Payment Notice for Construction Contracts

The Construction Act

Interim payment mechanisms in construction contracts are contingent on the payee and payer issuing various payment notices 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.

Requirements for the Issuance of Payment Notices

The Scheme applies to the extent that a construction contract fails to fulfil the minimum requirements established by the Construction Act for the issuing of payment notices.

This also includes the strict time frames where the payee and payor must issue their notices.

For the purposes of the Construction Act, a construction contract means an agreement for carrying out (or arranging for the carrying out) construction operations. This includes design work or advising in relation to construction operations. Construction operations are broadly defined in s.105 of the Construction Act but are subject to several exclusions. These include construction works related to nuclear processing, oil and gas, extracting minerals, and installing plant or machinery to prepare food and drink. There are also other exclusions. It is important to check whether a contract falls into 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 that are in compliance with this statutory regime.

Any schedules of amendment which aim to alter such provisions must not 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, which often causes severe consequences.

The result can mean that a payer (such as, an employer) is obliged to pay the full amount that was set out in a valid payment application of the payee should the payer fail to serve a valid payment notice or 'pay less' notice (specifying its valuation of the work) in time.

Interim Payments

This approach to interim payments is important to the industry because it assists in maintaining cash flow to the wider supply chain. However, it can also result in an instance 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 been carried out.

The Construction Act has been criticised for 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 given useful guidance and consideration to the law within this area should feed into the precedent forms of payment notices construction parties and their consultants adopt on construction projects in the UK.

Downs Road Development LLP v Laxmanbhai Construction (U.K.) Ltd [2021]

The case of Downs Road Development LLP v Laxmanbhai Construction (U.K.) Ltd [2021] EWHC 2441 (TCC) provides a stark warning for payers seeking 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. This 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. The Employer would then 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 (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 Decision of the Court

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.

Issuing Payment Notices

Unfortunately, it is common 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.

Parties need to ensure they have robust systems and procedures that are in place to make and process interim payment applications. They should also ensure 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.

For more information regarding payment notices for construction contracts, you can contact the Construction Solicitors at Myerson.