Introduction
According to the Department of Census and Statistics of Sri Lanka, the construction industry has contributed the highest share – 7.5 percent – within the industry sector in the year 2019. It grew by 4.0 percent during the year 2019 when compared to the year 2018[1]. For Gross National Income (GNI), it was nearly one thousand billion SLR for the year 2018[2]. It is more than twenty-five percent of the GNI of the whole industrial sector. Therefore, any disruption in the process of the construction industry may destabilize the industry. Then it may have a huge impact on the economy of the country.
As in any other sector, the lifeblood of the construction industry is the flow of the money. In Sri Lanka, most of the personnel in the industry know getting payments is not an easy task. Therefore, to safeguard the industry, there should be a mechanism that ensures the flow of money is not disrupted.
The Industry
The delivery of a construction project is highly complex. The industry itself is an amalgamation of several chained operations. It involves multi-disciplinary inputs provided by various participants such as employers, authorities, professionals, consultants, contractors, sub-contractors, tradespeople, technicians, etc.
The inherent feature is that most of the construction activities are labor-intensive and final products are seldom defect-free. The other feature is to award the contract to the lowest bidder. These bids typically prepare in a limited time period. Due to the pressure of the employer, most construction programs are unrealistically compressed. The construction costs are comparatively high, while productivity becoming lower. The inadequately trained workforce and financial constraints weaken the industry’s ability to adopt new technologies to cope up with new challenges. Therefore, in the industry, there is a high level of technical and economic risk.
When considering the economic risk, most of the time, contractors are paid in arrears. The minimum gap between the execution of the work and the interim payment is two months. In that sense, the contractor is an unsecured creditor of the party for whom he has contracted to work.
Security of Payment
Objective
Cascade of payments from Employers from top to all the way down to workers is very essential to maintain the cash flow. Cash flow management is critical to the survival of contractors and sub-contractors. The viability of their business depends more often on the cash flow than the profit. The existence of the labor market also depends on the cash flow emanating from the employers. Also, prompt payment for completed works offers strong intensive to contractors and sub-contractors. It helps to improve the quality and on-time delivery of projects.
In the present system, if payments are not received from the employer to the contractor, all lower-level personnel – subcontractors, suppliers, and workers – will suffer. Normally, Subcontract arraignments are for ‘pay-when-paid’ or ‘back-to-back’ basis. Even with the prompt payments from the employer to the contractor, there is no means to ensure such payments will flow down to subcontractors and to workers. Any diversion of money in the upper tiers will result in an interruption of the cash flow at lower level personnel.
The objective of the security of payment system is to address the above problems in the construction industry. And then resolve payments disputes in a timely manner. This scheme establishes a process to provide contractors with a quick and inexpensive statutory way to get their due payments or recover money owed to them.
Definition
Security of payment is a generic term which uses to describe the entitlement of contractors, subcontractors, consultants or suppliers in the contractual chain to receive payments due under the terms of their contract from party higher in the chain. Security of Payment gives statuary entitlement to the payment that a person entitled to receive or able to receive under the contract.
Process – in brief
If a dispute exists as to the money due to be paid, the Security of Payment Act (hereinafter called Act) provides for the appointment of an adjudicator to assess the monies to be paid, the due date for payment and any interest that may accrue. To be a quick and cheap process, the act provides a system called ‘Rapid adjudication’. The theme of the process is ‘pay now and argue later’. It is designed to promote speedier cash flow.
The Claimant
As per the Act, the organization or person making the claim is named as Claimant. The Claimant can make payment claim identifying the work done, and the amount claimed. In the claim, it is to be stated that such a claim is made under the Act.
The Respondant
The Respondent is the organization or the person who has to respond to a claim by way of paying money or defend it. The Respondent has to respond to a claim by providing a payment schedule. The time allowed is usually ten working or calendar days. In his reply, the Respondent should indicate the amount agreed to pay, reasons for any differences from the amount of the claim. If the Respondent feels that the claimant has no right to claim any amount shown in the claim, it should be shown under the ‘excluded amount’. The usual statutory time frame for payment is two days. If payment is not produced or payment is not made within this time frame, the Respondent becomes liable for the full amount claimed.
