Payment Notices 20 Years On...

Some 20 years ago, Parliament sought to tackle the problem of poor payment practices in the construction industry by enacting the Housing Grants, Construction and Regeneration Act 1996 ("HGCRA"). Commonly referred to as the "Construction Act", the HGCRA was later amended by the Local Democracy, Economic Development and Construction Act 2009 ("LDEDCA") which came into force in 2011. The intention of the LDEDCA was to strengthen and improve the HGCRA provisions relating to payment processes and hence once again address the issue of cash flow. Further references in this article to the "Act" refer to the HGCRA as amended by the LDEDCA.

Recap of the Payment Requirements in the Act

All "construction contracts" (as defined by the Act) must include:

  • An adequate mechanism for determining what payments become due under the contract, and when.
  • A final date for payment in relation to any sum which becomes due.
  • Provisions for the giving of a payment notice not later than five days after the payment becomes due, which notice must specify the amount considered to be due and the basis on which it is calculated. This is known as the "notified sum".

A payment notice must be given even if the notified sum is nil. Subject to any "pay less notice" (discussed below) the payer pays the notified sum to the payee by the final date for payment. The contract should stipulate who gives the payment notice (usually this is the employer or a specified person, e.g. employer's agent).

If the relevant party fails to give the payment notice within the times specified in the contract, then the other party may give a payment notice in default. In such circumstances, the payment notice in default is deemed to be the payment notice and determines the notified sum. The final date for payment is then deferred to account for the delay to the determination of the notified sum.

If the party is permitted by the contract to issue a notice (that would fulfil the requirements of a payment notice) such as an application for payment, and does so, then in the absence of a payment notice this will be deemed to be the payment notice in default and no further payment notice will be required.

The notified sum is subject always to the payer's entitlement to give a pay less notice (which must fulfil the same requirements as a payment notice) within the timescale required under the contract. If a valid pay less notice is given, this determines the notified sum and supersedes any payment notice or payment notice in default.

For an employer, therefore, there are generally two chances to get things right in the payment notice or, if not, in the pay less notice. The employer has no third chance because if no pay less notice is given, the notified sum must be paid.

Some Recent Cases on Payment Notices

Henia Investments Inc v Beck Interiors Ltd [2015] EWHC 2433 (TCC)

The court highlighted the importance of knowing whether a document filed by the contractor, in this case an interim application for payment, fulfilled the requirements for a payment notice in default in order to determine the notified sum. The court held that in order for an application for payment to stand as a payment notice it must be "in substance, form and intent an interim application stating the sum considered by the Contractor as due at the relevant due date and it must be free from ambiguity" (emphasis added). The application served by the contractor in this case was not clear as to which month it related to. The court therefore held that it could not be said to be free from substantial ambiguity and therefore the application did not stand as a payment notice.

Jawaby Property Investment Ltd v The Interiors Group [2016] EWHC 557 (TCC)

These proceedings concerned an interim valuation which was issued by the contractor as an "initial assessment" of the amount he considered due at 2.3 million. The parties subsequently visited the site with Ashley Property Services Limited (Jawaby Property Investment Ltd's agent) who issued a negative payment certificate based on a total valuation of 1.6 million. Clearly there was a difference of opinion and, being dissatisfied with the payment certificate, the contractor gave notice of its intention to suspend performance under the contract. In this case, the court held that the contractor's "initial assessment" was neither a valid application nor a payment notice in default as it "did not follow the usual pattern and was materially different to that adopted on previous occasions". Critically, the application described itself as an "initial assessment" and furthermore failed to value the works up to the contractual due date (as required for a payment notice).

ISG Construction Limited v Seevic College [2014] EWHC 4007 (TCC)

ISG, the contractor, submitted an interim application and Seevic, the employer, failed to serve either a payment notice or pay less notice but nevertheless did not pay ISG. ISG commenced an adjudication to confirm that the sum claimed in the interim application was payable. Seevic commenced a second adjudication for the correct valuation of the works under the interim application. The first adjudicator found that the interim application constituted a valid payment notice and awarded ISG the amount claimed in the interim application plus interest. The second adjudicator however valued the works at a lower sum than that claimed in ISG's application.

Unsurprisingly, Seevic paid ISG the lower amount decided by the second adjudicator. Equally unsurprisingly, ISG commenced proceedings for enforcement of the first adjudicator's decision. The court held that the first adjudicator was correct in determining that the sum stated in the application for payment was the sum payable by Seevic.

The judgment stated:

"The statutory regime would be completely undermined if an employer, having failed to issue the necessary payment or pay less notice, could refer to adjudication the question of the value of the contractor's work at the time of the interim application (or some later date), and then seek a decision requiring either a payment to the contractor or a repayment by the contractor based on the difference between the value of the work as determined by the adjudicator and the sums already paid under the contract."

Galliford Try Building Limited v Estura Limited [2015] EWHC 412 (TCC)

In this case, the court further clarified the rationale of the decision in ISG v Seevic. In particular, the court made clear that when the application for payment does not relate to the final payment any dispute as to value can be corrected in a subsequent interim application, stating:

"...the employer cannot bring a second adjudication to determine the value of the work at the valuation date of the interim application in question. But it does not mean any more. There is nothing to prevent the employer challenging the value of the work on the next application, even if he is contending for a figure that is lower than the (unchallenged) amount stated in the previous application. If this was not made clear by my judgment [i.e. in ISG v Seevic], then it should have been."

In other words, once the notified sum for an interim payment has been determined by a valid payment notice or payment notice in default benefiting the contractor, and the employer fails to challenge this by way of a pay less notice, the employer is not entitled to seek to re-open the valuation of the amount for payment by way of adjudication the employer has "had his chance". All may not be lost for the employer however, as they might be able to rectify the situation by challenging the amount in the next interim application, provided (critically) that the contract permits negative interim valuations in order for money to flow back to the employer (which is not always the case and was not the case for the contractor here).

