Construction Contracts: Are Your Payment Terms Compliant?

A recently published decision from the Technology and Construction Court has demonstrated the importance of parties to construction contracts[1] complying with the Housing Grant Construction & Regeneration Act 1996 (as amended by Part 8 of the Local Democracy, Economic Development and Construction Act 2009) (the “HGCRA”) when it comes to payment terms.

Rochford Construction Limited v Kilhan Construction Limited[2]:

In Rochford Construction Ltd v Kilhan Construction Ltd [2020] EWHC 1947 (TCC), Fraser J dealt with a case management hearing concerning CPR Part 7 and CPR Part 8 applications arising out of an adjudication. The subsequent CPR Part 8 hearing found that the parties' contract did not comply with the HGCRA and instead incorporated parts of the Scheme for Construction Contracts (England and Wales) Regulations 1998 (the “Scheme”).

In Rochford[3], contention arose when the defendant subcontractor submitted an interim application for payment for period ending 30 April 2019. The interim application amounted to c.￡1.4m and was submitted on 20 May 2019. There was no payment made by the claimant contractor. The claimant contractor purported to issue an interim payment notice for c.￡1.2m on 23 October 2019. A dispute was referred to adjudication concerning the validity of the interim payment notice, whether it was issued late and whether it failed to specify how the sum sought was calculated.

The adjudicator concluded that the due date was 20 May 2019 (the same date that the interim application for payment was submitted) and that the final date for payment was thirty days from that due date on 19 June 2019. The claimant contractor had not served a payment notice within five days of the due date, nor a pay less notice no less than seven days prior to the final date for payment. As a result, the adjudicator decided that the interim application for payment was the default notified sum and awarded this accordingly in his decision. The subcontractor issued CPR Part 7 adjudication proceedings[4] (seeking enforcement of the adjudicator’s decision) as the claimant contractor had refused to pay.

The claimant contractor subsequently issued CPR Part 8 proceedings[5] stating that, in essence, the adjudicator’s decision was wrong because he did not give effect to the subcontract terms concerning the date for making a claim and the requirements of a final date for payment. The claimant contractor’s point was that the defendant subcontractor should have issued its interim application for payment on the last day of the month and that the final date for payment was fixed by reference to the service of the defendant subcontractor’s invoice. In this regard, the subcontract stated:

"application date end of month … commercial … valuations monthly as per attached payment schedule end of month. Payment terms thirty days from invoice as per attached payment schedule. S/C payment cert must be issued with invoice."

It is noteworthy that there was no payment schedule attached. The court noted that if there had been, “it seems far less likely that this dispute would have arisen”[6].

In respect of the interim application for payment being submitted late and the subsequent argument that there was no valid request for payment (as it was not submitted at the end of the month), this was rejected by the court[7]. It was found that the parties had not agreed a due date, following which paragraph 4 of the Scheme applied. On this basis, and under the Scheme, the date of the interim application for payment was the due date (20 May 2019).

In respect of the final date for payment, the court noted that the parties’ agreement did not provide a date which was certain in respect of the final date for payment. This was because the final date for payment was linked to the invoice date which was found to be “unworkable … [and] simply impractical”[8]. However, the court did accept that the thirty-day provision was intended as a final due date provision, to the extent that it could fit with the Scheme. As a consequence, the final date for payment was to be determined under the Scheme as per the adjudicator’s decision, being thirty-days from the due date.

‘Pay Now, Argue Later’

The implications of failing to serve a valid payment or pay less notice are demonstrated by a long line of ‘smash and grab’[9] cases. The outcome is inevitable; where an adjudication is commenced following the payer’s failure to issue a timely payment or pay less notice, any validly given notice from the payee will represent the default notified sum which becomes payable. In circumstances where such a decision is made against the payer by the adjudicator, the message from the courts is clear: ‘pay now, argue later’[10].

Payment and pay less notices must comply with the dates set out within the contract’s payment terms, which in turn must comply with the HGCRA. If the existing contract payment terms are found to be non-compliant, the Scheme will apply which may expose the payer to a ‘smash and grab’ adjudication.

