https://www.pinsentmasons.

com/out-law/analysis/new-hong-kong-security-of-
payment-regime-for-public-works-contracts

New Hong Kong Security of Payment regime for public works contracts

OUT-LAW ANALYSIS | 15 Oct 2021

The Hong Kong Special Administrative Region (HKSAR) Development Bureau has
issued a new Technical Circular which prescribes the mandatory incorporation of
Security of Payment (SOP) provisions into all public works contracts later this year.
This is a very significant development as it involves for the first time the introduction of
the contractual right to refer payment disputes to adjudication and the prohibition of
“pay if paid” or “pay when paid” provisions. All the contractors working on future
public works will need to comply with the new mandatory requirements and amend
their subcontracts to comply with those requirements.
The regime will take effect in two stages.
From 31 December 2021, the SOP provisions will apply to tenders from Group B
contractors for contracts of value up to HK$400 million or Group C contractors for
contracts of any values exceeding HK$400m on the “List of Approved Contractors for
Public Works”.
From 1 April 2022, the SOP provisions will apply to tenders from other contractors on
the “List of Approved Contractors for Public Works” or the “List of Approved
Suppliers of Materials and Specialist Contractors for Public Works”.
Take-aways
SOP is known for protecting the cash flow in the construction sector, especially for
subcontractors working at the lower tiers. However, instead of following the footsteps
of UK, Australia and Singapore in enacting a SOP legislation, Hong Kong has ventured
into an uncharted territory of implementing SOP provisions purely by contractual
arrangement.
The timetable for introduction of security of payment legislation remains unclear. It
means that contracting parties to public works contracts in the meantime will have no
access to courts in obtaining payment of an adjudicated amount or challenging
adjudicators’ decisions which are obviously wrong or made without jurisdiction.
Whilst the new regime is at the moment confined to public works contracts, the new
ability to adjudicate payment disputes as they arise and the elimination of “pay if paid”
or “pay when paid” provisions in public works contracts are likely to change the
landscape of the construction industry in Hong Kong drastically. Main contractors will
no longer be permitted to delay payment to their subcontractors on the ground that the
main contractors have not been paid by the employer under the main contracts.
The contract administrators of the public works contracts are tasked with policing the
compliance with the contractual SOP provisions by the main contractors. They can give
“poor” or “very poor” ratings in the contractor’s performance report in the event of non-
compliance with the SOP provisions by the main contractors. A contractor given
consecutive "adverse" contractor’s performance reports may be requested to voluntarily
refrain from tendering, and may be subjected to other regulating actions, such as
removal, suspension, downgrading or demotion from the List of Approved Contractors
for Public Works.
Under the new contractual regime, significant contractual and administrative burdens
are imposed on the main contractors to, among other things, ensure that the SOP
provisions are being incorporated and complied with at subcontracts at all tiers and deal
with adjudications. This will increase the operating cost of the main contractors and in
turn be factored into their tendering price for public works contracts.
Given the imminent effective date of the Circular, Group B and Group C contractors
should immediately start reviewing their subcontracts and preparing to incorporate the
SOP provisions which are contained in Annex D to the Technical Circular into all their
relevant subcontracts. Subcontractors should also do likewise down the subcontract
chain.
Elements of the SOP regime include:
 The prohibition of “pay if paid” or “pay when paid” provisions.
 Contractors or subcontractors should submit payment claims at the time specified
in the relevant contract or subcontract.
 The recipient of the payment claim, either the employer or main contractor, must
provide a response to the payment claim within 30 days of the contractor’s
payment claim or any agreed shorter period.
 The admitted amounts must be paid within 60 days of the payment claim.
 If any payment dispute arises between the contractor or subcontractor and the
employer, the contractor or subcontractor can refer the payment dispute to
adjudication.
 The adjudicator must issue a determination within 55 days of the appointment to
resolve the dispute unless the parties agree otherwise.
 The paying party must pay the amount which is determined by the adjudicator
within 30 days of the notification of the adjudicator’s decision. Failure by the
main contractor to pay a sum which is admitted or adjudicated to be payable will
