Introduction

In the recent case of Graham Leslie v Farrar Construction Limited [2016] EWCA Civ 104, the Court of Appeal considered whether an employer could recover overpayments of build costs made to a contractor on five completed property developments. The result, that the overpayments were not recoverable, may be surprising to many operating in the construction industry. The court’s reasoning, however, is applicable to any contract that contains a mechanism for interim and final payments. So it is certainly worth a look.

Background

Graham Leslie was a wealthy businessman who made his money in the pharmaceutical industry. In his retirement, as one does, he wished to build up a property portfolio. To achieve this goal Mr. Leslie sought out Farrar Construction Limited (“FCL”), a construction company whose principal shareholder and director was Neil Farrar.

Sometime in 2008 Mr. Leslie and Mr. Farrar reached an agreement in the following terms: (i) sites would be identified and agreed as suitable for development; (ii) Mr. Leslie would buy those sites; (iii) FCL would design and construct housing on the sites to an agreed design and budget; (iv) Mr. Leslie would pay FCL its “build costs;” (v) on completion the open market value of the development would be agreed, the acquisition and build costs would be deducted, and the resultant profit share divided equally. This was referred to during the course of the litigation as the “Framework Agreement.”

In their wisdom the parties decided not to reduce their agreement to writing, ignoring the pleas of Mr. Farrar’s accountant to do so. Nor did they identify what was meant by the term ‘build costs,’ in particular which items of expenditure were included or excluded. What could possibly go wrong?

This state of affairs was not a problem for the first five years, when the developments proved profitable. Five developments were completed in that time, though many more were ongoing. In each case, before work began, the parties agreed a costs budget. As works proceeded, FCL submitted requests for interim payments. These requests were always for round sums not supported by any detail or evidence of costs actually incurred. These amounts were referred to by the parties as ‘budget costs’.

Mr. Leslie made the payments because they were within the costs budget and appeared reasonable. He obviously placed a lot of trust in Mr. Farrar and the two were described as initially having an “extremely good relationship.” Indeed the relationship between the two men was so good that Mr. Farrar waived FCL’s profit share on one of the developments, estimated at £165,000, as a wedding gift to Mr. Leslie.

Once the honeymoon period was over, the relationship began to deteriorate. Work was not proceeding as smoothly on some of the other development sites and Mr. Leslie began to form the view that Mr. Farrar was taking advantage of him. In July 2013 Mr. Leslie refused to continue funding the remaining ongoing developments.

Mr. Leslie swiftly commenced a claim in the Technology and Construction Court claiming repayment of all sums that he had overpaid FCL. He claimed the difference between the ‘budget costs’ paid and the ‘build costs’ that he had agreed to pay. In its counterclaim FCL claimed it was owed the money Mr. Leslie had withheld in respect of the ongoing developments, in addition to damages for repudiation.

Mistaken payments and unjust enrichment

To begin his analysis, the judge at first instance had to decide which items of expenditure constituted build costs within the meaning of the Framework Agreement. He held that this phrase meant the direct cost of labour and materials together with site specific preliminaries. It excluded Head Office overheads, non-site specific general business costs and capital expenditure on plant and machinery.

Using that definition of build costs FCL had in fact overcharged Mr. Leslie by 22%. Given that the profit share was divided equally, the net loss to Mr. Leslie was 11% of the sums he invested. This did not, however, justify Mr. Leslie’s refusal to perform his obligations under the contract in July 2013. That refusal constituted a repudiation of the Framework Agreement and the judge awarded damages to FCL on that basis. The interesting part of the judgment, however, is the treatment of the recoverability of the overpayments to FCL.

Mr. Leslie claimed the overpayments fell to be repaid under the doctrine of unjust enrichment. He argued that FCL had been unjustly enriched because the overpayments were made in Mr. Leslie’s mistaken belief that the sums were properly payable. The judge agreed that the overpayments had been made under a mistaken belief, but expressed the belief rather differently. The judge considered that at the time Mr. Leslie made each of the interim payments he was operating under a mistaken assumption of fact, namely that FCL’s present intention was to use the money only to fund the direct cost of construction.

