Cautionary tale on payment pitfalls under construction contracts

by on for The Construction Index

Jonathan Pawlowski, partner at Brecher Solicitors, reviews the lessons of Leeds City Council v Waco UK Ltd.

Payment provisions under the majority of construction contracts are governed by the requirements put in place by the Housing Grants, Construction & Regeneration Act 1996. These provisions have caught out many an unwary employer, but the recent case of Leeds City Council v Waco UK Ltd saw a contractor fall foul of the statutory requirements and lose its right to payment.

A construction contract must clearly outline the amounts and timing of payments, which must be made in instalments, until the project is complete. It must also include a “payment due date”, (when a sum crystallises but does not have to be paid), and a “final date for payment” (a set date by which the payment must be made) for each instalment. Some construction contracts allow the contractor to issue an application for payment a few days prior to each “payment due date”, but this is not a statutory requirement.

The Construction Act allows for two important notices: the “payment notice” and the “pay less notice”. Within five days of each payment due date, the payer should issue a payment notice. The payment notice is the payer’s valuation of the work carried out up to the payment due date, regardless of whether the contractor has submitted an application for payment. If the employer fails to serve a payment notice, the contractor may submit its own payment notice, identifying the sum which it says is due by the final date for payment. The application for payment may serve as the contractor’s payment notice.

If, before the final date for payment the payer has grounds for paying less than the sum originally stipulated (e.g. a claim for liquidated damages), then the payer must issue a pay less notice, which sets out the revised sum the payer considers is now due.

The pay less notice must be served no later than a prescribed period before the final date for payment. The parties are free to agree the prescribed period, but if this is not stated in the contract, the period is deemed to be seven days before the final date for payment.

The penalty for failing to serve a pay less notice can be harsh. In the absence of a valid pay less notice, the employer has to pay the entire amount certified in the payment notice. If this results in an overpayment, then the payer must correct the position in the next payment cycle.

The Leeds City Council case gives us an interesting insight into circumstances where the requirements of the Construction Act prevented the contractor from being paid. Here, the parties entered into a JCT Design & Build Contract. Prior to practical completion, the contractor was to be paid on the 26th of each month. After practical completion, interim payments were to be made at intervals of two months.

Before practical completion, most of the contractor’s monthly applications for the payment were submitted late. Nonetheless, the contract administrator treated the applications as if they had been made on time. After practical completion, the contractor continued in the same vein, making applications for payment which did not follow the exact dates set out in the contract.

The contractor issued interim application for payment number 21, for just under £500,000. Leeds City Council refused to pay, but did not serve a payment notice or a pay less notice. The contractor referred the dispute to adjudication, where the case was found in favour of the contractor on the grounds that the council had failed to serve the requisite notices. The council still refused to pay and the contractor issued proceedings in Court, for summary judgment, to enforce the Adjudicator’s decision. The Court refused to grant summary judgment and instead, granted Leeds City Council permission to defend the case on the condition that it paid the contractor the sum awarded by the Adjudicator.

Leeds City Council’s argument was that the contractor had no entitlement to be paid on any dates other than those specified in the contract. It argued that the interim application was made six days early and this rendered it invalid. The contractor’s defence was that the parties had agreed to vary the dates for payment, which was evidenced by a course of conduct: they had never followed any of the contract dates.

The Court dismissed the contractor’s defence and found in favour of Leeds City Council.

This case provides a warning to contractors not to be overly efficient and issue applications for payment early. The contractor could not rely on the course of conduct in this case as evidence of an agreement to vary the dates for making interim payment applications – the course of conduct argument only allowed Leeds City Council to accept an application for payment if it was a few days late. However, the position with interim application number 21 went well beyond this understanding. There was no evidence that the council had waived its right to object to an application for payment when it was issued before the specified date.

If a contractor submits an application for payment early, an employer may challenge the validity of the application on the grounds that it is premature even if it fails to serve the requisite notices. The contractor’s remedy is to wait for the next “payment due date” and make a fresh application for payment.

This case serves as a reminder not to place your carefully drafted contract in the bottom drawer of your desk and let it gather dust.  Check the contract payment dates and make sure they are adhered to, right up to the issue of the final certificate.