entitle its subcontractor to suspend work or apply for direct payment by the
employer.
Hong Kong October 15 2021
Summary
With the Hong Kong Development Bureau’s (DevB) contractual security of payment
regime coming into effect from 31 December 2021 (the SOP regime), we now examine
some important challenges which facing the Hong Kong construction industry as it
comes to grips with the new contractual environment. The SOP regime is set out in
the Technical Circular (Works) No.6/2021 published by DevB on 5 October 2021 for
the implementation of security of payment provisions in public work contracts (the
Circular) and will take effect in two stages, commencing on 31 December 2021 and 1
April 2022.
With the issue of DevB’s Circular implementing a contractual SOP regime for Hong
Kong public works contracts and sub-contracts starting from 31 December 2021, the
need to prepare for the Circular’s impact is intensified. It is therefore worth taking a
deeper look at the issues and challenges presented by the SOP regime as currently
implemented by DevB, and consider how these challenges might be best met.
In this article, we will further consider (i) the direct payment mechanism, (ii) the lack of
judicial supervision under the current DevB regime, (iii) the importance of a system for
ensuring adequately skilled and trained adjudicators, and (iv) the time periods relating
to payment and adjudication.
The direct payment mechanism
The direct payment mechanism entitles a sub-contractor (of any tier) to request the
Government as employer to make direct payment for any unpaid adjudicated amounts.
It has been introduced to address the lack of a (statutory) enforcement mechanism
through the courts.
Briefly, where a sub-contractor submits a copy of an unpaid adjudication decision to the
Government, the Government will pay all or part of the adjudicated amount to that
claiming sub-contractor and then make a corresponding deduction from payments due
to the main contractor - unless the main contractor can show that the adjudication
decision has already been satisfied or is no longer binding, or that the deducted amount
cannot be recovered from sub-contractors at a higher tier to the claiming sub-contractor.
If Government makes such a deduction from the main contractor, then the main
contractor, and in turn, the sub-contractors at a higher tier to the contractor that failed to
pay as required by the adjudication decision, are entitled to recover the direct payment
amount by making corresponding deductions down the sub-contracting chain.
Unlike the direct payment mechanism under the Employment Ordinance (Cap. 57)
which caps a main contractor’s liability for unpaid wages to the employees of its
subcontractors at two months’ wages and excludes liability for the wages of employees
of nominated subcontractors entirely, there is no limitation on a main contractor’s
liability under the DevB model.
Clearly the direct payment mechanism places a substantial burden on main contractors,
as they bear the primary burden of payment failures at any subcontract tier.
Judicial oversight?
In jurisdictions where security of payment is governed by statute, parties have
(comparatively) quick and ready access to the courts to enforce or challenge
adjudication determinations. However, without a statutory underpinning to the
contractual SOP regime, there is no direct access to the courts for a party to challenge
an adjudication, for example, on the grounds of the adjudicator going outside of his or
her jurisdiction or where a party considers it has not been treated fairly through the
adjudication process.
As such, disputes arising out of an adjudicator’s decision will be subject to the dispute
resolution process provided for in the contract, which under Government forms of
contract will be by way of arbitration. Such awards will be private and confidential, and
may be challenged only in the limited circumstances.
While adjudication is intended to be a quick interim process, other jurisdictions (and
indeed adjudicators in those jurisdictions) have benefited from guidance of the courts as
to the extent of an adjudicator’s jurisdiction and in relation to procedural matters. This
has particularly been the case during the early days of the implementation of a new SOP
regime. The Hong Kong courts’ opportunity to opine publicly and give guidance on
these issues will be extremely limited.
Ensuring adequate training and support for adjudicators
Adjudication is a relatively new process in Hong Kong. As a result, there are few
experienced professionals in Hong Kong possessing extensive adjudication experience.
The experience on other jurisdictions has been that support will be required for
adjudicators in the early days of implementation of the SOP regime. This will no doubt
fall to the adjudicator nominating bodies (ANB). In this regard, measures adopted in
other jurisdictions to address ongoing training and support for adjudicators are
instructive:

