Construction Contracts (England) Exclusion Order 2022

Monday 13th June 2022 Grand Committee

Considered in Grand Committee

17:43

Moved by

[Lord Callanan]

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

[Lord Callanan]

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.

17:45

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—

[Lord McNicol of West Kilbride (Lab)]

Oh!

[Lord Callanan (Con)]

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.

[Baroness McIntosh of Pickering (Con)]

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.

[Lord Berkeley (Lab)]

My Lords, I too am grateful to the Minister for his explanation—I tried to understand most of it. I too am interested in paragraph 7.3, to which the noble Baroness referred, because it comes back to the question of the best way of achieving fair competition when there is going to be a massive new project to provide better services in the water sector. One has to look perhaps at the example of the Thames Tideway tunnel—that probably comes under the category of being large. Whether it will deliver what Thames Water thinks that it will at a price that customers can afford remains to be seen. I do not quite see why these two large projects should be dealt with separately. Could the Minister name them and give us some idea of what they are about and what the risks might be? I will not go into them now, because they could be anything.

The regulator is apparently in charge of all of this and will vet contracts that it seems to me will be to design, construct and operate—why can these not be done by competitive tendering, with the usual construction industry fallbacks if things go wrong? It would be interesting if the Minister could give us more information about not only the two big ones but the 18 strategic water resources ones. How will anyone be able to tell or believe—we hope that we will be able to believe—that the regulator has delivered for the customer as well as for shareholders?

[Lord Fox (LD)]

As the Minister knows, I am no lawyer—perhaps I should have taken a law degree before attempting this statutory instrument. I note that it is not just the European Union that can amass red tape; we seem to be doing it very well on our own, so I am not sure it can refer us to the WTO for competition.

This is a very complex model. I was caught by the idea that we appear to have been progressing without it for a while. In a sense, is this closing a loophole that has been spotted, or does this reflect a trend in how the market is going about delivering these projects? What drove the decision to table this statutory instrument now? In other words, what has caused this to happen now when it clearly could have happened some time before or in future?

In passing, the Minister mentioned benefits to consumers. I think he outlined that there would be some sort of competitive tendering process, and therefore the price of a particular project would go down in cost. I am interested in the very sharp end of the consumer experience—the connection and that kind of thing. I assume that this applies to that as well as to the larger projects. If it does not, how will a new consumer attempting to join the system experience it? As I understand it, at the moment they are given a “take it or leave it” price by the water supplier. Does that continue to be the case? Will there be an opportunity for consumers to drive down the cost to them of an individual connection or is this focusing only on much larger projects?

The other point is how this flows through the supply chain. The Minister mentioned that the tier 1 contractors are potentially liable to be most affected. However, this marks a change right down through the chain to tiers 2, 3 and others. I would be interested to know how low down their tier structure the department intends to bring suppliers up to speed on how they address their role in this change in the supply chain. Other than that, I think I welcome this and certainly look forward to the Minister’s answers.

[Lord McNicol of West Kilbride (Lab)]

My Lords, I again thank the Minister for his introduction to another very technical SI. Until his introduction, the only real question I had was around the consultation. He touched on it at the end of his introduction, but I could not find any of the details of the responses to it online. That is probably me, but could he say a little more about the feedback received as part of the consultation?

Following on from the themes of the general public and who will benefit from this SI, the Minister said there were some concerns and worries from the first-tier subcontractors. I think we all agree that the removal of “pay when paid” was good. I worry a little, if we are bringing back special circumstances which in reality are “pay when paid”—although under slightly different processes in terms of certificates and completions—whether we are opening it up. Is the Minister worried about this at all or is the SI tight enough to prevent “pay when paid” returning to the construction sector?

The final point has been touched on by the noble Lords, Lord Berkeley and Lord Fox, and is about fair competition and the general public. Does the Minister believe there will be any increase in price or unitary charge for the general public in this SI? With that, I will leave my questions.

