Akin Akinbode of Dentons discusses key cases that provide lessons in respect of the payment process. Smash and grab approaches will not always work, they warn.
- Employers must be vigilant and serve pay less notices where appropriate and on time, otherwise payment applications could become due in full
- A court will not automatically enforce a ‘smash and grab’ adjudication decision if there is a risk of manifest injustice to the employer
- Where the ‘smash and grab’ claim relates to a final account, it appears an employer can refer the valuation of the application to a further adjudication
- Parties should be wary about agreeing a payment schedule without also agreeing a payment process in the event of delays
- Payment applications under hybrid contracts require special attention and must fall only within the ambit of ‘construction operations’
The 2011 changes to the Housing Grants, Construction and Regeneration Act 1996 (the HGCRA) gave contractors an automatic right to payment where the employer fails to issue a valid payment notice. Effectively, employers who do not serve a pay less notice are taken to be agreeing to the value stated in the application, right or wrong. Many contractors have used the lack of a pay less notice as a technical argument to recover outstanding sums through adjudication (the ‘smash and grab’ claim), regardless of the true value due. In response, employers started to issue separate adjudication proceedings to challenge the contractor’s valuation, but, as we will show below, the courts have clamped down on this process.
The current position: interim applications
When a dispute regarding an interim payment application is adjudicated, an adjudicator must be taken to have decided the question of the value of the work for the purposes of that application. As such, an employer is prohibited from bringing a second adjudication to determine the value of the work as at the valuation date of the interim application in question. In ISG Construction Ltd v Seevic College  EWHC 4007 (TCC) (ISG), the employer, after failing to serve a pay less notice, had taken the valuation to a second adjudication and obtained a valuation less than the payment application. In subsequent enforcement proceedings, however, the Technology and Construction Court (TCC) found that an employer’s ability to refer a valuation to adjudication after failing to serve a pay less notice would undermine the statutory payment regime.
An alternative route open to an employer in this situation is to dispute the value of the sum in the next payment application, or commence court/arbitration proceedings to determine the final account.
Payment applications: strict compliance
To succeed in a 'mash and grab'adjudication, contractors must make absolutely sure that their payment applications are in order, a point confirmed in Caledonian Modular Ltd v Mar City Developments Ltd  EWHC 1855 (TCC). The TCC stated that contractors must be prepared for the courts’ strict interpretation of the payment provisions contained in the HGCRA 1996.
In this case, there were no express payment and adjudication provisions, therefore the Scheme for Construction Contracts (England and Wales) Regulations 1998, SI 1998/649 (the Scheme) was implied into the parties’ agreement. The first 15 payment applications during the project consistently followed a 28-day payment cycle. Then, in February 2015, the contractor sent an email to the employer attaching various documents that purportedly related to payment. One of the documents was titled ‘Final Account Application Summary’. In March 2015, the contractor sent an invoice in respect of the works that included a copy of the ‘Final Account Application Summary’ (which was claimed to have been provided in February 2015). A week later the employer issued a pay less notice in response. The contractor started adjudication proceedings on the basis that the document provided in February 2015 served as a 16th payment application and that the documents issued in March 2015 were served as a default notice.
The TCC held that the February 2015 documents did not constitute a valid payment application as the documents did not clearly state that they were a new payment application. The TCC inferred that the contractor did not, at the time of issuing the documents, consider them to be a payment application. The documents were issued too early in the payment cycle (just a fortnight after the 15th application). In any event, had it been an early payment application, the contractor should have at the very least drawn it to the employer’s attention. Two months later, Henia Investments Inc v Beck Interiors Ltd  EWHC 2433 (TCC) reaffirmed that a payment notice must be compliant with the contractual mechanism and sufficiently clear as to its form and intent.
Risk of manifest injustice
Galliford Try Building Ltd v Estura Ltd  EWHC 412 (TCC) was the first case in 2015 to throw a lifeline to employers that fail to issue the requisite payment notices under the HGCRA 1996 – albeit in limited circumstances. The contractor commenced enforcement proceedings in respect of an adjudicator’s decision that required the employer to make payment following a successful ‘smash and grab’ adjudication. Despite finding that the employer had no valid defence to the contra application, the TCC enforced part of the adjudicator’s decision on the basis of the ‘unusual’ and ‘exceptional’ circumstances, which included the employer’s financial situation.
The employer acknowledged its liability to pay, however it resisted on the basis that the contractor’s payment application was grossly overvalued. As a result, the contractor was afforded the full amount sought in respect of the works, thereby giving the contractor little incentive to submit a final account or indeed complete the works. Additionally, the employer claimed that it was not in a position to pay the sum and that, if it did, it would not be in a financial position to pursue its right to the money through litigation. The TCC was sympathetic to this argument, concluding that, despite the absence of a pay less notice, automatic enforcement should not ensue without considering the fairness of the circumstances. The TCC stated that a stay of enforcement should only be granted where there is a ‘risk of manifest injustice’. In giving the partial enforcement order, the judge stressed that a defendant claiming financial hardship must robustly demonstrate that it is not merely difficult to pay, but impossible.