 In New South Wales, the relevant SOP legislation incorporates a “Code of

Practice”. This requires ANBs to ensure that the nominated adjudicator can
demonstrate that they understand the applicable SOP legislation.
  Singapore maintains a “Code of Professional Conduct and Ethics” which requires
ANBs to act with due diligence and care and to take reasonable steps to ensure
the competence of their adjudicators.
 The Australian state of Victoria takes a more stringent approach. Its “Conditions
of Authorisation” require adjudicators to have relevant qualifications, experience,
and training. For instance, adjudicators must have at least five years’ experience
either in managing construction contracts or in contract dispute resolution.

For quality control, some foreign ANBs require adjudicators’ decisions to be reviewed
by a more senior adjudicator. Other ANBs make available an extensive database
providing case law and past decisions to guide adjudicators. Still other ANBs have put
in place a mentoring system so that a junior adjudicator can discuss their case with a
senior adjudicator.
Time periods relating to payment and adjudication
The SOP regime is “long” in that the time periods in the payment and adjudication
processes are generous when compared against other jurisdictions.
Under the Circular, the maximum payment period is 60 calendar days:

 This period is long when compared with other jurisdictions. In New South Wales,
payment by an employer to its main contractor is to occur within 15 days of an
admission that payment is due. In Singapore, the comparable period is 35 days.
 The period has been shortened when compared to the most recent public
consultation in 2015, when the DevB had proposed an interim payment period of
60 calendar days and a final payment period of 120 calendar days.
 Many respondents to the consultation raised concerns about the potential impact
such long periods may have on the efficacy of the regime in promoting project
cash-flow, and advocated for shorter payment periods of 45 and 90 days
respectively.

Likewise, a claimant has 28 days after the receipt of the payment response to commence
adjudication:

 The comparable period in Singapore is seven days.

 Such 28-day period is the same as the period proposed in the 2015 public
consultation for referring matters to adjudicator. The majority of the respondents
appeared to support the 28-day period.
 DevB’s stated reasons for the 28-day period is to allow claimants to better
consider their position before commencing adjudication and to give additional
time for negotiation between the parties. Whether these objectives will be
 achieved is yet to be seen – potential claimants may be reluctant to unreservedly
participate in negotiation, for fear of prejudicing their position in any future
adjudication.

Living with Security of Payment

Given that the contractual SOP regime will come into effect on 31 December 2021 for
larger Government contracts and then in April 2022 for the remainder of the
Government contracts covered by the Circular, it is important for the industry to prepare
for its impact and to ensure that internal processes and personnel are ready for the
coming changes.
Main contractors will need to decide their approach to adjudication under their direct
contract with Government particularly where it is faced with adjudication applications
from its subcontracting chain.
Now that the regime has been published, the outcomes will only improve if the system
is used as it is intended at every level. There is no doubt there will be some uncertainties
and bumps along the way. However the Hong Kong construction industry’s enthusiastic
adoption of security of payment processes may also encourage a quicker transition to a
legislative regime, providing greater certainty for the future of Hong Kong construction
contract payment practices.
Hong Kong October 12 2021
Summary
On 5 October 2021, the Development Bureau (DevB) published the Technical Circular
(Works) No.6/2021 for the implementation of security of payment provisions in public
work contracts (Circular).
The Circular promulgates a contractual regime to implement “the spirit of the Security
of Payment Legislation” in public works construction contracts and sub-contracts (the
SOP regime). For affected contracts, the Circular (i) regulates payment application and
certification processes, and (ii) enshrines adjudication as an interim dispute resolution
mechanism.
THE SOP REGIME
The SOP regime will take effect in two stages. For Group B or Group C contractors
listed in DevB’s “List of Approved Contactors for Public Works”, the SOP regime will
apply to tender invitations issued on or after 31 December 2021. For tenders invited
from listed contractors which fall outside of Groups B or C, the SOP regime will apply
to tender invitations issued on or after 1 April 2022. 1 April 2022 will also be the date
from which the SOP regime applies to suppliers and contractors listed in DevB’s “List
of Approved Suppliers of Materials and Specialist Contractors for Public Works”.
Key elements of the regime include:

