Security of Payment Legislation: The Way Out of Hong Kong's Construction Payment Conundrum

The Task Force on Security of Payment Legislation, formed under the Construction Industry Council’s Committee on Subcontracting, recently submitted a report to the Government that recommends the enactment of legislation to address longstanding payment issues within the construction industry. A veteran industry expert tells us more.

The construction sector is a key driving force behind Hong Kong’s economy. In 2011, it contributed to about 3.5% of the city’s GDP. Currently, it employs around 310,000 persons. According to the Census and Statistics Department, the gross value of construction works by main contractors in 2011 totalled HK$128.5 billion in nominal terms. For public projects, the expenditure in capital works was about HK$58 billion in the financial year 2011/12. With considerable demand for infrastructure, this is estimated to exceed HK$60 billion annually for the next few years. Hence, the adoption of fair and good payment practice is conducive to the healthy and sustainable development of the construction industry.

As with other developed jurisdictions, Hong Kong’s construction industry has adopted a subcontracting system. Under the traditional practice of “pay-if/when-paid”, subcontractors are not to be paid until the contractor gets paid. Whether due to the contractors not being paid on time or other reasons, subcontractors are often not paid on time for work performed. And eventually, the payment problem becomes so complex and deep-rooted that it becomes very difficult for the issue to be resolved amicably.

Over the years, several reports aimed at rectifying such problems have been published.

The “Construct for Excellence” Report

In 2001, the “Construct for Excellence” report published by the Construction Industry Review Committee (“CIRC”) in 2001 suggested the need to consider enacting security of payment legislation which aims at providing contractors, subcontractors and suppliers with a means of obtaining quick and easy payment for work or supplies provided to lead contractors or principals under construction contracts.

In June 2005, the then-Environment, Transport and Works Bureau reported to the Provisional Construction Industry Co-ordination Board on measures put in place by the Government in response to the CIRC recommendations on security of payment. This included the pilot scheme on voluntary adjudication and dispute resolution advisors in public works contracts, promulgation of the standard form of domestic subcontract for specialist works (the “Blue Form”), the promotion and use of written contracts by contractors and subcontractors, as well as the introduction of contractual requirement of subcontractor management plans to enhance management of subcontractors by main contractors, etc.

Preliminary Survey - Survey on General Building Contractors’ and Specialist Contractors’ Status on Cash Flow & Other Related Issues

In April 2008, the Hong Kong Construction Association commissioned the Public Opinion Programme at the University of Hong Kong (the “HKU Programme”) to conduct the abovementioned survey, which revealed that over 90% of respondents indicated high material costs as the No 1 problem facing contractors. No 2 was outstanding payment from other contract parties, affecting over 60% of respondents. These were followed by other moderately serious problems including demand on wages by workers, payment in disagreement with the other contract parties, etc.

However, the results of this survey, while helpful, was not seen to do enough to identify the main causes and effects of late or non-payment within the construction industry as a whole. This was due mainly to the fact that it focused merely on two groups of practitioners, main contractors and specialist subcontractors.

Comprehensive Survey - Survey on Problems of Outstanding Payment in Construction Supply Chain (the “2009 Survey”)

In 2009, the Construction Industry Council (“CIC”) commissioned the HKU Public Opinion Programme to conduct the abovementioned survey to identify all critical causes of payment problems sustained in the construction industry. This covered a wide range of participants from employers, consultants, contractors, subcontractors and suppliers. It revealed that the payment problem was more serious in the private sector than the public sector. These included:
 

  • late resolution of disputes;
  • continuation of work while arrears were not settled;
  • late settlement of final account;
  • delay in certification of interim payments; and
  • other obstacles for payment.

In response to the above issues, the CIC’s Committee on Subcontracting proposed setting up:

  • a Task Force on Standard Contract Provisions for Domestic Subcontracts to work out a set of standard clauses for incorporating into domestic subcontracts as appropriate;
  • a Task Force on Dispute Resolution Documentation to define the coverage and procedural flow of the proposed dispute resolution mechanism across different types of construction contracts; and
  • a Task Force on Security of Payment Legislation to consider the necessity of security of payment legislation (“SoP Legislation”) in Hong Kong.

Further Survey - Survey on Payment Practice in the Construction Industry (the “2011 Survey”)

Even though the 2009 Survey had identified prevailing payment problems, it was not designed to identify issues in the construction supply chain. The government’s Development Bureau, in collaboration with the CIC’s Task Force on Security of Payment Legislation, conducted in August 2011 the abovementioned survey to address such issues.

