, it is the very opposite of the “one-point responsibility” that is often achieved under a Design and Build contract. In Construction Management, design responsibility is split between several consultants and then further divided between Trade Contractors who may have design portions and design responsibility within their respective Trade Contracts.  As a consequence, there is no one person who assumes overall responsibility for everything;
• by contrast to a Design and Build procurement where the client is in one contract with one Main Contractor, under Construction Management the client finds itself in direct contract with many Trade Contractors. Look at it this way:  Instead of receiving one Adjudication Notice on Christmas Eve from one disgruntled Main Contractor, there is the potential for the client to receive 30 Adjudication Notices on Christmas Eve from 30 disgruntled Trade Contractors.  (I discuss Adjudication in more detail below).

So downstream in Construction Management, the client is faced with a myriad of contractual relationships with Trade Contractors and this, in turn, gets reflected in the client’s upstream relationships with the project’s stakeholders.

The tenants, purchasers and funders of any construction project will invariably require “collateral warranties” or “third party rights” from those consultants and contractors who design and build the projects they have an interest in.  These are the means by which these stakeholders can pursue remedies against consultants and contractors should they need to.  Without the benefit of collateral warranties or third party rights, the stakeholder’s ability to recover any loss they might incur in the event of subsequent building defects is limited under English law.

Construction Management is not really a procurement route for the uninitiated client embarking upon its first project

Under a Design and Build project, one collateral warranty from the Main Contractor (who is fully liable for all his sub-contractors) may go a long way to covering off most of the risk.  In contrast, under Construction Management, those tenants, purchasers and funders are going to need collateral warranties or third party rights from every single Trade Contractor no matter how big or small his Trade Contract, given that the buck no longer stops with one Main Contractor who is responsible for everything.  That leaves everyone in the position of trying to extract numerous collateral warranties or third party rights from a Trade Contractor under a modest Trade Contract for say, £100,000 worth of signage work.  You can bet that the signage Trade Contractor has little appreciation that the delivery of his collateral warranties may be a pre-condition to the drawdown of the client’s funding under an upstream facility agreement with the bank.

If the tenants, purchasers and funders of a construction project cannot get their hands on sufficient collateral warranties or third party rights from all the numerous Trade Contractors involved in a project then they will perceive there to be a “liability gap”.

The average house price in London is now about twice the average house price in the UK.

Their usual response to try and close this liability gap is to press the developer for an indemnity under which the developer himself effectively guarantees the work of all those Trade Contractors and makes himself liable for any defective design or workmanship on the project.  This is clearly something experienced developers try to avoid.

So, Construction Management is not really a procurement route for the uninitiated client embarking upon its first project and this form of procurement often requires a considerable effort in managing the expectations of the upstream stakeholders.

How would you say the issues you may face in construction today, differ from when you first began to practice?

Without a doubt, the biggest change relates to the dispute resolution procedure of “adjudication”.

When I first began to practice construction law, it was not uncommon for the more hard-nosed developer, when faced with a claim from a contractor (or equally a contractor faced with a claim from a sub-contractor), to simply delay dealing with the claim or delay making payment.

As a procedure, adjudication is at the other end of the spectrum to litigation and has often been described as a “rough and ready” form of justice because the Adjudicator is obliged to deliver his decision within 28 days of the process starting.

The aggrieved claimant would be faced with having to pursue its claim through the courts using the process of “litigation” which invariably is very lengthy and very expensive (A feature of construction litigation when I was a young lawyer was that the costs of the action could often exceed the sums in dispute by the time the matter got to court).  With this in mind, it was well understood that if the defendant could drag out that process for as long as possible or adopt tactics to make it as expensive as possible for the claimant to pursue the claim, then there was some chance that the claimant (usually already struggling with cash flow in any event) would become insolvent before it could ever see its day in court and as a consequence that claim might just ‘go away’.

In response to these practices Parliament in this country introduced the “Housing Grants, Construction and Regeneration Act” (often colloquially referred to as the Construction Act) which implied into all construction contracts in England and Wales the dispute resolution process of “adjudication”.

As a procedure, adjudication is at the other end of the spectrum to litigation and has often been described as a “rough and ready” form of justice because the Adjudicator is obliged to deliver his decision within 28 days of the process starting.  It offers a very quick and very cheap alternative to litigation, however, the justice that may be achieved within such a brief 28 day period (by Adjudicators who are not from the Judiciary) is sometimes said to be of a variable quality.