1. The prohibition of “pay when paid” provisions.

2. Payment claims are to be submitted by a contractor or sub-contractor at times
specified in the relevant contract or sub-contract.
3. Payment responses are to be issued by the employer (or the higher tier contractor
or sub-contractor, as relevant) within 30 days (or any agreed shorter period) of
the contractor’s payment claim.
4. The net admitted amount required to be paid within 60 days of the payment claim
being served.
5. The contractor (or sub-contractor, as relevant) is entitled commence adjudication
within 28 days if no payment response is issued when due, if it is dissatisfied with
the payment response, or if the net admitted amount is not paid when due.
6. Once the adjudication is commenced, the adjudicator must issue their
determination within 55 days of his appointment, unless both parties agree
otherwise.

The contractual SOP regime is intended to be a pre-cursor to a later statutory regime

and has been designed to allow Government and industry participants to acclimatise to
operating in an SOP environment, and to identify potential issues before legislation is
introduced.
COMPARISON WITH THE DRAFT CIRCULAR
DevB’s Circular as issued includes changes and clarifications to that earlier draft. Some
of the key changes and clarifications cover:

 Incorporation of the SOP regime into affected contracts: The Circular now
makes it clear that the Security of Payment Provisions set out in Annex C to the
Circular are to be incorporated into the affected main contract as an appendix by
way of new additional or special conditions of contract set out in Annex B.
 Direct payment process: Where a sub-contractor makes an application for direct
payment of an adjudicated amount, Government now has the discretion to make
direct payment of any amount it considers reasonable based on the information
provided. Relatedly, a certification process is introduced to allow the main
contractor to certify and submit documentary proof of (a) the insolvency of a
subcontractor at any higher tier to the claimant, or (b) the inability of the main
contractor or a higher tier subcontractor to recover the amount of direct payment
through deductions to other payments due. These are in addition to the grounds
included in the earlier draft circular (and which have been retained in the Circular
as issued) that (c) the claimed adjudicated amount has been settled in full, or (d)
the relevant adjudication is no longer binding.
 Relationship between the claim handling procedure and the EOT claims: The
draft Circular stated that before a claim for additional payment could be referred
to adjudication, all claim handling procedures stipulated in the relevant contract
must have been gone through. The Circular as issued clarifies that this
requirement extends to EOTs and time-related payment claims. Critically, the
Security of Payment Provisions provide that where additional payment is claimed
in connection with a specified compensable event, a payment dispute does not
arise unless and until the contract administrator has notified his rejection or
assessment of that claim, or has failed to do so within the applicable timescale or,
if no timescale is specified, a reasonable time. This means that, in practice, the
contract administrator will have first decided on an EOT claim before the matter
may be submitted to adjudication.
 Effect of an adjudicator’s determination on time-related costs and EOT: As
discussed in our earlier article, the adjudicator is empowered to make binding
determinations as to time-related costs forming part of a payment dispute and, if
necessary for making such a determination, non-binding determinations as to the
extension of time due for relevant delays. The Circular now appears to clarify the
intended effects of an adjudication decision on EOT. The new drafting suggests
 that the date of completion of a contract will be revised to reflect the EOT
entitlement determined by the adjudicator. It also appears that an adjudicator’s
determination that an EOT applies in respect of a delaying event will suspend any
right to terminate on the grounds of any delay covered by that EOT.