Matthew Harding (t/a M J Harding Contractors) v Gary George Leslie Paice and Kim Springall [2015] EWCA Civ 1231

These proceedings followed an adjudicator's decision to award the contractor, Harding, the sum specified in its interim valuation because the employer had failed to serve a valid payment notice or pay less notice. The Court of Appeal upheld the decision of the first instance judge, holding that the employer was entitled to have the final account revalued and challenge the contractor's account by litigation or adjudication and "the failure to serve a compliant pay less notice could not deprive [the employer] for ever of the right to challenge the contractor's account."

On the face of it, this case seems inconsistent with the decision in ISG Construction Limited. However, this case related to the sum due under the final account rather than an interim payment notice. The key distinction recognised by the court is that, unless contractual provisions prevent it, any actual or perceived over-valuation in an interim valuation can be rectified in a subsequent valuation, if the contract allows for negative valuations (as this one did). There is no such possibility for correction via the final account however.

Manor Asset Ltd v Demolition Services Limited [2016] EWHC 222 (TCC)

In this case the contractual payment provisions required the contractor to raise an invoice after achieving a relevant milestone, with payment to be made 72 hours after that invoice. The parties did not amend the terms relating to service of a pay less notice, which was to be served five days before the final date for payment. However, it would be impossible for the employer to serve a pay less notice five days before the final date for payment when the invoice was payable within three days. The court found (despite this not being suggested by either party) that there was an implied term amending the prescribed period for submitting the pay less notice so that the employer could issue a pay less notice right up to the final date for payment.

Summary of the Court's Current Views

The court provided a useful summary on the issue of payment notices in the judgment in Jawaby Property Investment Ltd v The Interiors Group, highlighting the following key points:

  • If the interim payment provisions of the contract comply with the Act then the effect is to require the employer to pay the notified sum at the prescribed intervals "irrespective of whether or not that sum in fact represents a correct valuation of the works to date."
  • If an employer, for whatever reason, fails to give the relevant payment notice, then if the contractor is permitted or required to give notice of the amount it considers due and the basis upon which it is calculated and does so, e.g. by an interim application, this will be deemed to be the payment notice in default and will determine the sum payable under the contract. However, as noted in Caledonian Modula v Mar City Developments [2015] BLR 694 "... if contractors want the benefit of these provisions, they are obliged, in return, to set out their interim payment claims with proper clarity. If the employer is to be put at risk that a failure to serve a payless notice at the appropriate time during the payment period will render him liable in full for the amount claimed, he must be given reasonable notice that the payment period has been triggered in the first place."

Points to Note

Contractors should therefore:

  • Ensure that their interim applications (and payment notices in default) are clear in order to stand a chance of being valid (i.e. they must meet the form, substance and intent requirements for payment notices under the Act).
  • Think twice about labelling an interim application or payment notice in default as an "initial assessment" or similar, or departing from the usual operation of the contract, as this increases the scope for potential challenge to the validity of the application or payment notice.
  • Take care if exercising rights to suspend or terminate for non-payment if that action is based on a payment notice in default because if it is invalid, the suspension or termination may fail, leading to a risk of delay damages and/or damages for rescission.

Employers should therefore:

  • Consider amending the interim valuation provisions in contracts to allow for negative valuations. This offers protection in case a contractor's payment notice in default determines the sum due by giving an opportunity to claw back any resulting over-payment in subsequent valuations.
  • Consider amending any payment regime that calls for payment notices within so many days from a contractor's application to specified days each month. This is more certain than having to be ready for a contractor's application at any time.

All parties should therefore:

  • Ensure that payment notices and payment notices in default value all work carried out up to the due date, otherwise there is a risk that they are invalid.
  • Be aware that if the mechanisms of the contract are departed from, there may be a deemed waiver of those contractual requirements. In the case of Leeds City Council v Waco UK Limited [2015] EWHC 1400 (TCC), there was an irregularity in that the contractor made monthly applications up to three or four business days after the contractual date. The employer had paid out on 10 such irregular applications over a period of 11 months or so. The court held that by this conduct the employer had waived the contractual requirements and the rejection by the employer of such an irregular application several months later would not be permissible because it was inconsistent with the course of conduct which had by then been established.
  • When negotiating and before entering into the contract, consider carefully how the payment mechanisms are meant to operate to ensure that they will actually work in terms of timing. We suggest plotting out a timeline showing when applications, payment notices, final dates for payment and pay less notices are proposed to fall due. Should a mechanism simply not work, the court has shown a readiness to imply terms in order make the payment regime work within the requirements of the Act. However it is always better to have certainty that the contract is correct.
  • Properly diarise deadlines for applications, payment notices, pay less notices and final dates for payment.

Conclusions

20 years after having become part and parcel of construction contracts in England and Wales, it is surprising how often parties can be tripped up by the requirements for payment notices, or enter into contracts with payment procedures which either do not work or are non-compliant with the Act. It is perhaps partly a fault of the legislation, which in its original form was not clearly drafted, and in its amended form is only marginally better. This does not make the provisions easy to understand to the lay party. However the key reason for such problems probably remains a lack of awareness. Not every party to a construction contract is familiar with the requirements of the legislation because construction is not the essence of their business, it is often simply a service which they require. This demonstrates the importance of taking the right advice at the right time. There is at least some comfort that the courts have, in dealing with cases involving payment issues arising under the Act, shown a readiness to be proactive and to seek to make faulty contracts work. Even though it has now been 20 years since the Act first came into force, we suggest the flow of payment related disputes, where the process itself is a key element of the problem, are unlikely to go away.