Where a contractor has made a payment application under a JCT building contract and the architect/contract administrator has not issued an interim certificate (a payment notice), the employer’s failure to serve a valid pay less notice will result in the employer being obliged to pay the whole sum stated in the contractor’s payment application (which will be deemed a default payment notice). If the contractor’s application remains unpaid at the final date for payment the contractor will be entitled to suspend, adjudicate and/or recover this sum as a debt with interest.
Where the architect/contract administrator fails to issue an interim certificate the employer should immediately review the amount claimed in the contractor’s application as that is the amount that will be due unless a pay less notice is served. If the employer disagrees that the amount claimed in the contractor’s application is due, it must serve a pay less notice within the prescribed period; a notice served late will be invalid.
Once the deadline for service of a pay less notice in that payment cycle has been missed it is too late: the employer has lost the opportunity to withhold money from that payment. Even if the employer has evidence of discussions or correspondence with the contractor disputing the amount applied for this will not obviate the requirement to pay.
Serving a valid payless notice is not just a question of issuing it within the prescribed timeframe. The notice must also be in the correct form and contain the requisite details.
The employer must serve a pay less notice even if it believes nothing is due or if it intends to rely on set-off, counterclaim or abatement to reduce or extinguish the amount for which the contractor has applied.
In the absence of an interim certificate (payment notice) or a valid pay less notice, the employer will have no option but to make payment to the contractor of the amount in the contractor’s application and seek to remedy any overpayment by reducing subsequent payments, if that option is still available. This is a risky route to take as the contractor may dispute that there was any overpayment and the application may already relate to a final payment.
Once the employer has failed to issue a pay less notice it does not have much choice: if it withholds payment regardless, the contractor is entitled to suspend performance of any or all of its obligations under the contract and/or refer the dispute to adjudication. At adjudication the contractor is likely to be successful as the employer will struggle to raise a defence to failure to pay where a valid pay less notice has not been served. The employer is also likely to incur significant costs on account of legal and adjudicator’s fees. Furthermore, the courts have found that the contractor is entitled to pursue the unpaid sum as a debt as, in the absence of a pay less notice, the debt is not open to dispute. However, the courts have also found that in some circumstances at least the absence of a valid pay less notice cannot convert a sum that was not properly due into one which is properly due, although the employer is likely to have to adjudicate or litigate to have that issue determined.
Although it is several years since the statutory payment regime in construction contracts, set out in the Housing Grants, Construction and Regeneration Act 1996 was amended by the Local Democracy, Economic Development and Construction Act 2009 (“the Construction Act”), we are still seeing a number of cases where an employer (as the paying party) has not followed the contractual or statutory payment process correctly.
It is easy to get caught out by mistakenly serving pay less notices which are not within time or in the correct form or by failing to serve notice at all, especially for parties whose main business is not construction.
An employer entered into a building contract for fit-out works based on a standard form JCT building contract with amendments. The contract sum was in the region of £12 million. After practical completion, amid a background of disagreements between the parties as to the extent of unfinished and defective work, the contractor made a payment application for a sum in excess of £1 million. Crucially, the employer’s contract administrator failed to issue an interim certificate in accordance with the building contract so the contractor’s application became the default payment notice. The employer did not agree that the amount claimed was due but it failed to issue a pay less notice and proceeded to withhold payment, inadvertently breaching the contractual and statutory payment process.
The contractor commenced adjudication proceedings for non-payment. The employer could not rely on the fact that the amount in the payment application was generally disputed to justify non-payment, even though it had plenty of evidence that the issue was under discussion between the parties. Eventually a settlement was agreed but the employer’s negotiating position was weakened as it was involved in an adjudication it knew it could not win. Where, as in this case, the issue arises in the context of a final payment, the danger is even greater as there will be no second bite at the cherry, the employer will not have the opportunity to try to recover the overpayment in a subsequent payment cycle. The employer’s only option at that stage would be to attempt to adjudicate or litigate on the issue of whether the amount claimed was properly due.
Does the statutory payment regime apply to my contract?
The current statutory payment regime established by the Construction Act applies to all ‘construction contracts’ entered into on or after 1 October 2011. Agreements for undertaking construction works, design or surveying work or for providing advice on building, engineering, decoration or landscaping will be ‘construction contracts’ if they are for or relate to the carrying out of ‘construction operations’ as defined by the Construction Act. This will include almost all JCT building contracts and professional appointments entered into for the purposes of property development, other than contracts with a residential occupier.
Construction contracts that do not contain payment provisions which meet the minimum and mandatory requirements set out in the Construction Act will be subject to implied terms set out in the Scheme for Construction Contracts which forms part of the statutory regime.
It is crucial that employers protect themselves from the risks of having to overpay by ensuring that valid pay less notices are served on time and in accordance with the provisions of the relevant contract or the implied statutory provisions where applicable.
If you are an employer and you are concerned about pay less notices:
- Check the wording and requirements of your construction contracts and that they are compliant with the Construction Act. Ensure that all payment procedures required under the contracts are followed including the timely service of valid pay less notices.
- If the payment provisions in your construction contracts are insufficiently detailed or otherwise do not adequately cover the statutory requirements, refer to the implied statutory provisions in the Scheme for Construction Contracts.
- Do not allow disagreements and arguments with a contractor over an amount claimed to act as a distraction from, or substitute for, the requirement to serve a pay less notice.
- Consider using template pay less notices for each interim/payment application.
- Diarise reminders for the relevant time limits that apply to the payment procedure.
- If in doubt seek legal advice.