Valuation matters: contra charges

We continue our ‘valuation matters’ mini-series with a focus on contra charges, which are deductions made by one party for costs caused by a failure to comply with the other party’s contract obligations. They are a regular feature of payment notices issued by main contractors to subcontractors.

For me, contra charges are the scourge of the construction industry, and if there was one area where we need reform, it is contra charges. The introduction of the Construction Act in 1998 has led to improved payment practices; however, contra charges are used as a workaround to those regulations.

You can issue a timely, Act-compliant payment notice that wipes out a subcontractor's entire payment with a list of contra charges that have brief descriptions and amounts against them. In the same payment notice, you can £nil all of the subcontractor’s entitlements until they provide more information to your satisfaction.

I could, and might, write a whole article series on the use of contra charges as a means of legally starving the supply chain’s cash flow, but I will stay on message and keep this article focused on how they should be valued.

For those on the receiving end of contra charges, this will give you some insights into how to defend them.

Contract Obligation

It is not enough for someone to say they performed some work caused by another, state an amount, and deduct it from a payment.

You need to show that the subcontractor had an obligation to do something or not do something. For example, you were obliged to protect some existing finishes; you didn’t, damage occurred, and you are liable for it.

This is an important step, and it is often missed because people administer contra charges based on what they think was agreed. They take a preferential view to suit the deduction they want to make. That may hold for a short while, but when tested, it will fall to pieces, and your credibility will be undermined.

If you are preparing subcontracts, make sure you document these obligations, and they are clear to both parties. Likewise, if you are reviewing subcontracts, then make sure you check these obligations and ensure they are reasonable.

Proof

If you are making the claim, then the onus is on you to prove that there was a breach of the obligation and that it caused you to incur cost. What you are looking for here is contemporaneous records to show what really happened.

For example, if there was a leak and it caused damage, then just saying there was a leak and it must be a particular subcontractor that caused it isn’t enough. I have seen situations where someone proves beyond doubt that there was a leak, and whilst that proves the impact, it does not prove liability. You will need records that show how the leak was caused, so if, for example, it was a faulty fitting, then prepare records that show the failure at the fitting and, ideally, get the other party to record their agreement.

In the leak example, it can become difficult to trace a leak caused by a fault with the external cladding and/or roof. If the same subcontractor is performing both pieces of work, then liability is straightforward, but it is not so easy when there are two different subcontractors who could be responsible.

Where this occurs, there will inevitably be a need to open up the works to trace and identify the source of the leak. When this happens, prepare and issue a report contemporaneously recording what you did and what the findings are. Those moments are important, so preparing and preserving that evidence is crucial.

The important thing here is records, records, records, but not just any records—you need records that prove the point you have made or intend to make.

Valuation

At an early stage of the valuation process, it is common that budget allowances or high-level estimates are provided that indicate the likely cost impact of an issue. You may get away with this for one, maybe two, payment cycles, but you should aim to firm up your valuation as soon as possible.

In the same way that you would price a variation, there should be a cover sheet showing the amount of your valuation and how it has been calculated. The quantities and rates used should be supported by reference to the information you have put forward to substantiate the amount.

For example, if there are a number of labour hours, then include the timesheets. If there are material prices, include the supporting purchase order and invoice, etc. If it is a subcontractor cost, then provide all the information that you relied upon to make payment to the subcontractor.

Passing through the costs isn’t enough. You need to test that an amount is reasonable before you pay for it. Are you taking labour hours at face value, or is there a signed timesheet behind it, and are the hours reasonable relative to the work performed? Have you just taken a subcontractor’s quote and instructed it without challenging whether it is reasonable, or does it include more than the scope of the alleged failure?

Communicating with the subcontractor

It isn’t helpful if these issues pop up in a payment notice with the subcontractor having no knowledge and being given no opportunity to challenge or query the deduction. Take a no-surprises approach to these issues, as it will make the process of agreeing on a valuation much easier for both sides.

You should put this forward as a pack of information that states the contract obligation, how it was breached, and the costs that the breach caused you to incur. I would recommend an overlaying word narrative outlining these key points with an Excel calculation of the amount and information behind that, which supports the rates and the quantities, etc.

You should issue this to the subcontractor as soon as possible so that the subcontractor can review and query the information, in the hope that you can come to an agreement on the principle and the quantum.

The sooner this is done, the sooner everyone knows where they stand and can manage their financial position accordingly.

Final Reflections

The guidance provided in this article is, in many respects, a mirror of the guidance I gave and always give about how to value variations. This is because it is the same, but in reverse.

It surprises me that a QS understands how to value a variation, can pick holes in a subcontractor’s valuation, but, when it comes to contra charges, does the absolute bare minimum to make a deduction.

If you are committed to improving payment practices in the construction industry, then don’t be that QS with double standards. Set higher standards for yourself and be the QS that communicates deductions to the same standard that you would expect to be provided to you.

Next week, we will continue the focus of this valuation matters mini-series with a focus on damages claims.

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