15 January 2018

Payment in construction contracts: Construction Act 1996

This note explains the payment mechanism, including stage payments, the meaning of an adequate payment mechanism, payment notices, default payment notices, pay less notices and the requirement to pay the notified sum.

It is often said that cash is king. However for the construction industry its life blood is cash-flow. It is therefore crucial for the industry to make sure that this cash-flow continues. An important aspect of this is being aware of the contractual provisions in a construction contract and how these operate. Failure to comply with these could lead to a loss of right to payment.

Scheme for Construction Contracts 1998

The payment construction contract are governed by the provisions in the Construction Act 1996 and the Scheme for Construction Contract (England and Wales) Regulations 1998 (SI 1998/649) (“the Scheme”).

Scheme is an implied term

The Scheme provides a fall-back position where a construction contract does not include the necessary payment provisions of the Construction Act 1996. Its provisions take effect as implied terms.

Construction Act 1996 and Scheme apply to construction contracts

The Construction Act 1996 and the Scheme now apply to any agreement that is a construction contract. This includes oral and partly oral contracts. If you are carrying out works under an exchange of correspondence, e-mails, telephoned instructions or a mixture of these, then these will still apply to your contract if it involves construction operations.

Payment requirements under the Construction Act 1996

Section 109: stage payments

Payment must be made by instalments, stage payments or other periodic payments for any work provided for by a construction contract. The parties are free to agree the amounts of the interim payments and the intervals or circumstances in which payment becomes due.

Scheme for Construction Contracts 1998 implied: section 109(3)

If a construction contract is silent on stage payments, the provisions of the Scheme are implied into the construction contract. 

In essence, paragraphs 1 and 2 of the Scheme provide that periodic payments are based on the value of the work performed in the relevant period: paragraph 12 of the Scheme defines the "relevant period" for valuations as every 28 days.

Contract needs an adequate mechanism

Every construction contract is to provide:

  • An adequate mechanism for determining what payments become due under the contract and when those payments become due (section 110(1)(a).
  • A final date for payment for any sum that becomes due (section 110(1)(b).

Due date for payment

The term "due date for payment" is commonly used to describe the date when payment becomes due under the contract section 110(1)(a).

Final date for payment

All construction contracts must set a "final date for payment" for any payment due under the contract (section 110(1)(b)). The parties are free to agree the length of time between the due date for payment and the final date for payment.

The final date for payment acts as a long-stop date. If the paying party does not make payment by the final date for payment and does not serve a pay less notice, the unpaid party will have a statutory right to suspend performance of its obligations under the construction contract.

Scheme for Construction Contracts 1998 implied: section 110(3)

If the parties do not include in their construction contract the payment provisions required by section 110(1), the relevant provisions of the Scheme are implied into the contract (section 110(3)).

Sections 110(1A) to (1D): conditional payments

No more pay-when-certified or other conditional payments: section 110(1A)

Parties are not permitted to include pay-when-certified clauses in their contracts. For example, a sub-contract payment clause should not provide that a sum only becomes due to a sub-contractor when the (main) contractor's application for payment (including the sub-contract works), has been certified as having been carried out under the (main) building contract by the employer's architect or engineer (section 110(1A)(b)).

Pay-when-paid in upstream insolvency: section 110(1B)

Section 113 of the Construction Act 1996 has always prevented pay-when-paid clauses, except where a paying party itself was not paid because of another payer's insolvency (so-called upstream insolvency).

Section 110(1B) of the Construction Act 1996 confirms that pay-when-paid clauses in cases of upstream insolvency are excepted from the prohibition on conditional payment clauses.

Section 110A: payment notices

Section 110A(1) requires a construction contract to provide for a payment notice to be given not later than five days after the payment due date

Requirements of a payment notice

The payment notice must specify:

  • The sum is considered as due.
  • The basis on which that sum was calculated.