HGCRA

Where a construction contract[11] is 45 days or more in duration[12], the beneficiary is entitled to request interim or stage payments. Whilst the parties are free to agree the intervals at which such interim or stage payments become due[13], the HGCRA sets out requirements which must be reflected within the contract’s payment provisions, absent which the Scheme will be implied. The flow chart below outlines the payment process under the HGCRA:

Figure 1 – outline payment provisions under the HGCRA

The parties are free to agree the period between the due date and the final date for payment. If the payment provisions are found to be non-compliant with the HGCRA, the Scheme may apply a period of seventeen days. This is significantly less than the period which is often stipulated in practice. The risk to payers is that they may issue a ‘pay less’ notice after the seventeen-day period imposed by the Scheme, due to their mistaken belief that a longer period has been agreed in the contract. The ‘pay less’ notice will be held to have no effect despite its intention of reducing the amount paid.

It is common for contracts to include a payment schedule setting out the relevant dates for payment. These dates must reflect the payment terms contained within the contract to avoid ambiguity. Further, it is vital that a period of no more than five days after the due date is stipulated for the giving of a payer’s notice or payee’s notice (as required by s.110A(1)(a) and s.110A(1)(b) of the HGCRA, respectively) to ensure compliance with the HGCRA.

Conclusion

Following Rochford[14], parties to construction contracts are advised to review their payment terms and ensure that, as far as can be determined, there is compliance with the HGCRA. This will assist in preventing arguments being raised that a contract’s payment provisions are non-compliant and that the Scheme applies, either entirely or in part[15]. As demonstrated in Rochford[16], such an argument, if correct, may lead to payment and ‘pay less’ notices having no effect where they are late. Instead, a payee’s application for payment or notice may become the notified sum upon which a ‘smash and grab’ adjudication can be launched.

Whilst the court in Rochford[17] did state that the due date could be determined by reference to an invoice or notice, the final date for payment must be linked to the due date. In particular, the court recognised that “it will be important for the payer to be exactly certain how much time he or she has in which to serve a payless notice, the final date for payment being the date which is critical to that step”[18].  Where, as in Rochford[19], the payment terms state that the final date for payment is linked to the serving of an invoice, the payment terms are likely to be non-compliant with the HGCRA.

If a party finds that their payment terms, or part thereof, are non-compliant with the HGCRA, they should promptly seek to amend the payment terms through appropriate means. If no amendment is possible, the party should ensure compliance with the relevant part(s) of the Scheme on the basis that it applies.

[1] See ss.104-106, HGCRA.

[2] [2020] EWHC 941 (TCC).

[3] Fn. 2.

[4] See Rochford Construction Ltd v Kilhan Construction Ltd [2020] EWHC 1947 (TCC).

[5] Fn. 2.

[6] See para. 12, Rochford [2020] EWHC 941 (TCC).

[7] See paras. 22-48, Rochford [2020] EWHC 941 (TCC).

[8] Para. 56, Rochford [2020] EWHC 941 (TCC).

[9] ‘Smash and grab’ refers to the commencement of an adjudication on the premise that a notified sum has not been paid. There will be no consideration of the true value. For example, see ISG Construction Ltd v Seevic College [2014] EWHC 4007 (TCC), Galliford Try Building Ltd v Estura Ltd [2015] EWHC 412 (TCC) and Kersfield Developments (Bridge Road) Limited v Bray and Slaughter Limited [2017] EWHC 15 (TCC).

[10] See Macob Civil Engineering Ltd v Morrison Construction Ltd [1999] EWHC Technology 254, albeit limited exceptions exist outside the scope of this article.

[11] See ss.104-106, HGCRA.

[12] The period of 45 days can either be specified in the contract or estimated by agreement between the parties as being less than 45 days in duration.

[13] S.109(2), HGCRA.

[14] Fn. 2.

[15] As noted in Rochford [2020] EWHC 941 (TCC) at paras. 17-20, the Scheme will only apply to the extent that such an implication is necessary. See Bennett (Construction) Limited v CIMC MBS Limited (formerly Verbus Systems Ltd) [2019] EWCA Civ 1515.

[16] Fn. 2.

[17] Fn. 2.

[18] Para. 58, Rochford Construction Ltd v Kilhan Construction Ltd [2020] EWHC 941 (TCC).

[19] Fn. 2.