If the Claimant not satisfying with the payment schedule of the Respondent, he can initiate adjudication under the Act. For that, the claimant has to lodge an application with an Authorized Nominating Authority (ANA). The time period for this action is specified in the Act. The appointment of the Adjudicator takes a few days. After appointing, the Adjudicator must give his determination within ten working or calendar days. In the adjudication process, the Adjudicator decides whether the claim complies with the requirement of the Act, the value of the claim, and the date of payment. The Adjudicator’s decision is final and binding. Monies due under payment schedule or Adjudication can recover in a relevant court of Law as a debt owing to the Claimant.
Comparisons
Several countries have already adopted the Security of Payment Legislation. Singapore and Malaysia are a few of them. Singapore enacted this system passing an Act called Building and Construction Industry Security of Payment Act 2004. The recent Act passed in Malaysia in 2012 named the Construction Industry Payment and Adjudication Act.
Both Acts clearly mention the objectives of Acts. It is to improve cash flow by helping to speed up payments in the building and construction industry. Both Acts specifically say it can apply only for written contracts. But the Act passed in Australia even allows payment disputes in oral contracts as well. In these two countries, it does not cover construction works in relation to residential in nature which intended for own occupation.
The Singaporean Act contains provisions invalidating “pay if paid” or “pay when paid” clauses of construction contracts. But, the Malaysian Act does not specifically mention clauses similar to above in a contract. The Act passed in Australia, also does not allow similar clauses in construction contracts.
Claiming procedure
Both Acts in Singapore and Malaysia give the same procedure for forwarding a claim. First, unpaid party or the claimant may serve a payment claim on a non-paying party or respondent. The payment claim must be in writing. It should indicate the amount claimed and the due date for payment. All necessary information such as provisions in the contract, description of the work to which the payment relates must be informed. Specifically, it should be stated that the claim is made under the Act.
The Singapore Act says the respondent must respond within seven working days after serving the payment claim. While the Malaysian Act allows ten working days to serve on the unpaid party. The response must be in writing, addressing the claimant. It shall state the respondent’s proposal on how to make the payment, and if not agree, indicate as “nil”. Whether the respondent party agrees or does not agree to pay the claimed amount, he should reply within the time period.
According to the Singapore Act, if the claimant does not receive a payment response by a stipulated date, the claimant or the respondent may try to settle the dispute with the other party within seven days. This seven day period is referred to as a dispute settlement period. Within this period, the claimant cannot initiate any adjudication. But according to the Malaysian Act, if there is no response, the un-paid party has the right to refer the dispute to adjudication.
Appointment of adjudicator
In both Acts, the appointing authority named in the act appoints the adjudicator. The Singapore Act allows seven days to the respondent to respond after serving a copy of the claimant’s adjudication application. While in the Malaysian Act it allows ten working days.
In both cases, the adjudicator has the power to decide on the procedure which he is going to adopt. For example, it can be a document only procedure, a conference, or both. After serving the adjudicator’s determination, the respondent must pay the adjudicated amount within seven days.
Both Acts mentioned that failure to pay the claimant may result in the suspension of work and may also file the adjudication determination as a judgment debt.
Conclusions
Uninterrupted cash flow is a very important matter in the construction industry. It matters most when the industry depends on small and medium scale contractors providing services, sometimes even without any advance payments.
The experience outside Sri Lanka in relation to the use of legislative and other measures to enhance the Security of Payment found successful. It is high time to consider the application of Security of Payment system in Sri Lanka, thinking more for the betterment of the construction industry
Foot notes
- http://www.statistics.gov.lk/national_accounts/dcsna_r2/reports/2020.03.31/press_note_english.pdf
- https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/publications/annual_report/2018/en/14_Appendix.pdf