The recent case of ISG Construction Ltd v Seevic College [2014] provides helpful guidance in relation to disputes involving non-payment which are referred to adjudication on 'technicalities'. The case is also the first time the 'new' payment scheme (introduced to the Housing Grants, Construction & Regeneration Act 1996 (the "Construction Act") by the Local Democracy, Economic Development and Construction Act 2009 (the "LDEDC Act")) has been scrutinised by the courts. Most importantly, the case emphasises how important it is for employers to issue interim payment and pay less notices and the serious consequences of failing to do so.

Payment Provisions - The Construction Act

The Construction Act requires the employer to issue to the contractor interim payment notices, setting out the amount which the employer considers due at each due date for payment. Subject to the issuing of a valid pay less notice, the employer must then pay to the contractor the amount set out in the interim payment notice by the final date for payment.

In the event that the employer fails to issue a payment notice (but the contractor issues a valid application for payment), the LDEDC applies and the full amount set out in the contractor's validly issued interim application for payment becomes due. In such circumstances, unless a valid pay less notice is issued, the employer must pay the amount set out in the contractor's application for payment by the final date for payment.

As a result of the new rules introduced by the LDEDC Act, contractors have increasingly been able to refer payment disputes to adjudication where they have validly issued an interim application for payment, but no valid payment and/or pay less notice has been issued by the employer. In such circumstances, the employer essentially has no defence in the adjudication and is required to pay the amount set out in the contractor's application for payment, even if the works have been over-valued.

Previously, the employer's 'get out of jail' response to such an adjudication would often be to commence a second 'counter-adjudication' prior to the conclusion of the first adjudication. The 'counter-adjudication' would ask the adjudicator to properly value the contractor's interim application for payment. Therefore, before the contractor had the opportunity to enforce any adjudicator's decision in its favour in the first adjudication, the employer would have an adjudicator's decision properly valuing the works. Although both parties would have incurred the costs involved in two adjudications, usually, by using these tactics, the employer would not have to pay to the contractor any more than the actual value of the works. However, the decision in ISG Construction Ltd v Seevic College (2014) has significantly changed the position for employers.

Background - Case Facts

Seevic College ("Seevic") engaged ISG Construction Limited ("ISG") to carry out construction works under a JCT Design and Build Contract, 2011 (the "Contract"). The Contract required ISG to submit monthly applications for payment and also required Seevic to serve payment notices, by not later than 5 days after each due date. Pursuant to the Contract, if Seevic failed to serve a payment notice, the amount set out in ISG's application for payment would become due. If Seevic wanted to pay less than the amount set out in its payment notice (or ISG's application for payment, if applicable), then Seevic was required to issue a pay less notice by no later than 5 days before the final date for payment.

In accordance with the Contract, ISG submitted its application for payment no. 13 ("Application No. 13") for £1,097,696.29. Seevic failed to issue a payment notice and/or a pay less notice and then failed to pay the sum set out in Application No. 13 to ISG. ISG referred the dispute over Application No. 13 to adjudication ("Adjudication No. 1") arguing that in the absence of a payment notice and/or pay less notice, Seevic was obliged to pay ISG the full amount set out in Application No. 13. 
In anticipation of an adjudication decision in ISG's favour, four days before the adjudicator's decision was due, Seevic commenced a counter-adjudication against ISG ("Adjudication No. 2"), asking the adjudicator to determine the true value of Application No. 13. In Adjudication No. 2 the adjudicator decided that the amount due to ISG was £315,450.47 (i.e. significantly less than £1,097,696.29).

Judgment

ISG applied for summary judgment to enforce the decision in Adjudication No. 1 and for a declaration that the decision under Adjudication No. 2 was invalid.

ISG argued that the contract's payment notice regime meant that the value of Application No. 13 was decided in Adjudication No. 1; however, Seevic argued that the value of the works was excluded from Adjudication No. 1 because the first adjudicator had expressly said that he had not decided whether that sum was the “correct value of [the] work”.

The judge referred to the judgment in Watkin Jones & Son Ltd v Lidl UK GmbH [2001]. In that case, Watkin Jones contracted with Lidl for the construction of a new retail store pursuant to a contract based on the JCT Standard Form Building Contract for Contractor's Design, 1998 edition. The contract in question stipulated that, in the event that the employer failed to issue the relevant notices, the amount applied for must be paid. In that case, the court decided that the employer could not refer the issue of the proper valuation of the amount claimed to a second adjudication because he was not entitled to "go back over such ground". In agreeing with Watkin Jones & Son, the court in the present case concluded that if an employer fails to serve any notices in time, this can only be construed as agreeing the value stated in the contractor’s application.

Accordingly, the adjudicator in Adjudication No. 1 had decided the value of the work ISG had carried out, and the adjudicator in Adjudication No. 2 did not have jurisdiction to re-visit that issue.

The judge also noted that the LDEDC Act would be "completely undermined" if an employer, having failed to issue a payment or pay less notice against an interim application, could then refer to adjudication the value of that interim application. In such circumstances the adjudicator's decision would, effectively, "trump" the contractor's interim application. Given there is no free-standing entitlement to payment other than through the contractual payment mechanism, the "contractor's only entitlement to payment during the course of the project is by way of an interim application". Accordingly, ISG was not entitled to be paid the value of the work at "any arbitrary date during the course of the contract" because the entitlement to payment only arises either through the mechanism for interim payments or the final account. Aside from cases involving fraud, "in the absence of a payment or pay less 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."

Conclusions to be drawn

ISG v Seevic acts as a stark warning of the 'pay now, argue later' ethos which underpins the Construction Act and the LDEDC Act.

In this case, Seevic's failure to issue a payment or pay less notice meant that it was bound to pay ISG almost £1.1m, as opposed to a sum closer to £300,000. Seevic also had to pay for ISG's costs of the application for summary judgment. 
Particularly as employers are no longer entitled to commence 'counter-adjudications' in response to 'technicality' adjudications, employers must issue payment and pay less notices if they do not want to be bound by the contractor's application for payment. Failure to do so may also expose the employer's contract advisors to a claim in negligence.