This survey collected a wide range of information on contracts, payment schedule and progress payments, conditional payment practice, construction disputes in respect of construction works (including supply of goods and services) and stakeholders’ views on effectiveness of possible legislative and administrative measures to secure payments in the construction industry. It covered some 8,100 companies in the construction supply chain, including five major operators, private sector developers as well as public sector employers, consultants, main contractors, subcontractors (including specialist subcontractors and general trade subcontractors) and suppliers. With the support from the Census and Statistics Department as well as various stakeholder groups, the survey successfully interviewed over 1,200 companies, with an overall response rate of 64%.

In short, unlike previous surveys, this one extended the scope to collect stakeholders’ views on the effectiveness of possible administrative and legislative measures to secure payments in the construction supply chain. It revealed:

  • that the average outstanding payments per annum for the reference period were HK$9.4 billion for main contractors (8% of total annual business receipts), and HK$9.9 billion for subcontractors (12% of total annual business receipts);
  • common problems encountered by various types of operators with regard to upper-tier parties;
  • that disagreement and disputes between contracting parties were the major reason for payment problems encountered by the main contractors, subcontractors, and consultants;
  • that difficulty in receiving payment does exist within the industry, with subcontractors bearing the brunt of it - 57% of subcontractors polled considered payment problems to be either very serious or serious, whilst 49% of suppliers, 45% of main contractors, and 37% of consultants shared the same view.
  • the payment problem was more serious in contracts adopting “pay if/when paid” practice – 50% of respondents in the subcontractor and consultant sectors said that conditional payment in such form was imposed upon them by upper-tier parties; 39% of main contractors adopted such practice in their contracts with lower-tier parties; and 16% of subcontractors engaged in similar practice with lower-tier parties. However, a majority of subcontractors (74%) and suppliers (79%) considered such a practice to be not acceptable/not reasonable; and
  • in general, it was considered that both administrative and legislative measures would be very effective in resolving the payment problem with regard to public works; while only legislative measures were required to be very effective in resolving this with regard to private works.


Report on Security of Payment Legislation to Improve Payment Practices in the Construction Industry

Based on the results of the 2011 Survey, the Task Force on Security of Payment Legislation collected views from major stakeholder groups - employers, main contractors, specialist subcontractors and domestic subcontractors - on practical measures to improve payment practices.

Stakeholders’ Feedback

Developer - In an effort to maintain the principle of “big market, small government” in Hong Kong, The Real Estate Developers Association of Hong Kong set out that legislative measures should only be proposed when all other administrative measures have been exhausted and proved ineffective.

Main Contractor – The Hong Kong Construction Association pointed out that various administrative measures implemented in recent years were only modestly effective in curing the payment problem within the public sector, and ineffective within the private sector. Legislation was therefore considered as the most efficient way to tackle the extensive and widespread problem.

Specialist Subcontractor - The Hong Kong Federation of Electrical and Mechanical Contractors Limited noted that legislative and administrative measures are not mutually exclusive. Enhanced administrative measures could be introduced and adopted in parallel with the development of security of payment legislation.

Domestic Subcontractor – The Hong Kong Construction Sub-Contractors Association felt that legislation was required as various administrative measures adopted by the public sector had not provided an adequate and effective means to improve underlying payment practices along the construction supply chain.

Subsequently, the Task Force on Security of Payment Legislation issued a report and made recommendations on the necessity for security of payment legislation in Hong Kong. This report was submitted to the Secretary for Development in mid-September 2012.

Proceeding with Legislation

The Development Bureau then formed the “Working Group on Security of Payment Legislation for the Construction Industry” to start preparatory work towards introducing such legislation, with the body holding its first meeting on 31 October 2012.

Chaired by the Development Bureau, the group comprises 13 members across employers/developers, main contractors, subcontractors, as well as the CIC, Hong Kong International Arbitration Centre and professional bodies. Its work includes:

  • conducting a review of security of payment legislation enacted in other jurisdictions;
  • identifying essential elements to be introduced into the legislative framework to suit Hong Kong conditions;
  • carrying out a trial run of an appropriate operating mechanism to ensure its practicality and effectiveness;
  • conduct a three-month industry-wide consultation to seek stakeholders’ views on the proposed legislation and the operating mechanism;
  • refining the operating mechanism and the legislative framework after industry consultation; and
  • preparing a final report to be served as drafting instructions which set out the background to the proposal and what the Development Bureau would wish to achieve with the new legislation.


Conclusion

The construction supply chain has long been suffering from the difficulty or failure to receive payment once work has been completed. The reality as reflected in the survey results and comments from the respondents confirm such. The CIC recognises the need to put in place a security of payment legislation to work in parallel with the contractual and interim administrative measures. A solution must be found as soon as possible given the slew of ongoing projects, and those that are in the pipeline.
 

By Christopher To, Executive Director Construction Industry Council

 

Jurisdictions: