Payment provisions in construction contracts
When the amendments to the Housing Grants (Construction and Regeneration) Act 1996 (“the Construction Act”) were introduced by Part 8 of the Local Democracy, Economic Development and Construction Act 2009 (“the New Act”) it was not entirely clear how the changes in the payment provisions section would impact on the behaviour of parties to construction contracts. In the year since our last Annual Review the first wave of case law relating to these amended provisions has been reported. The message appears relatively clear; employers, get the payless notice process wrong at your peril. However, as is so often the case when new law develops, even relatively clear legal principles often give rise to spin off issues, and questions.
Jonathan More provides a practical guide through the relevant cases.
The statutory requirements
First, a brief reminder of the relevant statutory provisions.
In its original form the Construction Act set out that the payer had to give notice specifying the amount of the payment made or proposed to be made, and the basis upon which the amount is calculated. There was no obvious consequence for failing to comply with this requirement, indeed, as it was only the employer who could issue such notices it seemed to duplicate the certification process common in most construction contracts, and was often simply ignored.
The New Act amendments require construction contracts to provide that a payment notice is issued for every payment provided for by the contract. The sum contained in a payment notice is “the notified sum”. The person whom issues the notice is dictated by the contract, and can be either the payer, a “specified person” as dictated by the contract (i.e. the Architect or Contract Administrator) or by the payee itself. The notice must specify:
(i) the sum that the person giving the notice considers to be due or to have been due at the payment due date in respect of the payment; and
(ii) the basis on which that sum is calculated.
Note the basis of the figure in the notice is what is considered to be due.
There is now a consequence for failure to issue a payment notice as required; the payee may issue a “default” payment notice stating the amount considered to be due and the basis for calculation. This amount is contained in the payment notice, or the “default” payment notice, is the notified sum.
These changes are important because the New Act requires that the payer is under an absolute obligation to pay the notified sum subject to whether or not a payless notice is issued. There is no language requiring this sum to be “proper value”, the sum simply has to be “notified”.
Previously there was a mechanism for a payer to avoid paying a sum due if there were grounds to do so by issuing a notice of intention to withhold payment.
The New Act amendments mirror this very closely, the key change being the obligation on the payer to pay the “notified sum” if no payless notice is issued.
A payless notice must state the sum considered to be due on the date the notice is served and the basis on which that sum is calculated, and must be issued within the requisite time requirements in the contract.
The key legal principles from case law
As a result of the recent case law, reviewed in more detail below, the following principles will be applied to payment provisions in construction contracts:
(i) In respect of interim payment applications, and absent fraud, where no valid payless notice has been issued, the contractor will be entitled to the amount applied for irrespective of the true value
of the work carried out.
(ii) An application for payment following termination of a contract, is distinguished from the above principle either:
- on the basis that the contract provides for a proper valuation of work post-termination and not simply a notified sum, or
- that, as a consequence of the contract termination, the next application for payment will be the final one, with no further interim applications or payments due.
(iii) To qualify as a valid payment notice, an application for payment should:
- be clearly stated as being a formal application for payment and put the payer on proper notice, and
- comply with the contractual requirements and timetable for making an application for payment.
(iv) Even in cases where a valid payless notice has not been issued there may be sufficient unusual circumstances which may restrict enforcement of an adjudication decision.
ISG Construction Ltd v Seevic College1
The case which provides us with the first key principle is ISG v Seevic.
This application for summary judgement by ISG revolved around two adjudications. The first (“Adjudication 1”) decided that Seevic required to pay the full amount of ISG’s Application No. 13 for an interim certificate. Seevic had served neither a payment notice nor a payless notice. This sum in question was circa £1m. The second (“Adjudication 2”), before the same adjudicator, decided that the proper value of ISG’s works as at the date of Application No. 13 was significantly lower, at £300,000.
Seevic did not comply with the decision in Adjudication 1, and simply paid the balance deemed due as the value of the works i.e. £300,000.
The application made by ISG was for (i) enforcement of the decision in Adjudication 1, and (ii) a declaration that the decision in Adjudication 2 was invalid for want of jurisdiction, as this dispute was the same or substantially the same as that decided upon in Adjudication 1.
In considering the issues Mr Justice Edwards-Stuart ruled that
“Absent fraud, in the absence of a payment or payless notice issued in time by the employer, the contractor becomes entitled to the amount stated in the interim application irrespective of the true value of the work actually carried out. The employer can defend itself by serving the notices provided for by the contractual provisions.”
In addition he found that any attempt to avoid the absence of a proper notice by going back over old ground and revisiting the amount in the relevant valuation in another adjudication was not permitted. The dispute relating to Application No. 13 had been dealt with in Adjudication 1.
In short the failure by the employer to serve a payless notice in time must be taken to be the employer agreeing the value stated in the application, right or wrong. Therefore, ISG was entitled to both enforcement of Adjudication 1, and also a declaration that Adjudication 2 was invalid for want of jurisdiction as it decided a question that, as between the parties, must be taken to have been decided by him in Adjudication 1.
Matthew Harding (t/a M J Harding Contractors) v Paice & Anr2
This general principle was distinguished in the case of Harding v Paice, heard again by the same judge (albeit that this case was heard before ISG v Seevic).
Paice were property developers who engaged Harding to carry out residential works to two properties in Surrey under the terms of a JCT Intermediate Building Contract 2011.
For various reasons Harding gave notice to terminate the contract part way through the works. The termination provisions provided that Harding was required to submit a final account in respect of the work it had carried out, including the total value of the work properly executed up to the date of termination. Paice was to pay the amount that was “properly due” in respect of the account within 28 days of submission of its final account.
Paice did not make payment, and failed to serve a valid payless notice. Harding adjudicated, in response to which Paice issued counter-adjudication proceedings in an attempt to revalue Harding’s final account.
Harding then applied for an injunction to prevent the counter-adjudication from proceeding, arguing that the failure by Paice to serve a valid payless notice meant that the sum in its final account became the amount that was “properly due” under the contract. Harding further argued that the substance of its account had been already referred to adjudication and it could therefore not be revisited.
Mr Justice Edwards-Stuart noted that in the relevant contract the payment provisions following termination were different from the interim payment machinery in the contract, in that they did not require the employer to pay the amount stated (i.e. the notified sum). Instead, the employer was to pay the amount “properly due” in respect of the account, in order to reflect the reckoning process that is inherent in final accounts.
The judge further noted that the adjudicator had concluded that in the absence of a valid payless notice Paice had to pay the amount stated in Harding’s account.
Mr Justice Edwards-Stuart disagreed with the adjudicator’s approach. Such a conclusion, he said, would deprive the employer forever of the right to challenge the contractor’s account, and in some cases (for example, if the contractor had considerably overvalued its account), the contractor would be permitted to receive a windfall to which he would otherwise not be entitled, and which the employer could never recover.
In terms of the jurisdiction argument it was held that the adjudicator had not determined the amount “properly due” to Harding. He had decided that the absence of a valid payless notice automatically meant that the sum claimed in the final account was due and had to be paid, which was a different matter.
Galliford Try Building Ltd v Estura Ltd3
Mr Justice Edwards-Stuart was being kept busy by such matters and a couple of months after these first two cases, another adjudication enforcement action – Galliford v Estura relating to the lack of a payless notice – called before him.
Very late in the construction programme Galliford issued its Interim Application for payment No. 60 (“IA60”). It was for a sizeable amount and included an anticipated Final Account. The value of the work in IA60 was only £4,000 short of the amount anticipated in the Final Account, which was just short of £4m. Estura served neither a payment notice nor a payless notice. Estura didn’t pay, Galliford commenced adjudication proceedings, and the adjudicator awarded the full amount of the notice to Galliford.