An ambush typically occurs when a claimant spends several months secretly crafting a claim and substantiating it with voluminous (but not always relevant) documentation.

To offset this, an Adjudicator’s decision is what the law in the UK refers to as “temporarily binding”.  This means that despite having engaged in adjudication, the parties are still at liberty to refer their dispute to the Courts through litigation where the time can be taken to arrive at a more considered verdict, however in the interim they must comply with the Adjudicator’s decision.

There is no doubt the process of adjudication has seen the demise of the abusive stalling tactics that were once so widespread within the construction industry.  At the same time, it has on occasion led to its own forms of abuse as some of those who were once on the receiving end of these unsavoury practices have learnt to manipulate the system and highly speculative Adjudication claims are not unknown.  These are sometimes referred to as “ambush” or “smash and grab” adjudications.

An ambush typically occurs when a claimant spends several months secretly crafting a claim and substantiating it with voluminous (but not always relevant) documentation.  Then, at a time of its choosing, the claimant launches an adjudication in the knowledge that the adjudicator has only 28 days in which to conclude the process and deliver a decision.  To meet that timetable the Adjudicator may direct that the unfortunate defendant is only be allowed seven days in which to prepare and deliver a defence.  Keep in mind that the claim may comprise 20 lever arch files of documentation and be for many millions of pounds.  In such circumstances, both the defendant and the Adjudicator are seriously up against it.

Unfortunately, despite the Housing Grants Act having been with us for a number of years now, the capacity of paying parties to fail to serve Pay Less Notices within the required time limits never ceases to amaze construction lawyers.

A smash and grab adjudication arises out of another feature that was implied into construction contracts by the Construction Act and that is the use of the “Pay Less Notice”.  It is now a requirement of the law in England and Wales that if the paying party under a construction contract wishes to pay less than the amount claimed in say a contractor’s monthly interim payment application, then that paying party must serve a Pay Less Notice stipulating what it intends to deduct and why from the money the contractor has claimed in payment.  In the absence of a Pay Less Notice served within the stipulated time limit, the claimant contractor is entitled to be paid all sums he has claimed in his interim application regardless of the underlying merit of that application.  (The logic runs that having possibly overpaid the contractor in one month the paying party can recover or deduct in subsequent months any overpayment previously made).  Unfortunately, despite the Housing Grants Act having been with us for a number of years now, the capacity of paying parties to fail to serve Pay Less Notices within the required time limits never ceases to amaze construction lawyers.

A feature of some payment applications made towards the end of projects is the inclusion of very large and very unsubstantiated sums of additional money.  Such sums might be included, one might speculate, in the hope that the Pay Less Notice disputing the sums is missed or is late, thus rendering those sums payable.

In the absence of a Pay Less Notice the claimant is in a position to quickly launch (and usually win) an adjudication to be paid on the basis that no Pay Less Notice has been issued, regardless of the underlying merit of the claim for payment.

The paying party retains the ability to try and recover the sums paid out in subsequent actions but there is no guarantee that the money will be recovered.

So irrespective of Brexit, much has happened that has contributed to a cooling down of the property market and the construction sector.

Brexit uncertainty has somewhat triggered a slump in the construction sector in the UK; why is this the case, in your opinion?

The performance of the property market (which is intrinsically linked to the construction sector) has long been regarded as a key economic indicator of the overall health of the UK economy.  Prior to the Brexit referendum in the summer of 2016 house prices were rising.  Since the referendum the property market and by association the construction sector has certainly cooled, but what we have not seen is the “meltdown” of the market that many were predicting following the referendum.  This probably says much about the underlying strength of the UK economy.

Experience tells us that the development industry tends to be cyclical and there are some commentators who are of the view that the UK was due for a downturn in any event regardless of any impact Brexit may have had.

A further consideration in all this is that here in the UK we now have something of a two‑speed economy especially in relation to the property and construction sectors.  We have: i) what happens in London and its surroundings; and ii) what happens in the rest of the country.  The average house price in London is now about twice the average house price in the UK.

Prior to the referendum in 2016, the increase in property prices was very much a feature of the London property market and was driven by foreign investment into that part of the country.  It seemed that anyone with money anywhere in the world was choosing to invest it in London property and as a result, the locals were being priced out.

What Brexit has prompted is a fall in the value of the British pound.  As a consequence (and leaving aside the tax disadvantages referred to above) UK property now represents a more attractive investment to foreign investors who can get much more “bang for their buck”.

