An introduction to milestone payments under construction contracts

Milestone payments are payments that become due when a certain stage in the construction contract is reached.

This article will set out what milestone payments are, the advantages and disadvantages of milestone payments and practical points to note when using, or planning to use, milestone payments under a construction contract.

What are milestone payments and are they permitted under the HGCRA?

As noted above, a milestone payment becomes due when a certain stage in the contract is reached. This could be:

A point in the construction programme, such as a building being watertight or a road having its surface course installed; or
On another event, such as obtaining Building Regulations approval or the delivery of a key component of the building which had been manufactured off site.

Milestone payments provide an alternative to a payment regime that refers to a regular period in time. One example of the latter is the regime under the Scheme for Construction Contracts (England and Wales) Regulations 1998 (as amended) (the “Scheme”), which provides for payments every 28 days. Those payments are by reference to whatever quantity of work has been carried out during that 28-day period.

In Bennett (Construction) Limited v CIMC MBS Limited [2019] EWCA Civ 1515, the court held that a milestone payment regime was generally an “an adequate mechanism for determining what payments become due under the contract, and when” as required by the Housing Grants, Construction and Regeneration Act 1996 (as amended) (the “HGCRA”). In Bennett, the judge referred to payment of a proportion of retention monies on practical completion as being a common milestone payment within construction contracts.

Advantages and disadvantages of using milestone payments

There are clear advantages to using milestone payments in construction contracts. Firstly, milestone payments are based on the contractor’s performance (its “output”) rather than its input. This acts as an incentive to the contractor, which will only be paid when it achieves the milestone and not for any interim steps or inefficient working.

Secondly, using milestone payments make it easy for the parties to predict their cash-flow. Milestones are simpler to link to a programme and therefore the parties can more easily plot when money will flow in and out.

Thirdly, milestone payments can be easier to administer. The contractor’s quantity surveyor will not be required to carry out a detailed gross measure every month and instead can simply carry out a “box ticking” exercise as part of his or her payment application. Conversely, the application will be easier for the employer (or its representative) to verify.

However, there are also downsides to using milestone payments. Firstly, the main disadvantage is the potential for confusion which mostly arises from poor drafting. In Bennett v CMIC, the court considered a milestone payment regime which relied on the paying partying “signing off” stages of the works. However, it was unclear who was doing the signing off, when and how. If the milestone payment regime is not an “adequate mechanism”, the Scheme’s 28-day system will be implied. Clearly, this is not what the parties to a contract incorporating milestone payments intended and will have wide reaching commercial and practical effects.

Another disadvantage is the possible rigidity of the milestone regime. Construction contracts are often extremely complex and subject to changes in scope, price and programme. Whilst these are easy to absorb in a traditional time-based payment regime, the parties should consider how to incorporate them into the milestone system.

This rigidity can also affect the payee if the contract is terminated during its currency. In this instance – absent any provisions to the contrary - the contractor would lose the right to be paid for any work towards a milestone that had not been reached. This was the case in Timberbrook Ltd v Grant Leisure Group Ltd [2021] EWHC 1905 (TCC), where the judge said at paragraph 48 that

The claimant contractor’s claim for £38,000 for works carried out up to termination therefore failed.

Practical points

As set out above, using milestone payments has a number of advantages. Below are some practical tips to ensure their successful use.

Plan properly. An effective milestone regime should be properly planned. Consider how the milestones will be divided and how – as paying party or the payee – this will affect cash flow. Milestones that are high in value or far apart may leave a payee exposed commercially.
Draft clearly. It is important that the parties avoid the mistake in Bennett v CMIC and ensure that there is a clear and objective process for reaching a milestone. This may be by naming a person to certify that the milestone has been achieved, for example the contract administrator or a third party expert. Another example would be to provide third party certification. Expanding on an example above, the payee could provide a Building Regulations approval certificate to trigger payment.
Consider variations. During a contract, the parties may agree variations to the scope and price. Using the example of a contract to build a house, the employer might ask the contractor to build a detached garage too. It is important that the milestone payment schedule is amended to incorporate this additional work and value.
Consider termination. A contract may be terminated during its currency for a variety of reasons. Where a contract provides for milestone payments, if the contract is terminated before a milestone is reached, the payee (usually a contractor or sub-contractor) will lose the right to payment for that element. Therefore, that party may wish to insert a provision that allows for reasonable payment of part of a milestone should the contract be terminated. This would overcome the issue in Timberbrook noted above.