No pay less notice relating to a final account
Cases like ISG confirm that employers cannot run a ‘follow-up’ adjudication to value an interim application in circumstances where a valid pay less notice is not served. However, Harding (t/a M J Harding Contractors) v Paice  EWCA Civ 1231 (Harding) suggests that this may not apply equally to cases involving final accounts.
In Harding, the employer failed to serve a valid pay less notice in connection with a final account and was held liable to pay the full amount. The employer promptly commenced a further adjudication to determine the true value of the final account. Issues arose as to whether this issue of valuation was the ‘same or substantially the same’ as the dispute decided on by a previous adjudicator relating to ‘the amount properly due in respect of the account’. The Court of Appeal found that the previous adjudicator had only considered the contractual issue at hand and not the contractor’s valuation of the disputed sum. The adjudicator therefore did, in fact, have jurisdiction to review the valuation.
This distinction between how interim and final applications are dealt with appears to be based on the judiciary’s consistent concern to ensure that there is an avenue to review an entitlement to sums owed. Both Harding and Aspect Contracts (Asbestos) Ltd v Higgins Construction Plc  UKSC 38 (Aspect) confirm this approach. In the case of a final account (as in Harding), where an adjudicator does not consider the value of the final account, an employer will have no further recourse to challenging the final account if it is prohibited from doing so by the court. This is to be contrasted with a situation involving an interim payment application, whereby an employer would be permitted to challenge the value in the following application. Of course, as Aspect confirms, had the adjudicator assessed the value of the final account in Harding, then it would still have been open to the employer to appeal any alleged overpayment by way of litigation.
How long have you got to seek a final determination of a valuation at court?
In Aspect, the Supreme Court upheld a Court of Appeal decision stating that an implied term exists under the Scheme that a party has a right to have a dispute arising out of an adjudication finally determined by a court. As such, assuming a court considers there was an overpayment, the payee has a right to recover those funds up to six years from the date of payment.
Hybrid contracts involve an element of construction works covered by the HGCRA 1996 and other works that do not. Such contracts can present particular problems when it comes to dealing with payment applications – as the parties found out in Severfield (UK) Ltd v Duro Felguera UK Ltd  EWHC 3352 (TCC). The works to be carried out were for the design, supply and erection of steel structures for the construction of two power generation plants. A dispute arose over the contractor’s interim payment application, as it did not provide a clear breakdown of the construction operations and those works relating to power generation (which fell outside of the HGCRA 1996). The adjudicator decided in the contractor’s favour. However, in subsequent enforcement proceedings it was held that the adjudicator had dealt with matters that were outside of the HGCRA 1996 and therefore exceeded his jurisdiction. The issue was referred to further court proceedings. The TCC held that the different payment regimes in respect of works governed by the HGCRA 1996, and those works that are not, must be respected in relation to payment applications. While the judge acknowledged that this approach was ‘uncommercial’ and ‘a recipe for confusion’, it was the inevitable result of the legislature’s decision to exclude, arguably, obvious construction operations from the ambit of the HGCRA 1996.
Those operating under a hybrid contract for both construction work and other works or services must be vigilant about serving separate payment applications in respect of the construction operations only.
The danger of agreed payment schedules
In Grove Developments Ltd v Balfour Beatty Regional Construction Ltd  EWHC 168 (TCC) the contractor was held to have no contractual right to issue further payment applications beyond those dates specifically set out in an agreed payment schedule (which ended in July 2015). The TCC acknowledged that it would make commercial sense for the agreed payment cycle to continue from July 2015 until practical completion. However, this was not what the parties had originally agreed to under the terms of the contract, nor had the parties formally agreed a subsequent payment schedule.
The TCC held that ‘business common sense’ should not be imported into a contract where no ambiguity exists as to what the parties agreed. The default position provided by the HGCRA 1996 (that interim payments will continue throughout the whole construction period) does not prevent the parties from contracting on a different basis. The parties may agree to front load payments in advance of a final payment that takes into account the remaining value of the work. In this case, the parties’ agreement was clear and had not been subsequently amended. The employer had opposed the contractor’s proposed change as soon as the payment application was submitted beyond the agreed dates – which was demonstrated by contemporaneous correspondence. Had both parties adopted the change, and varied their agreement, whether by formal written acknowledgement or by conduct, the situation may well have been different.
While this may appear to be a strict approach taken by the TCC, it was always open to the parties to agree an alternative approach to payment and amend the contract (but they did not). The TCC observed that it is, generally, reasonably foreseeable that works may be delayed and that there will therefore be a period of overrun in which no application payments will be made.
This case highlights the importance of understanding the payment arrangement agreed to under the contract and the realistic commercial effect such an arrangement may have in the not unlikely circumstances that the project is delayed – not least because the courts are unlikely to be sympathetic to requests to undo unfavourable commercial terms agreed between competent parties. (An appeal hearing was concluded on 28 July 2016; however, at the time of writing this article, judgment had not yet been handed down.)
This article was first published in the December 2016 edition of Construction Law. For a subscription, please complete the online subscription form at http://www.constructionlaw.uk.com/. You can also sign up there for Construction Law's free newsletter.