That belief was mistaken because Mr. Farrar, as the controlling mind of FCL, hadn’t given any thought to the specific purpose that the interim payments should be used for. All he did was to ask for round sum payments on account because those were the amounts he thought were needed to keep Farrar Construction in sufficient funds to continue with the developments. The judge didn’t comment further on whether, in his experience, this state of mind was a common feature in building contractors.

Having established that there had been an overpayment of over £800,000 made by mistake, the judge held that Mr. Leslie was not entitled to be repaid any of that amount. The correct legal analysis was that the parties, by their conduct, had reached an agreement that the build costs FCL was entitled to be paid equated to the budget costs that FCL had charged Mr. Leslie. The sums which FCL sought were within budget and Mr. Leslie was content to pay them without any investigation. Mr. Leslie had in effect assumed the risk that the build costs and the budget costs were not the same, and, by paying those costs without question, had entered into a settlement to finally resolve the matter for each completed development.

If that analysis was not correct, the judge held that the same conclusion could be reached by two alternative means. First, that by his conduct Mr. Leslie had waived his right to make any detailed inquiry into the actual build costs of each development. Second, that Mr. Leslie made an implicit representation that he would not require FCL to ascertain and substantiate its actual build costs, FCL had relied on that to its detriment (by refraining from asserting higher build costs than the budget allowed), such that Mr. Leslie was estopped from claiming recovery of any overpayments.

Knowingly running the risk

Mr. Leslie appealed to the Court of Appeal on the ground that the judge ought to have allowed recovery of the overpayments on the five completed developments as monies paid under a mistake. Lord Justice Jackson, giving the judgment of the court, forcefully rejected that argument.

He stated that the core legal principal, formulated and refined over the last two centuries, is that if C, because of a mistake, pays money which is not due to D, he can recover money unless one of the recognised defences applies.

Were any defences applicable in this case? Jackson LJ found the answer in the early 19th century case of Kelly v Solari (1841) 9 M & W 54. An insurance company had paid out £987 to the widow of the deceased in respect of three life insurance policies, overlooking the fact that one of the policies had lapsed. The insurers sought to recover the overpayment. Lord Abinger CB stated the relevant principle as follows:

“The safest rule however, is that if the party makes the payment with full knowledge of the facts, there being no fraud on the other side, he cannot recover it back again. There may also be cases in which, although he might by investigation learn the state of facts more accurately, he declines to do so, and chooses to pay the money notwithstanding; in that case there can be no doubt that he is equally bound.”

Another member of the court, Parke B, agreed stating:

“If, indeed, the money is intentionally paid, without reference to the truth or falsehood of the fact, the plaintiff meaning to waive all inquiry into it, and that the person receiving shall have the money at all events, whether the fact be true or false, the latter is certainly entitled to retain it …”

Jackson LJ also considered the rather more recent case of Brennan v Bolt Burdon [2005] QB 303. At first glance one could be forgiven for missing the relevance of this decision. The claimant’s claim form was struck out for late service and the parties agreed to walk away from the dispute and bear their own costs. Subsequently there was a Court of Appeal decision in separate litigation, the effect of which was that the claimant’s claim form had in fact been served in time.

The claimant returned to court to appeal the striking out of its claim form. He argued that the parties’ agreement was vitiated by a common mistake in law, namely that the claim form had been served out of time. The Court of Appeal rejected that argument, holding that there had been a compromise of the litigation on a give and take basis. Each party had forgone the chance of achieving a better result and avoided the risk of suffering a worse result. The parties had to accept the consequences of what they agreed, even if the law subsequently changed to the advantage of one side or the other.

