Proposed Security of Payment Legislation in Hong Kong

By Sacha M. Cheong and Dominic C. Lau, K&L Gates, Hong Kong

A prominent feature of the construction industry is its pyramid structure with long chains of contracts and sub-contracts from developers down to small sub-contractors and suppliers.

The inclusion of conditional payment terms (favorable to the paying party), frequent disputes at all stages of the projects, and cumbersome dispute resolution processes can often result in substantial delay in payments to the smaller sub-contractors and suppliers. On the one hand, these sub-contractors and suppliers are usually dependent on the parties higher up in the contracting hierarchy for new work, and they often lack the financial means and resources to engage in protracted disputes. On the other hand, delayed or nonpayment could adversely affect their cash flow, resulting in difficulties in ordering and securing goods and services, paying employee wages, and sometimes even the suspension of work.

To address these problems, the United Kingdom pioneered the statutory adjudication scheme for security of payment in 1996, which has since been followed (with slight variations) by several other countries, including Australia, New Zealand, Singapore, and Malaysia.

The two primary objectives of these statutory regimes are to:

1. establish rules for entitlement of the receiving parties; and
2. provide quick and enforceable resolution of the dispute.

Between 1 June 2015 and 31 August 2015, the Hong Kong government carried a consultation on the implementation of a statutory adjudication scheme for security of payment for the local construction industry. A consultation report was published in April 2016.

The proposed legislation and responses to the consultation from the public

Removal of unfair payment terms

Under the proposed scheme, the parties remain free to agree on when claims for payment can be made and how such claims should be quantified.

However, any agreement will be subject to the following restrictions:

1. Conditional payment terms such as “pay if paid,” “pay when paid,” or “pay when certified” will be unenforceable; and
2. The payment periods cannot exceed 60 calendar days for interim payments and 120 calendar days for final payments. Where the parties have provided for a longer payment period, it will be automatically replaced by the said statutory upper limits.

The responses to the consultation indicate that there is widespread support for limiting the length of payment periods as described above. Indeed, many of the responses suggested an even shorter period.

Statutory payment claims and responses

Under the proposed scheme, statutory “payment claims” can be made for amounts due for construction work, consultancy services, materials, or plant supplies. Costs for delay and disruption may be covered if the relevant contracts provide so.

Where there is no express agreement on the payment terms, the default position is that claims for the value of the work provided can be made monthly.

Upon receipt of a statutory payment claim, the paying party is required to serve a response within 30 days, indicating whether it disputes all or part of the claim or seeks to set-off the claim against any amounts due to it. Notably, the majority of responses favor a shorter response period, suggesting a reduction to 14 calendar days or 10 working days.

Unlike the approach adopted in the United Kingdom, failure to issue a response under the proposed legislation does not mean that the claim is admitted. The paying party will be precluded from raising a set-off defense in the future, but it is otherwise entitled to dispute liability for the payment and the quantum. The responses appear to prefer the model used in the United Kingdom.

Statutory adjudication

The proposed scheme provides parties with a statutory right (but not an obligation) to refer to adjudication any disputes relation to payment or extension of time within 28 days.

The adjudicator would typically be a professional in the construction industry appointed either by agreement of the parties or nominated by the Hong Kong International Arbitration Centre.

The procedure is designed to be speedy, as compared to arbitration and court proceedings. A typical adjudication lasts only 60 working days. The adjudicator must be appointed within five working days, following which he or she has 55 working days to reach a decision. It is only possible to extend these dates by agreement between the parties. A shorter timescale is possible for simple cases.

The adjudicator’s decision is enforceable through the courts, and it stands good unless and until parties bring the adjudicated dispute to arbitration or court and obtain final determination.

Applicability

The proposed scheme will cover all construction contracts, consultancy appointments supply contracts, and sub-contracts for government works and works procured by specified statutory/public bodies.

In terms of the private sector, however, the proposed scheme is rather limited. It covers works of the same type relating to:

1. buildings which are newly built or substantially rebuilt or reconstructed; and
2. projects where the price of the main contract exceeds HK$5 million (or related consultancy services costing over HK$0.5 million).

The idea behind the rather limited scope is that the scheme may be too harsh for private sector employers, such as owner corporations, who are generally inexperienced and lack the knowledge to handle the fast-tracked claim/response and adjudication processes.

Conclusion

The proposed scheme is a welcomed development for Hong Kong’s construction industry and aims to remove the unfairness created by harsh payment terms imposed on contractors and suppliers down the contracting hierarchy, as well as provide a statutory mechanism for the speedy resolution of payment and time-related claims.

While providing a quick and enforceable decision, the scheme also preserves the parties’ rights to bring the adjudicated disputes to arbitration or court proceedings for final determination.

The experience of other jurisdictions that have implemented similar payment and adjudication schemes has been generally positive and appears to be particularly popular with smaller sub-contractors and suppliers who rely on steady cash flow to survive.

The responses submitted in respect of the public consultation in Hong Kong are also generally supportive of the proposed scheme. The Hong Kong government is in the course of finalizing the legal framework and preparing a bill for submission to the Legislative Council. There is as yet no confirmed timeframe for when the scheme will come into force.