What to dispute? In this case the dispute was less about payless and more about the enforcement process itself. Estura accepted Galliford was technically entitled to the sum stated in the application.
It submitted, however, that there were exceptional circumstances in this case which meant that it should not have to submit to summary judgement in respect of the sums awarded by the adjudicator, as Estura:
(i) would not get an opportunity, by way of adjudication, to challenge a palpably wrong interim application as IA60 essentially covered Galliford’s valuation of the job and there was no incentive for them to do any further work (either with regard to contractual process or in respect of physical works), and
(ii) could not afford to pay the amount of the award and enforcement would lead to insolvency which would deprive it of its right to pursue correction of the decision.
Mr Justice Edwards-Stuart appeared to be quite vexed about the circumstances of this case. He agreed with both the above arguments raised by Estura that there were unusual circumstances in this case and that it would be unable to pay the adjudicator’s award in full if ordered to do so.
The court had two options. First, to take a robust approach and refuse to grant a stay on the grounds that to do otherwise would be contrary to the policy of the court to enforce the decisions of adjudicators. Galliford could then either force insolvency or negotiate some sort of compromise. Or second, to stay enforcement of all or part of the amount of the judgement.
The decision in the end was that due to “the very unusual circumstances of this case” it would not be fair on Estura to refuse a stay. However, only a partial stay was granted with enforcement of £1.5m allowed. Such action by the court, it was stated, would be appropriate only in rare cases.
Caledonian Modular Ltd v Mar City Developments Ltd4
In Caledonian v Mar City some important housekeeping was done in respect of how to determine whether a valid application for payment has been made by a contractor.
Caledonian engaged Mar City to carry out construction works at Colindale in North London.
Caledonian issued an application no. 15 seeking a net payment £1.5m. Mar City issued a valid payless notice indicating a net payment of £6,317.07. Two weeks later, under cover of three e-mails, Caledonian issued some documents to Mar City (“the Emailed Submission”) including a further copy of application no. 15 prefixed with the words “Final Account”. In this the net payment claim increased by around £6,000. Caledonian did not substantially respond to Mar City’s subsequent requests for clarification other than to describe the submission as an “update”. Mar City took no action in respect of the Emailed Submission.
An application for payment, referenced as no. 16, was issued by Caledonian four weeks later, in response to which Mar City issued a valid payless notice.
Caledonian subsequently claimed that the Emailed Submission had in fact been application for payment no. 16 and that in the absence of a payless notice they were entitled to the sum claimed. The dispute was referred to adjudication. The adjudicator agreed with Caledonian.
In the following enforcement proceedings Mar City contended that the Emailed Submission was not a valid application for payment.
The two main issues to be decided were as follows:
(i) Did Caledonian’s Emailed Submission amount to an application for interim payment?
(ii) In an enforcement application could the court decide a substantive issue that was before the adjudicator i.e. the status of the submission, or was the court restricted simply to either enforcing or not enforcing the second adjudication decision?
On the first issue, the Judge found that the Emailed Submission was not an application for payment or a valid payee’s notice:
(i) none of the emails or the documents sent stated that this was an application for interim payment;
(ii) subsequent correspondence did not indicate that it had been an application for payment; and,
(iii) at the time Mar City repeatedly asked Caledonian what the documents were. In response Caledonian did not state that the documents were an application for payment.
The Judge disagreed that a contractor can “update” an application by a few thousand pounds when the overwhelming bulk of that application had already been the subject of a valid payless notice. He observed that this could lead to contractors regularly applying every few days with “updated” applications in the hope of gaining windfall through the employer slipping up by failing to serve a payless notice. It had to be clear, and the employer had to be on notice, that documents intended to be an application for payment were properly identifiable as such.
