Interim payment mechanisms in construction contracts are predicated on the issuance of various payment notices by both the payee and payer along the supply chain.
In the UK, the Housing Grants, Construction and Regeneration Act 1996 (as amended) (the 'Construction Act') provides a statutory entitlement to payment by instalments, stage payments or other periodic payments (unless the works are estimated to take 45 days or less to complete). The parties are free to agree on the amount of the payments and the intervals at which (or the circumstances in which) they become due but in the absence of such agreement, the relevant provisions of the Scheme for Construction Contracts (the 'Scheme') applies.
The Scheme applies to the extent that a construction contract fails to meet the minimum requirements mandated by the Construction Act for the issuance of payment notices. This includes the strict time frames within which the payee and payor must issue their notices.
For the purposes of the Construction Act, a construction contract means an agreement for the carrying out (or arranging for the carrying out) of construction operations, including design work or advising in relation to construction operations. Construction operations is broadly defined in s.105 of the Construction Act but is subject to several exclusions. These include construction works relating to nuclear processing, oil and gas, extraction of minerals and installation of plant or machinery for the preparation of food and drink. There are also other exclusions. It is important to check whether a contract falls within one of the exemptions in s.105 or s.106.
The latest editions of standard form contracts (such as JCT, NEC and FIDIC forms) provide payment mechanisms in compliance with this statutory regime.
You can read our previous blog on the payment mechanisms in JCT Design & Build 2016 contracts and subcontracts in practice for a full illustration.
Any schedules of amendment which seek to vary such provisions mustn't inadvertently cause non-compliance with the Construction Act. If so, this can create a situation where the compliant contract provisions apply, and the relevant provisions of the Scheme replace the non-compliant ones. This can lead to parties issuing the wrong payment notices at the wrong time, often with severe consequences.
The result can mean that a payer (e.g. an employer) is obliged to pay the full amount set out in a valid payment application of the payee if the payer fails to serve a valid payment notice or 'pay less' notice (specifying its valuation of the work) in time.
This approach to interim payments is generally essential to the industry as it helps maintain cash flow to the wider supply chain. However, it can also result in situations where the payee has an entitlement to the sums due simply because the payer has failed to issue its payment notice properly, where the payee would otherwise not be entitled to it – for instance, where the relevant work had not in actual fact been carried out.
The Construction Act has been criticised as lacking detail on the substantive requirements of the payment notices themselves (beyond when they are due) and when this will (and will not) result in invalidity. However, cases before the Courts have provided useful guidance and consideration to the law in this area should feed into the precedent forms of payment notices construction parties and their consultants adopt on construction projects in the UK.
The recent case of Downs Road Development LLP v Laxmanbhai Construction (U.K.) Ltd  EWHC 2441 (TCC) provides a stark warning for payers considering attempting to circumvent the requirements of the Construction Act.
In this case, the parties contracted for various construction works using an amended JCT Design and Build Contract 2011, which required the Employer to issue a payment notice to the Contractor no later than five days after the payment due date.
For each payment cycle, the Employer would issue a payment notice specifying an amount due of £1 within the required time period. This was, in effect, a holding notice, after which the Employer would follow up with a second payment notice (issued out of time) with a proper valuation.
The Court had to determine whether the first notice was valid. In doing so, it considered the statutory requirement (reflected in the contract) that each payment notice shall:
'Specify the sum that the party giving the notice considers to be or have been due at the due date in respect of the relevant payment and the basis on which that sum has been calculated'.
The Court concluded it was invalid. The sum stated as due was not one that the Employer 'genuinely considered' to be due – it was simply a nominal holding amount. This was taking into account the covering email that accompanied the payment notice and the previous conduct of the parties (i.e., the fact the Employer had repeatedly taken this approach in previous payment cycles). Also, the first notice failed to set out the basis of the Employer's calculation, and it lacked any supporting material or explanation as to why the figure of £1 was being certified as due.
Unfortunately, it is a common tactic for payers to issue payment notices specifying artificially low sums to force a payee to settle a wider dispute or conclude its final account at a more favourable level. However, this case illustrates the need for a bona fide assessment by the payer of the payee's payment applications, with a failure to do so being open to challenge.
Myerson's specialist Construction Team routinely represents clients in litigation, arbitration and adjudication proceedings relating to disputes regarding interim payments.
The team also advise on standard form and bespoke construction contracts and the forms of payment notices to be given thereunder. After all, parties need to ensure robust systems and procedures are in place to make and process interim payment applications and that the contractual and/or statutory requirements are properly understood and adhered to. Problems can be avoided by ensuring that contracts at all levels of the supply chain are carefully drafted at the outset of a project.
To discuss these issues further or for more information on the range of legal services we can provide, please contact our Construction Team below.