The issue of the Circular intensifies the need to prepare for the implementation of the
SOP regime. It is therefore worth taking a deeper look at the issues and challenges the
SOP regime presents.
Hong Kong July 6 2021

As the old saying holds, cash-flow is the life blood of the construction industry. To
ensure that cash-flow is protected, many jurisdictions have introduced SOP
regimes to regulate payment practices and provide for rapid adjudication of
payment disputes. In our experience, SOP regimes are usually implemented via
legislation.
The first jurisdiction to enact a SOP legislation was the UK in 1998.1 The UK was
followed by other jurisdictions including various Australian states,2 New Zealand,3
Singapore4 and Malaysia.5 In Hong Kong, public discussion of SOP - related issues
goes back to 2001, when the Construction Industry Review Committee publicly
proposed that SOP legislation be enacted.6 A non- exhaustive history of further
developments relating to SOP in Hong Kong is provided in Figure 1 below.7
Figure 1 - Timeline of the development of a security of payment legislation in Hong
Kong

The Pilot Programme

In 2021, Hong Kong appears ready to implement a SOP regime for public works
projects. This will take the form of a pilot programme applying to public works
contracts and sub-contracts. To this end, the Hong Kong Development Bureau has
released a draft Technical Circular titled “Implementation of the Spirit of SOP in Public
Works Contracts”. This circular, if brought into effect, will incorporate SOP provisions
into public works contracts and related sub-contracts.
The draft Circular indicates that the contractual regime will apply to public works
contracts which go to tender during or after the second half of 2021. The regime will
apply to contracts issued by the Hong Kong Government only and will not cover
contracts issued by statutory bodies or corporations.
The pilot programme is intended to pave the way for the subsequent enactment of SOP
legislation in Hong Kong. Based on current information, the final legislation is likely to
affect all public works construction contracts (including contracts issued by specified
statutory/public bodies and corporations) for procurement of construction work or
related goods and services. It is also likely that that the legislation will apply to private
sector construction contracts with a value exceeding HK$5 million (for works contracts)
or HK$0.5 million (for supply of goods and services, including professional services).
The initial limited deployment of a SOP regime in Hong Kong on a contractual basis,
restricted to public sector activities, should provide the Hong Kong Government and the
industry with an opportunity to test the regime and to identify snags or ambiguities in
parallel with the development of the Security of Payment legislation.
Contractors will need to understand the effect of the new regime on their business, and
dedicate time and resources to ensure that they comply with and effectively manage the
Security of Payment requirements.
The SOP Provisions
The Circular provides a set of provisions for incorporation into the relevant public
works contracts. These provisions are known as the “SOP Provisions” and are set out in
an annex to the Circular. The Circular further envisages that the SOP Provisions will be
incorporated into the relevant public work contracts by Additional or Special Conditions
of Contract.
The SOP Provisions set out a mandatory process for the administration and payment of
progress payment claims. The Provisions also entitle the parties to the contract to refer
any payment dispute to adjudication to determine the dispute on an interim basis.
The SOP Provisions include the following elements:
·         The main contractor is entitled to submit a claim for a progress payment on or
after the “Reference Date” specified in the Contract. The payment claim must state the
amount claimed and the works, goods and services to which the claim relates.
·         The employer is to serve a response to the payment claim within 30 days of the
main contractor’s payment claim (or any shorter period specified in the contract). The
response must state any amounts admitted as due, any disputed amounts, any set-offs or
withholdings claimed (including the grounds on which any such set- off is based), and
the net amount which the employer agrees to pay to the main contractor.
·         Any amount admitted as due by the employer in its payment response must be
paid within 60 days of the payment claim (or any shorter period specified in the
contract).
·         If a payment dispute arises between the main contractor and the employer, the
main contractor may refer that dispute to adjudication within 28 days of the dispute
arising.
·         The adjudicator will have 55 working days from the date of his appointment (or
any longer period agreed by the parties) to decide the payment dispute.
