Cheques and balances

Intended to reduce the number of disputes in a claims-stricken industry, the Housing Grants, Construction and Regeneration Act arrived in 1998. It has spawned a substantial body of case law, but only recently has it been considered by the UK’s ultimate court, the House of Lords.

The basic aim of this act is to give contractors the right to submit regular applications for payment, and to oblige the employer to make regular payments in return for those applications. Cash flow is the lifeblood of the construction industry and the act is there to ensure it keeps flowing. An employer is only entitled to withhold payment from a contractor where a withholding notice is served within a specified timescale, stating the grounds for keeping back payment in accordance with section 111 of the act. Where no notice is served, the contractor is entitled to the full amount applied for.

However, where a contractor is insolvent, an employer does not have to pay sums that are due. Instead, the employer is able to offset losses suffered as a result of the contractor's insolvency against any outstanding payment due to the contractor. This provision is incorporated into many standard-form contracts, including JCT2005 and NEC3. So, does this contradict the provisions of the Housing Grants Act? And, what happens when an employer only becomes aware of a contractor’s insolvency after the final date for serving any valid withholding notice?

A case in point

These questions were put to rest in the recent case of Melville Dundas (in receivership) v George Wimpey UK. The contract involved was a JCT with Contractor’s Design 1998. It allowed the employer to terminate the contract on the insolvency of the contractor. It also allowed the employer to set off any sum due to the contractor against losses resulting from insolvency.

Cash flow is the lifeblood of the construction industry and the act is there to ensure it keeps flowing

On 2 May 2003, the contractor submitted an interim invoice for £396,630. The final date for payment by the employer was 16 May 2003. The employer did not pay the contractor by that date and on 22 May, administrative receivers were appointed for the contractor. The employer then terminated the contract and refused to make payment, relying on clause 27.6.5.1, which allows set-off in relation to losses resulting from insolvency.

But the contractor argued that this was contrary to the provisions of the Housing Grants Act, because no valid withholding notice had been served. The employer countered that it had been impossible to serve a notice in time, because it only became aware of the relevant circumstances after the period for serving a withholding notice had expired.

An appeal to the Scottish Inner House, the Scottish Court of Appeal, agreed with the administrative receiver that the contractor was entitled to payment in the absence of a valid withholding notice. It held clause 27.6.5.1 was contrary to the act and so could not be relied on.

The employer took the case to the House of Lords. Here a majority ruled an employer should be entitled to rely on a contractual provision allowing it to set off losses incurred as result of a contractor’s insolvency against any sums due to that contractor.

What about the absence of a valid withholding notice? The Lords considered that parliament, when approving the law, had probably not considered a situation where the insolvency only became known after the time for serving a valid withholding notice had expired. It therefore decided that section 111 was not intended to apply to situations of insolvency.