Meddling with VAT invoice clauses can sting you

The requirements of the recently changed Construction Act about payment notices are not easy to understand. But some contract drafting lawyers seem to relish the opportunity to make them even more complicated. The latest complication that they have dreamt up relates to VAT.

First of all we need to understand the typical arrangements for interim payment in, for example, a JCT contract.

The contractor submits an application on a date specified in the contract. The payment is due on that date, or the date that the employer receives the application if later. That fixes the “due date”.

The next move is for the employer. It issues a payment notice within the next five days, saying what it intends to pay. That is the amount that is due under the contract. It became due up to five days before.

If the employer thinks it has 28 days to pay, and only needs to put in a pay less notice five days before that, it will be a nasty shock to find out that the scheme applies

Now we need to know the “final date for payment”. In an unamended JCT contract, that date is the due date plus 14 days. The period is often changed to 21 or even 28 days. If the employer wants to pay less than the amount stated in the payment notice it must give a “pay less notice” at least five days before the final date for payment. When payment is made, the employer must add any relevant VAT.

While this should all work perfectly well, some employers and their solicitors are complicating matters by introducing a requirement that the contractor produce a VAT invoice before being paid.

One trick is to say an interim payment will not be due until the employer receives a VAT invoice for the sum stated in the payment notice. Another variety is to say that the final date for payment will be the later of 14 days after the due date and the date of receipt of the VAT invoice.

The motive may be to make sure that all the paperwork is in place, or it may be more sinister - an extra hoop for the contractor to jump through before he is paid. Either way, there is a problem. Neither of these requirements satisfies the Construction Act.

The first version - nothing due until the VAT invoice for the notified sum is received - ignores the fact that the payment notice is given not later than five days after the payment becomes due. If the invoice follows the notice, and the notice must be given after the payment becomes due, the invoice cannot be a condition for the payment becoming due.

The second version applies to the final date for payment. If the final date for payment depends on the date of receipt of the VAT invoice, which might be this week, next week, sometime or never, there is no clear date. That creates two problems. The first is that it is not clear when the final date for payment will be. The second is that the employer does not have an effective date by which it must give a notice of intention to pay less than the sum stated in the payment notice.

These amendments may have some surprising results. If a contract does not satisfy the requirements of the Construction Act, the statutory Scheme for Construction Contracts applies.

If the scheme is imposed on the contract the payment periods may change. Under most contracts payments are made on a calendar month basis, but the scheme has a default provision of 28 day periods. That might cause all sorts of problems with the employer’s financial arrangements. After a few months of thinking that it was paying on time, the employer will find that interim payments have been seriously late.

The scheme provides that the final date for payment is 17 days from the payment due date. That is more favourable to the employer than the 14 days in a standard JCT, but rather tighter than the usual amended date (21 or 28 days). If the employer thinks it has 28 days to pay, and only needs to put in a pay less notice five days before that, it will be a nasty shock to find that the scheme applies and the notice should have gone in 12 days after the payment due date.

Such problems only surface when relationships break down. The employer will serve a pay less notice and the contractor will challenge it on the basis that it was given too late. Thousands of pounds will be spent by both sides in an adjudication. As an adjudicator, I suppose I shouldn’t complain.

John Redmond is an arbitrator and consultant at Osborne Clarke