Scheme for Construction Contracts 1998 implied: section 110(3)

If the parties do not include in their contract the payment notice requirements in section 110A(1), the relevant provisions of the Scheme are implied into the contract (section 110(3)).

Paragraph 9 of the Scheme requires the paying party to give a payment notice no later than five days after the due date for payment.

Applications for payment

Many contracts require the unpaid party to notify the paying party or specified person of the sums it considers will be due to it on the payment due date and the basis on which that sum is calculated. These are usually known as applications for payment.

For an example of the sort of schedule the parties may agree to, see Stuart-Smith J's judgment in Grove Developments Ltd v Balfour Beatty Regional Construction Ltd [2016] EWHC 168 (TCC), where the parties had agreed a monthly schedule dealing with the making of 23 interim applications and payments, but did not provide for what would happen if there were contract overruns.

Leeds City Council v Waco UK Ltd

In Leeds City Council v Waco UK Ltd [2015] EWHC 1400 (TCC), Edwards-Stuart J considered the payment terms of JCT DB05 and held that Waco's application for payment 21 was invalid as it was made too early.

Standard form construction contracts contain different payment mechanisms again. Leeds City Council v Waco demonstrates that parties should comply strictly with the payment provisions in their contract so that they do not get caught out. Here Leeds had not served the relevant payment or withholding notice (the contract was entered into before the effective date), but was able to avoid the consequences of that failure by challenging the validity of Waco's application for payment.

Caledonian Modular Ltd v Mar City Developments Ltd

The issue of interim applications for payment was also before Coulson J in Caledonian Modular Ltd v Mar City Developments Ltd [2015] EWHC 1855 (TCC).

In a judgment that is consistent with Edwards-Stuart J's judgment in Leeds City Council v Waco (albeit for different reasons), the court held that a contractor could not issue an application for interim payment approximately half-way through a payment period and outside the agreed contractual (and statutory) payment mechanism.

The court also suggested that contractors should ensure their interim payment claims were clear and the employer was given reasonable notice that the payment period had been triggered.

Henia Investments Inc v Beck Interiors Ltd

In contrast, in Henia Investments Inc v Beck Interiors Ltd [2015] EWHC 2433 (TCC), Akenhead J suggested that, when construing or understanding whether a document was a particular interim application, it was necessary to consider the wording of clause 4.11.1 of the JCT Standard Building Contract without Quantities, 2011 Edition (SBC/XQ 2011), which provided that an interim application could be submitted at any time more than seven days before the payment due date. In theory, this meant a contractor could submit all its applications for payment on day one of the contract, although it was unlikely that "sensible contractors would do this".

Akenhead J also highlighted the importance of knowing whether a document filed by a contractor was an interim application for payment. This was because the application becomes the contractor's default payment notice if the contract administrator fails to issue an interim certificate in time. This meant an application for payment must be free from ambiguity and must be "in substance, form and intent an Interim Application".

Section 111: requirement to pay notified sum and pay less notices

Section 111 of the Construction Act 1996 (as amended) requires the paying party to make payment by the final date for payment, and a party must serve a "pay less notice" if it wants to pay less than the notified sum.

Paying party to pay notified sum

Section 111(1) of the Construction Act 1996 requires the paying party to make payment of the "notified sum" by the final date for payment. It defines the "notified sum" as the amount specified in the payment notice served under sections 110A(2) or 110A(3) (section 111(2)).

Giving a pay less notice

Section 111(3) allows the paying party to pay less than the notified sum, provided the paying party or specified person gives a notice:

  • Setting out the sum considered to be due on the date the pay less notice is served, including the basis of the calculation (section 111(4)). The sum referred to in the pay less notice may be zero.
  • That is served no later than the prescribed period before the final date for payment (section 111(5)(a)). The parties are free to agree what the prescribed period is, failing which, the Scheme will imply 7 days into the contract.

Note that:

  • If the paying party or specified person serves a pay less notice, the paying party must pay the amount specified in that pay less notice by the final date for payment (section 111(6)).