Between about 2015 and 2017 the UK Government introduced a number of changes to the tax regime applicable to foreign investment in UK property and these intentionally contributed to a cooling down of that London market:

Stamp Duty Land Tax (the tax paid by a purchaser of property over a certain price) had a 3% surcharge applied to it in relation to the purchase of second homes (i.e. property being bought for investment purposes).

Capital Gains Tax was made applicable to non-residents (i.e. foreign investors) on residential property in the UK.

Inheritance Tax was made applicable to all UK property regardless of how the ownership of that property was held.

So irrespective of Brexit, much has happened that has contributed to a cooling down of the property market and the construction sector.

Turning now to Brexit:

What Brexit has prompted is a fall in the value of the British pound.  As a consequence (and leaving aside the tax disadvantages referred to above) UK property now represents a more attractive investment to foreign investors who can get much more “bang for their buck”.

Without the fall in the value of the pound acting to continue to draw in foreign investment, we may have seen a much bigger slump in the property market and construction sector, particularly around London.

As a consequence, in some sectors of the industry, you will certainly hear people (albeit people with access to plenty of funding already) telling you that now is the best time to buy.

There is a view in some quarters that Brexit, once (or if) it finally happens, may lead to a dramatic fall in the price of a UK property.  This is not a view shared by everyone, however, if you are of this view then no-one wants to be the one to have to explain to the Board why the development site you bought in the lead up to Brexit is now worth half what you paid for it in the week after Brexit.

So inevitably Brexit has led to a “wait and see” attitude among some developers and purchasers.

At the same time, there is another view that there is a lot of foreign money now sitting out there just waiting for that Brexit induced fall in the price of property at which point it will pounce and gobble up as much UK property as it can get its hands on.

As a consequence, in some sectors of the industry, you will certainly hear people (albeit people with access to plenty of funding already) telling you that now is the best time to buy.

On the 18 July “The Times” newspaper ran an article on page 9 headed “London house prices fall as the rest of the country takes off”.  Despite house prices in the capital experiencing their biggest fall in a decade, it appears across the rest of the country prices are rising.

Many developers in this part of the world will tell you that if they could do one thing to stimulate development in the UK it would be to overhaul the rather cumbersome planning system we have in this country

On the same day “The Times” carried another article on page 45 reporting that despite the political uncertainty over Brexit, activity in the construction sector rose in the second quarter of the year.  The article went on to comment that the market was losing patience with the Government’s lack of clarity over Brexit and developers were beginning to push ahead with projects in any event.

Can the UK construction sector overcome this?

In many parts of the country, we still have the same underlying problem we have had for a very long time, namely there is not enough housing for everyone to live in, particularly affordable housing.

Brexit is not going to change that, there will still be the same chronic need for more housing.

A candidate in London’s next mayoral election was recently quoted as saying “unaffordable housing is the defining problem of our generation… compared to London’s housing situation Brexit is a cakewalk.”

Within the UK construction sector there is certainly a drive towards more modern methods of construction to increase the efficiency of production.

In the 1950s the UK Government built some 3000,000 homes a year across the country.  Various economic commentators estimate that there is now a need for a similar volume of house building yet current production is nowhere near this level.

Within the UK construction sector there is certainly a drive towards more modern methods of construction to increase the efficiency of production.  Modular building systems are catching the headlines and I have recently drafted a number of contracts for pods.  However, such measures on their own are not going to solve the housing crisis.  That is likely to require a major initiative from Central Government.  This is not something the construction sector can solve on its own.

Many developers in this part of the world will tell you that if they could do one thing to stimulate development in the UK it would be to overhaul the rather cumbersome planning system we have in this country and the ability of local interests to stymie much needed development.  The system’s critics will tell you that it seems to pay too much attention to the “haves” who are generally opposed to any further development at all in their backyards and not enough attention to the “have nots” who are desperately trying to get onto the housing ladder.

I have two boys who are eight and eleven years old.  With the price of property in the South East of England being what it is and at the current rate of house building, I have a nagging suspicion that they may still be living at home with me when they are 30 years old.

That said, it seems likely that we can expect an increase in the cost of construction post Brexit.

What do you think will be the immediate consequences of Brexit for the UK construction sector?

“Uncertainty” has been the defining characteristic of the run up to Brexit and we are all really just speculating about what the real consequences will be once the UK leaves the EU.  A cynic might add that no-one in Central Government is managing to convey the impression that they have got a proper handle on all of this.