On the second issue, the Judge stated that at the enforcement stage the court could deal directly with an issue decided by the adjudicator, if as here, the issue was short, self-contained, and required no oral evidence or any other elaboration beyond what was capable of being provided during a short interlocutory hearing. Therefore the second issue could be decided by way of a declaration by the court.
Henia Investments Inc v Beck Interiors Ltd5
Finally, Henia v Beck, before Mr Justice Akenhead, in Part 8 proceedings for declaratory relief, gave further consideration to the issue of the timing of not only a payless notice but also applications for payment and the interim certificate.
Henia engaged Beck to carry out extensive fit out works to a property in Kensington using the JCT Standard Building Contract without Quantities 2011 (“the Contract”). The contract provided that the interim payment due date was the 29th of each month with interim applications to be made no later than 7 days before the due date. The contract Administrator (“CA”) was required to issue an Interim Certificate no later than 5 days after the due date. The final date for payment was 28 days after the due date and any payless notices were to be issued no later than 3 days before the final date.
On 28 April 2015 i.e. 6 days late, Beck submitted a document described as “Interim Application for Payment No 18”. The CA issued Interim Certificate No 18, one day late, on 6 May 2015.
Beck did not submit an interim application during May 2015 but at 00.03 am 4 June 2015 – i.e. one day late – the CA issued Interim Certificate No 19 certifying a payment to Beck of £18,893.53. On 17 June 2015, Henia issued a payless notice stating that Beck’s entitlement was nil.
Beck contended that the document submitted on 28 April 2015 comprised a valid interim application relating to the 29 May 2015 due date and that because the CA’s Interim Certificate was late, this meant that the amount claimed on 28 April was now due. Beck further argued that the payless notice issued by Henia on 17 June was invalid on grounds that in such a notice Henia could only apply cross-claims like liquidated damages and not otherwise challenge the CA’s valuation.
The Judge found that in order for there to be no question as to the validity of an interim application for payment, it needs to be clear and unambiguous. Beck’s 28 April 2015 document could not therefore be treated as a valid Interim Application in relation to the 29 May 2015 due date where: (i) there was a relevant due date on 29 April 2015, which would have been the 18th relevant due date under the contract; (ii) there was nothing in the 28 April document that suggested a due date of 29 May 2015; (iii) there was no indication in the 28 April document to suggest that the 29 April due date had been missed and that the document was intended to relate to the 29 May due date; and, (iv) the 28 April document was not in substance, form and intent an Interim Application relating to the 29 May 2015 due date.
Whilst acknowledging that it was now a superfluous issue, the judge decided that if the 28 April document did not relate to the 29 May 2015 due date there was nothing in the contract to prohibit the employer from challenging a valuation certified by the CA.
Finally it was found that any failure by the CA to operate the extension of time provisions would not give rise to a condition precedent debarring Henia from claiming liquidated damages. Any potential short term unfairness to Beck could be resolved through the relevant contractual dispute resolution mechanisms. The Judge stressed that this finding was obiter where prior to judgment being handed down, in adjudication proceedings commenced by Beck, the Adjudicator had decided that no valid application for an extension of time had been submitted.
Other than the focus on payment provisions themselves, a theme that was prevalent in these cases was that the intent of the Construction Act, and the regime it has put in place, should be preserved as much as is possible and practicable. The assumption might be that this philosophy will always favour the contractor, focused as it is on maintaining cashflow. Whilst this is crucial, what the cases of Galliford v Estura and Caledonian v Mar in particular show is that the situation is not one sided, and protection of employer/client interests, is just as important a consideration.
The cases this year leave some questions still on the table, however, there is a good solid framework against which employers and contractors alike can manage their risks around the payment provisions of their contracts.
Download our latest Annual Review
Subscribe to our newsletters
We regularly produce newsletters, articles and papers to keep our clients and other stakeholders up to date with the latest developments and debates in construction and energy law. You can browse some of our most recent materials Here, or sign up to our monthly publications below to receive them directly to your inbox.