Pay less notice to be clear and unambiguous?

In Severfield (UK) Ltd v Duro Felguera UK Ltd, Coulson J considered the guidance from a number of judgments, including Henia Investments Inc v Beck Interiors Ltd and Caledonian Modular Ltd v Mar City Developments Ltd, and confirmed that a contractor's default payment notice must:

  • Set out the sum due.
  • Set out the basis on which the sum claimed is calculated.
  • Be set out with proper clarity and be free from ambiguity.

Paying party must serve pay less notice to withhold money

The paying party must serve a pay less notice to withhold money. If the paying party fails to serve a pay less notice and fails to pay, the unpaid party has the right to:

  • Suspend performance of any or all of its obligations under the contract.
  • Give notice of its intention to refer a dispute to adjudication.

However, it is important to remember that interim payments are "interim". If the paying party does not serve a pay less notice regarding one payment, it could serve a pay less notice relating to the next payment giving a recalculation of sums due.

This was confirmed in Harding (t/a M J Harding Contractors) v Paice and another [2015] EWCA Civ 1231, where Jackson LJ in the Court of Appeal noted that an employer's failure to serve a pay less notice had limited consequences because, while the employer may have to pay the full amount the contractor had claimed, it could argue about the figures at a later date (at the next interim application).

Failure to serve pay less notice means value of works agreed

Edwards-Stuart J scrutinised the section 111 payment regime in two judgments with very similar facts, ISG Construction Ltd v Seevic College [2014] EWHC 4007 (TCC) and Galliford Try Building Ltd v Estura Ltd [2015] EWHC 412 (TCC). In both cases, the employer failed to serve a pay less notice, resulting in the contractor starting an adjudication. The employer then started its own adjudication, seeking the sum claimed in the interim certificate/application for payment to be revalued:

  • In ISG v Seevic, the court held that the lack of a pay less notice meant the employer (Seevic) had agreed the value of the works claimed in an interim certificate and the adjudicator had decided the question of the value of those works. This meant the second adjudicator lacked jurisdiction as he was asked to decide the same dispute.
  • In Galliford v Estura, the court confirmed what it had meant in ISG v Seevic, that is, the employer had agreed the value of the works claimed in an interim certificate and the adjudicator had decided the question of the value of those works. However, that did not mean there was agreement as to the value of the work at some other date. It also meant the employer was prevented from starting a second adjudication to determine the value of the works at the date of the interim application, but it did not prevent the employer from challenging the value of work in the next (or later) application 
  • Interestingly, in Harding (t/a M J Harding Contractors) v Paice and another, Jackson LJ highlighted that the judgments in ISG v Seevic and Galliford v Estura dealt with interim applications for payment, not a contractor's final account. The court confirmed that the principle that the employer was "deemed to have agreed the valuation" did not apply to final accounts, something Edwards-Stuart J had said in Galliford v Estura.

Insolvency and section 111

Section 111(10) of the Construction Act 1996 provides that the paying party will not be required to make payment under section 111(1) provided that both:

  • The contract provides that the paying party need not pay any sum due if the unpaid party becomes insolvent. (The definition of insolvency is set out in section 113 (section 111(11))
  • The unpaid party becomes insolvent after the prescribed period referred to in section 111(5) (that is, after the time for the giving of a pay less notice has expired).

This insolvency saving provision follows the House of Lords' decision in Melville Dundas Ltd (in receivership) v George Wimpey UK Ltd [2007] UKHL 18 where:

Liquidated damages and section 111

A paying party must serve a valid pay less notice if it wants to deduct liquidated damages from money certified as due to the unpaid party. If the pay less notice is valid, the paying party can rely on it, even if circumstances later change (Reinwood Ltd v L Brown & Sons Ltd [2008] UKHL 12).

Dually qualified in English and Scottish law, Head of Construction Phil Morrison has over 25 years’ experience working with large private and public sector bodies to deliver infrastructure projects and to maintain their property portfolios.