Jackson LJ held that the same principle applied in circumstances where parties with opposing interests negotiate a financial agreement.The mere fact that it turns out that one party or the other has made a bad bargain does not vitiate the agreement.

Drawing these two strands of authorities together, the Court of Appeal held that this was a classic case of C voluntarily making a payment to D, knowing that it may be more than he owes, but choosing not to ascertain the correct amount. The dicta in Kelly v Solari were precisely applicable and Mr. Leslie was not entitled to recover any of the alleged overpayments.

The arguments on ‘mistake’ were a red herring. The court held that there had been no legally material mistake. The relevant point was that by failing to inquire into the basis of the invoices Mr Leslie had knowingly run the risk that he might be paying more than was strictly due. Whether Mr Leslie had knowingly run the risk was not dependent on his subjective state of mind, but on “an objective reading of the facts surrounding the payments as they could reasonably have been known to both parties.

In this instance, there were three facts which led the court to conclude that Mr Leslie had knowingly run the risk of overpaying:

“(i) Mr Leslie's main concern on all the developments was not to exceed the budget costs, subject to a couple of minor adjustments. That would ensure (and in the event did ensure) that Mr Leslie made a handsome profit.

(ii) Since the final payments were in line with the budget costs, Mr Leslie was unconcerned about whether or not the sums which he was paying accurately represented the build costs.

(iii) It was beneficial for both parties to avoid the costs and effort which would be involved in auditing and negotiating the actual amount of the build costs.”

Jackson LJ concluded by noting that, if necessary, he would have agreed with the first instance judge that Mr Leslie had waived his right to make any detailed inquiry into the actual build costs of each development. He preferred not to express any view on FCL’s estoppel argument, which he described as “a more difficult question.

Practical lessons

Although the decision of the Court of Appeal is somewhat fact-specific, there are a number of practical points that parties would do well to bear in mind in any contract involving interim payments.

The first, and most obvious, point is to make sure the details of any interim payment regime are contained in a written contract between the parties. Early in his judgment Jackson LJ dryly noted that:

“Misunderstandings of this nature are hardly surprising, if a builder and a property developer choose to embark upon a series of multi-million pound projects on the basis of a brief oral agreement which no one troubles to reduce to writing.”

Second, parties should be careful to avoid conduct from which it might be inferred that the contractual final account mechanism is being departed from and payments are being settled on a different basis. It is important to emphasise that Mr. Leslie would have had a contractual right to the overpayments he claimed if the Framework Agreement had been operated in the way the parties originally intended. He only lost that right because by his conduct he expressed his agreement to instead pay FCL’s budget costs.

It will be surprising to many parties to learn that convenient ‘agreements’ of this kind may later be treated as displacing the effect of the contractual terms originally agreed. Looking back at the facts the Court of Appeal took into account when deciding that Mr. Leslie knowingly ran the risk of overpaying, none seem particularly remarkable in the context of a construction project, or indeed in the context of any contractual venture involving interim payments.

Parties reasonably sure of making a healthy profit might be reluctant to devote further resources to drill down into the figures, especially if they require professional assistance to do so. This decision should serve as a warning to such parties that expressing that attitude in their dealings with another party may well bar any future claims to recover any overpayments made. In order to avoid that result, parties should make clear in any communications relating to interim payments that the sums being paid are subject to the final payment provisions contained in the parties’ contract.

Finally, cases of this kind will inevitable be highly fact-sensitive, depending as they do on “an objective reading of the facts surrounding payments as they could reasonably have been known to both parties.” It follows that such cases will be very difficult to challenge on appeal, as demonstrated by Graham Leslie v Farrar Construction Limited As McCombe LJ, in a short concurring speech, observed:

“We are being invited to overturn a judge's conclusion on a finding of fact, made after a complex trial. It was a finding made in a very careful and comprehensive judgment on eleven issues. In such circumstances, I would not easily be persuaded that he was not entitled to make that ultimate finding of fact on the evidence which he had heard and which we have not.”