That said, it seems likely that we can expect an increase in the cost of construction post Brexit.  For example:

The manufacturing industry in this country has long since passed its heyday and many components of our buildings are imported from Europe.  Those products, we hope, will still be available to us but the question will be how much is the price going to increase to get them into this country and how much longer will it take?  The short answer seems to be that it is likely to cost more and take longer.  How much more and how much longer, who knows.

Some developers are stockpiling components in anticipation of difficulties ahead.  Storing these components for many months all adds to the cost of construction.

For a long time, the UK construction industry has been heavily dependent on immigrant labour.  Once we have left the EU that labour may simply not be available to us which means the cost of domestic labour is going to increase and the cost of construction will go up.

 

About Ian

How do you go about developing innovative solutions that meet the commercial needs of the clients you work with in construction?

In the development and construction industry the range of clients I deal with is extremely wide and their understanding of the contracts they are dealing with ranges from the very sophisticated, to those who have never even seen a construction contract before.  Providing them with solutions is really about getting them to tell you what they really need and listening carefully to this.  What they think they’ve got and what they’ve actually got or what they want and what they actually need are often very different things.

I spend a lot of my time simply translating from commercial speak into legal speak and then back again.

The developer types I work with are hugely commercial people and it is in their nature to negotiate and strike a deal over everything.  They have no interest in spending any time in a courtroom.

I am relatively unusual in that I practice both contentious and non-contentious construction law and my job very much involves keeping clients out of formal disputes, albeit being ready for that when it is needed.

In your opinion, what makes a lawyer ideal for the construction field?

The ability to be highly analytical and both highly commercial at the same time.  Getting any deal over the line will involve both tenacity and compromise.  We have all heard the old adage “both sides thought they had a deal until they got their lawyers involved”.  Lawyers can always point out no end of things that might be wrong with a deal which the clients had not thought about.  However, having made the client aware of the risks, the deal still needs to get done.

Why did you pick construction law?

Before I studied law, I spent five years training as an architect which included spending time working in an architectural practice in Vancouver in Canada.  It is testimony to how difficult it is to make a decent living in that game that a number of the more world weary architects in the office would tell me, “It’s not too late to get out of this profession…you are still young enough… you don’t have a mortgage… you don’t have a family to support… try something else”.

I had a number of friends from school who had gone on to become lawyers whilst I was studying architecture and once the difference in our earning capacity became clear to me, I decided a move into law might be the better long term option.

Having got into postgraduate Law College it then became apparent that I could specialise in construction law.  With five years of architectural training behind me, I was quickly offered a training contract with a specialist construction litigation practice, at a time when some of my legal contemporaries were struggling to find work after graduation.

Do you have a mantra or motto you live by when it comes to helping your clients?

“Deliver”.  Let’s face it, in this game if you don’t deliver you don’t have clients for very long do you?

What has been your biggest achievement in the past 12 months?

Working out how to persuade my eight-year-old to do his homework every day.  It is pointless trying to get him to do it sitting at a table.  We now recite our times tables whilst he fires penalties at me in the garden.  This is more fun…  I just don’t want him to still be put there knocking them past me when he is 30 years old.  I want him to have moved out by then and have his own place.

Ian Reid
Partner

Trowers & Hamlins LLP
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About Ian and the Firm

I am Ian Reid, a Partner in the Construction Department at Trowers & Hamlins Solicitors LLP.

I practice both contentious (front end) and non-contentious (back end) construction law.

Trowers & Hamlins is an international law firm with approximately 145 partners and nearly 800 staff located across the UK, Middle East and Far East.  Our headquarters is in the City of London with other offices in Birmingham, Exeter, Manchester, Abu Dhabi, Bahrain, Dubai, Oman and Kuala Lumpur.

Trowers provides the full range of legal services and we have a particular focus on regeneration and development work.  Trowers has over 50 specialist construction lawyers and is one of the UK’s leading construction practices, acting for some of the UK’s leading developers.

I have worked around the world on a wide variety of construction projects including major urban regeneration schemes in London’s Docklands, city centre office blocks, luxury residential schemes, rail infrastructure projects, one of the world’s largest liquefied national gas projects, mining projects in the Australian outback, north sea oil rigs and resort developments in the South Pacific.

I have organised and chaired numerous conferences on construction law both in the UK and Australia.