Following the House of Lords' decision in Melville Dundas in April, the TCC has now decided in the case of Pierce Design v Johnston on 17 July that the case has a wide application - but unreasonable failure to pay may still be penalised.

The decision of the House of Lords in Melville Dundas in April resolved a tension between the payment provisions of the Housing Grants, Construction and Regeneration Act 1996 ("the Act") and contractual clauses applying to payments after termination of building contracts.

Section 111 of the Act requires the employer to give notice not less than 5 days before the final date for payment if he proposes to withhold payment from amounts otherwise due. In Melville the employer gave no such notice and the contractor went into administrative receivership after the final date for payment following which his employment was determined. Clause 27 of the standard form JCT contract provided that following determination "the provisions of this contract which require any further payment shall not apply" pending completion of works and settlement of accounts.

The majority in the House of Lords decided that the Act did not exclude the possibility that interim payment should be subject to a contingency where the relevant contingent event was sufficiently clearly spelt out. Any money paid over in the case of insolvency would be lost to the employer. The standard form provision was a reasonable compromise between the need to discourage employers from unreasonably retaining interim payments and to avoid upsetting the usual approach to set-off on insolvency; namely, that mutual set-off is permitted between employer and contractor. The Act's provisions could not be intended to apply to situations where a ground for withholding payment arose in circumstances where notice could not be given within the statutory time frame.

At the time many commentators considered that the decision applied only to termination for insolvency, but in the Pierce case the TCC has decided that it has a wider impact. In Pierce termination occurred on the ground of failure to proceed regularly and diligently with the work. At the time of termination numerous earlier valuations had not been paid and no withholding notices had been given. The TCC decided that the rationale of Melville should apply whatever the cause of termination, describing it as unattractive to suggest that "on one set of facts, a clause in the standard form contract complies with the Act whilst, on another set of facts, it does not". However there was a twist in the tale.

Clause of the JCT 1998 standard form prevented the employer from deferring payment in respect of amounts which had been unreasonably not paid and had accrued 28 days or more before the date of determination . The TCC decided that this proviso applied to the circumstances of this case and that its purpose was to deter unscrupulous employers from using determination as a way of avoiding their responsibility to make interim payments. Payment of the relevant withheld sums was therefore ordered.

Comment and business implications

Since the Melville decision was handed down the DTI (now DBERR) has produced its consultation paper on proposed reforms to the Act. It proposed that the Melville decision was and should be confined to cases of insolvency. However the TCC has now made it clear the the Melville decision was in fact based on broader grounds and so any such reforms would seek to limit its impact.

As always, the application of the decision must be measured against the particular contract clauses. The proviso which enabled the claimant to recover in this case does not reappear in the 2005 version of the JCT standard form. If it had not been present in Pierce, then it appears that the employer could have retained the outstanding sums until the final account was agreed.

It remains to be seen if the Court of Appeal will consider this point further. For the present the Pierce decision is likely to benefit employers and others in the position of a paying party, since they will be able to retain (typically) a month's payment due to the contractor or other receiving party, which will obviously assist with the cash-flow required to complete the project. If the currently proposed reforms to the Act proceed, the Pierce decision may well be reversed by legislation. However, at least in the case of insolvency (a common cause of termination) it appears unlikely that employers will be adversely affected by such reforms, and in relation to other termination events the omission of the Pierce proviso from JCT 2005 should in the meantime also work in favour of employers.