Key takeaways
Advance payments can ease contractor cashflow
Employers may pay early to avoid delays
Vesting protects off-site stored materials
Use certificates to confirm ownership and safeguard investment
Dual approach requires strong safeguards
Advance payment and vesting need bonds and checks
Intro - Cashflow is key
Various significant domestic/international events (wars, pandemics, inflation etc) have caused major disruption to the construction industry, creating shortages and increased/fluctuating costs for goods, plant and/or materials. This has had an impact on cashflow for contractors and has put many construction projects at risk of failure.
Such being the case, it is a growing theme that to assist with cashflow issues (and to enable a project to move forward without unnecessary delay), payment may be made by the employer for goods, plant and/or materials that may not arrive on-site until a future date.
This scenario is becoming more common in instances where there may be long lead-times on certain items, or where high-value equipment may need to be sourced early on in a project, but may not be incorporated into the project until a later date.
In this article we highlight the differences between ‘advance payment’ and ‘vesting’, any associated risk and what practical steps need to be taken (including what security needs to be put in place) by an employer in relation to both.
Whilst various standard form contracts provide for advance payment/vesting provisions (FIDIC, NEC etc), for the purposes of this article, we will be focusing on the relevant provisions in relation to standard form JCT contracts.
Who pays first?
It is important for an employer to be aware of whether they are paying for goods, plant and/or materials before or after they are initially purchased by the contractor. This will inform the employer as to what practical steps need to be taken and what security documentation may need to be put in place.
Consider the following three scenarios:
Scenario 1 - Advance payment only
Where the employer pays monies to the contractor before the contractor purchases the required goods, plant and/or materials, with such items to be delivered directly to site once purchased, this would require an advance payment only (no vesting).
Contractual position under JCT:
The amount of the advance payment to be made and the date that it shall be paid to the contractor is set out in the Contract Particulars.
The advance payment shall be reimbursed to the employer in the amounts and on the dates set out in the Contract Particulars.
Any advance payment will likely be reimbursed to the employer as deductions from interim payments and will continue to be reimbursed in this way until repaid in full.
Headline risks:
The contractor fails to repay the advance payment.
The contractor fails to purchase the required goods, plant and/or materials.
The contractor purchases the incorrect goods, plant and/or materials.
There is a fault with any goods, plant and/or materials purchased by the contractor.
Potential recourse:
Breach of contract – general damages.
Potential risk: Financial position/solvency of the contractor – will the employer be able to recover any associated loss?
The employer does not have a contract in place with the supplier of the goods, plant and/or materials, so does not have any direct contractual recourse with the supplier if any issues arise.
Managing risk: Advance Payment Bond (APB):
Where an advance payment is to be made, the employer should request an APB from the contractor. This is an ‘on-demand bond’, whereby the employer can recover the full value of the advance payment at any time from the contractor’s surety (usually a bank/lender), without the need to prove any fault by the contractor.
Whether or not an APB is required is specified in the Contract Particulars. If it is specified that an APB is required, then the provision/procurement of an APB by the contractor is a condition precedent to any advance payment.
The value of the APB will be reduced by the amount of any reimbursement made by the contractor to the employer and will cease when the full balance of the advance payment is repaid to the employer (and thereby reduced to nil).
The provision of an APB should mitigate any risk in making any such advance payment. A point of consideration for the employer is any potential additional costs associated with the procurement of an APB by the contractor. However, the employer should seek to pass on any such associated costs to the contractor, particularly where such an advance payment is made to assist with any issues around the contractor’s cashflow.
Scenario 2 – Vesting only
Where the contractor pays for the goods, plant and/or materials in the first instance, but the items are to be stored at an off-site location prior to incorporation into the project, with payment to be made by the employer after delivery to the off-site location, but prior to delivery to the site/incorporation into the project, this is vesting only.
Contractual position under JCT:
The goods, plant and/or materials to be purchased will need to be included in the building contract as ‘Listed Items’. ‘Listed Items’ are those goods, plant and/or materials that have been/are to be paid for by the employer but stored at an off-site location prior to incorporation into the project. The contractor is to purchase such Listed Items in the first instance, which would be paid for by the employer via an interim payment once the contractor has satisfied all of the required steps (set out below).
If the value of any Listed Items is to be included in any interim payment prior to delivery to/adjacent to the site, the contractor must provide reasonable proof that the property in the Listed Items is ‘vested’ in the contractor and is insured to its full value. Pending delivery to the site, the Listed Items are to be clearly identified as ‘held to order’ by the employer, with the site marked as its destination. Each item must either be set apart or clearly and visibly marked.
Headline risks:
The contractor has not yet purchased the required goods, plant and/or materials/they are not yet vested in the contractor.
The contractor purchases the incorrect goods, plant and/or materials or an incorrect quantity.
There is a fault with any goods, plant and/or materials purchased by the contractor.
Potential recourse:
Breach of contract – general damages.
Potential risk: Financial position/solvency of the contractor – will the employer be able to recover any associated loss?
The employer does not have a contract in place with the supplier of the goods, plant and/or materials, so does not have any direct contractual recourse with the supplier if any issues arise.
Managing risk: Vesting Certificate (VC):
As an additional security measure, the contractor may be instructed to provide a VC for any such Listed Items that have been paid for/are vested in the employer and stored off-site by the contractor.
A standard form VC should warrant that the Listed Items:
have already been prepared/manufactured and are ready for incorporation into the project;
are vested in the employer (or in the contractor, becoming vested in the employer upon payment);
are in accordance with the building contract;
are insured to their full value;
are held to the employer’s order, set apart, clearly identified and stored to the employer’s satisfaction;
will be delivered to site in accordance with any agreed programme; and
may be inspected at any time by the employer.
Before any VC is signed off by the employer, or any payment is made to the contractor for any Listed Items, it is critical that all of the matters raised in the vesting certificate are confirmed, in particular that the Listed Items are:
in the ownership of the contractor (title has passed);
stored at a location of the employer’s satisfaction;
identifiable and identified as the employer’s property; and
are physically inspected by the employer to confirm their existence and value.
The details of the Listed Items (product codes, unique reference numbers, make and model etc) need to be clearly set out in the vesting certificate.
The employer may request proof of the value of the Listed Items from the contractor (ie, supplier invoices) and satisfy itself that there is no ‘mark-up’ or hidden costs on the value of such items. The employer should be able to recover in full what it has paid for such items in the event that such items need to be recovered from the storage location (ie, in the event of insolvency of the contractor).
Throughout the vesting period, regular physical checks of the Listed Items should be undertaken by/on behalf of the employer.
Scenario 3 - Advance payment and vesting
Where the employer pays monies to the contractor before the contractor purchases the required goods, plant and/or materials, but the items are to be stored at an off-site location prior to delivery to the site/incorporation into the project, this would require both an advance payment and vesting.
In such a scenario, it is likely that both an APB and a VC will be required.
The APB will secure the advance payment made to the contractor prior to purchasing the goods, plant and/or materials and the VC will secure the items whilst stored off-site.
Summary
Whilst both advance payments and vesting may help to overcome cashflow issues and enable a project to move forward without unnecessary delay, it is important for an employer to assess any potential associated risks and to be aware of the practical steps it needs to take and what security measures it needs to put in place in order to protect itself.
If the contractor fails to follow the required steps set out above and/or fails to provide/procure the required security, then no payment should be made by the employer by way of any advance payment and/or for any ‘vested’ goods, plant and/or materials.