18:00

[Lord Callanan (Con)]

I thank noble Lords for their valuable contributions to the debate. Let me start by emphasising, as I did initially, that this exclusion order is very narrow in scope. It is well defined to ensure that it is used only for the intended and very specific contracts that I referred to. These are the two specific construction contracts that are used to deliver the direct procurement for customers model for high-value infrastructure assets in the regulated water and sewerage sector.

Let me also emphasise that the creation of an exclusion under this Act is very much an exception and not the rule. DPC is a competitive delivery model focused on accelerating the delivery of strategic infrastructure in this particular sector. The current absence of an exclusion for these specific contracts threatens the viability of DPC and the very great benefits it could bring to consumers. That position has been confirmed through consultations with appropriate stakeholders. That is the reason the Government have chosen to use the powers conferred on them to make exclusions from the provisions of the construction Act in this particular, limited, isolated case.

I shall now deal with the questions I was asked. First, to my noble friend Lady McIntosh: SUDS are not currently associated with the schemes being developed but may be, in the future, if they are of sufficient size to be required.

The noble Lord, Lord Berkeley, asked for details of the projects. The first project is United Utilities Water’s Haweswater aqueduct resilience programme, which I am sure the noble Lord is very familiar with. It is to replace the existing Haweswater aqueduct, which is at risk of failing, which currently transfers water from the Lake District to north-west England, especially Manchester. The second English project is sponsored by Southern Water, and it is to deliver water to the south-east of England. United Utilities Water’s Haweswater aqueduct resilience programme, a very large project, will replace parts of the Haweswater aqueduct, which brings water to Cumbria and Lancashire. Southern Water’s Hampshire water transfer and water recycling project is required to ensure supplies to the Hampshire region. It is able to meet, apparently, one-in-500-year droughts. That is the second scheme I referred to.

In response to the question asked by the noble Lord, Lord Fox, as I emphasised again, the exclusion order is narrow in scope, and it is well defined to ensure that it is used for these particular, intended contracts only—the two specific construction contracts that are used to deliver the DPC procurement model for high-value infrastructure assets. Those entering into the procurement mechanism will, of course, have full knowledge of the terms including that payments during the construction phase will be made at specified intervals and that payments made through the unitary charge will commence only once the asset is capable of operating. Importantly, alternative dispute resolution mechanisms will also be included within the CAP contracts. All remaining construction contracts through the supply chain of the DPC projects—and, let me emphasise, in particular those appertaining to SMEs—would, of course, remain subject to all the relevant provisions within the construction Act.

In response to the question from the noble Lord, Lord McNicol, this instrument is limited—

[Lord Berkeley (Lab)]

I am grateful to the Minister, but before he moves on, could he explain why the regulator, or the Government, thinks these very large contracts should be treated separately and differently, rather than having several smaller ones, as it may be, where the risk of things going wrong might be lower?

[Lord Callanan (Con)]

As I said, these are specific to a unique procurement model which is being trialled and which we think will be appropriate in the water and sewerage sector. We therefore think it appropriate to exempt these particular, very large contracts to enable the model which effectively, as far as the companies are concerned, delivers the construction, management, maintenance, et cetera of very large construction projects. It is a unique procurement mechanism which we think has the potential to benefit customers in the future, so in this very limited case it was deemed appropriate by the Secretary of State to exempt them from the regulations.

[Lord Fox (LD)]

I shall further demonstrate my confusion on this statutory instrument. I think I heard the Minister say that payment to the tier-one supplier could be delayed until the point at which the service has been delivered, but that payments to those lower down the supply chain would not be delayed. If that is the case, there is a significant cash flow issue for the tier-one suppliers who are not necessarily robust in cash, as we have seen in other projects. Has the department carried out an impact assessment in cash terms on the tier-one suppliers who would potentially be taking a knock here?

[Lord Callanan (Con)]

In essence, the noble Lord is right. The regulation exemption will apply to the main, overall contract, but the separate contracts that will exist lower down the supply chain with SMEs will still be subject to the provisions of the construction Act. I suppose the answer to the noble Lord’s question is ultimately it is for the main supplier to price in the risk. Of course, if it wants to be paid, it needs to deliver on the contract and on the service that it is being contracted to provide. As in all these things, it is about providing the right incentives and fair value for the taxpayer or, in this case, the water bill payer, and for the main contractor to deliver the project as efficiently as possible. Ultimately contracts between the lower-tier levels and smaller SMEs are still subject to the provisions and they will need to be paid in any case.