·         The employer shall pay the amount decided by the adjudicator within 30 days
after the adjudicator’s decision is delivered (unless the adjudicator directs otherwise).
·         If the employer fails to pay an admitted or adjudicated amount by the due date,
the main contractor will be entitled to suspend or reduce the rate of progress of its work.
The information included in the payment claim and response will establish the scope of
any payment dispute that may later be referred to adjudication. Therefore, the employer
and main contractors alike should ensure that the required documentation is prepared
with care and include all necessary information – mistakes at this stage will prejudice a
party’s position in any adjudication and could lead to an unfavourable adjudication
determination.
Mandantory Provisions For Inclusion In Sub- Contracts Connected With Public
Works Contracts
The Circular also annexes “Mandatory Sub-Contract Provisions” for incorporation into
all sub-contracts of any tier engaged under a relevant public works contract. The
Mandatory Sub-Contract Provisions largely correspond to the SOP Provisions, with
some notable differences which are described below.
Firstly, the Mandatory Sub-Contract Provisions expressly provide that any conditional
payment provision (such as “pay when paid”) included elsewhere in the sub-contract
will be unenforceable and of no effect. This provision is not reflected in the SOP
Provisions, presumably on the basis that the Hong Kong Government can ensure that no
such provisions are included in the main contract.
In addition, the Mandatory Sub-Contract Provisions entitle sub-contractors of any tier to
require the employer to make direct payment of any amount which has been adjudicated
as due from the main contractor (or a higher- tier sub-contractor, as relevant) but which
remains unpaid. The mechanism is complex, but in summary, requires the sub-
contractor to make a written declaration that all or part of the adjudicated amount is due
and remains unpaid, while the main contractor is given an opportunity to provide
documentary proof showing the contrary. Where a direct payment is made, the
employer will be entitled to make a corresponding deduction from amounts due from
the employer to the main contractor. Importantly, if the main contractor can demonstrate
the sub-contractor was not paid due to the insolvency of a higher-tier sub-contractor, the
employer will not make a direct payment.
Main contractors should be alert to the potential impact of the direct payment
provisions. To avoid liability to the employer, the main contractor needs to police all
tiers of its sub-contracting chain and ensure that payments are made as and when due.
The SOP Provisions impose an express obligation on main contractors to take all
reasonable steps to ensure that the Mandatory Subcontract Conditions are included in all
lower tiers of sub-contracts. Main contractors’ compliance with this requirement will be
monitored and failures to comply may result in a downgrade of that contractor’s
performance rating - likely impacting upon that contractor’s ability to win future public
works contracts.
Adjudicator’s Powers To Make Determinations On Time-Related Costs
In our experience, different jurisdictions have approached the question of whether an
adjudicator should have the power to make determinations on extensions of time
(“EOT”) and the related costs in different ways. The treatment of EOTs and time-related
costs will be an important element in any SOP regime implemented in Hong Kong.
How has this been addressed in the draft Circular?
The Circular says that the majority of the industry stakeholders support a proposal by
which the adjudicator would be entitled to make binding determinations as to time-
related costs forming part of a payment dispute. In order to make that determination, the
adjudicator would also be empowered to make non-binding determinations as to the
extension of time due for relevant delays. Despite the adjudicator’s EOT determination
being non-binding, the claimant would still be entitled to interim relief from liquidated
damages levied in respect of any period covered by an adjudicator’s EOT
determination.
Getting Ready
The introduction of a SOP regime will be one of the most significant reforms to the
Hong Kong construction industry in decades. Construction industry participants will
need to get up to speed on the legal, logistical and financial implications of the SOP
regime quickly and efficiently. Decisions on resourcing, claim management strategy and
risk mitigation are only some of the important issues affecting a construction business
which will need to be thoughtfully addressed. Relatedly, the implementation of SOP in
Hong Kong will unavoidably have its teething problems. Uncertainties, ambiguities and
unexpected issues will be commonplace and require careful management.