In response to the question asked by the noble Lord, Lord McNicol, this instrument is limited to a specific procurement model that Ofwat wants to use in the regulated water and sewerage sector. He referred to the consultation. That was held through individual and group meetings with the relevant construction industry and with water sector stakeholders and was undertaken over a two-month period.

I was asked a question on pay when paid.

[Lord McNicol of West Kilbride (Lab)]

I understand when the consultation took place. The bit I could not find when I was reading the statutory instrument was the response to the consultation and whether that has been published on the website or shared at all, because I could not find any information on the consultation. I knew exactly when it was and what happened.

[Lord Callanan (Con)]

It was not published, but I would be happy to send the noble Lord a letter with the details of the consultation in question.

I was asked a question on pay when paid. Again, it is quite technical. DPC first-tier subcontracts are not excluded from Section 113 of the Housing Grants, Construction and Regeneration Act 1996 under this statutory instrument. This means that pay-when-paid clauses are not permitted. Instead, payments will be made according to an agreed schedule for the delivery of the project.

The basis of DPC is to provide better value for money for customers, ultimately, and bills are expected to be lower than they would have been if the schemes were delivered by regulated water companies via the traditional business-as-usual model by which companies’ prices are set. The first-tier contractors are expected to be part of the highest-level CAP and they are responsible for funding the delivery of the schemes under those contracts.

I hope that I have been able to satisfy the Committee on the questions that were asked—obviously not.

[Lord Fox (LD)]

I apologise for labouring this point. First, an observation on the Minister’s answer to my last question is that, if I were a tier 1 contractor factoring in the risk to my cash flow, it would increase rather than decrease my price, because I would be taking some sort of insurance or loan to finance the flow of cash through my business. So I do not quite get the idea that competitiveness would work in the way the Minister is depicting.

I am struggling with why, and why now. Are there historic issues with delivery that have caused the department and the Government to want to push this model through this statutory instrument? We cannot simply point to the construction Act being there; the construction Act is there, but projects have been going on. What specifically has caused this to happen now? I still do not get that.

[Lord Callanan (Con)]

While Ofwat’s regulatory regime has been successful at challenging the performance and efficiency of what are ultimately monopoly companies, in some areas, such as the delivery of major infrastructure projects, we believe that competition can deliver greater benefits for consumers. That is why, with advice from the regulator and the appropriate consultations, we think that these procurement models will deliver better value with a greater competition benefit for consumers—which is why we are introducing them. I hope I have satisfied the noble Lord’s question and I therefore commend these draft—

[Noble Lords]

Oh!

[Lord Callanan (Con)]

Ultimately, of course, previous contracts have delivered and been successful, but we think that a different model, involving more competition, could deliver better value for consumers, which is why we have produced these regulations. I therefore commend them to the Committee.

[Lord Berkeley (Lab)]

I am grateful to the noble Lord again. Following his last comment—

[Baroness Bloomfield of Hinton Waldrist (Con)]

My Lords, I think the Minister has now taken his seat.

[Lord Berkeley (Lab)]

The noble Lord mentioned Southern Water as an example of the need for competition, and I am sure he is right about the need for competition—but who is competing? Is Southern Water competing against somebody else or are two contractors that are reporting to Southern Water, as the principal, competing? How does it work?

[Lord Callanan (Con)]

I will write to the noble Lord if my answer is not correct, but my understanding is that Southern Water is the procurer and will be regulated by Ofwat within the overall monopoly structure of the water industry. This is why strict regulation and price controls are imposed on water companies. The idea is that a company will be able to involve competition in selecting contractors for the delivery of particular projects. So the company will be the procurer, albeit under the overall model regulated by Ofwat.

Motion agreed.

Committee adjourned at 6.13 pm.