Payers beware

The recent case of ISG Construction Ltd vs Seevic College is one of the first reported cases on the new payment provisions in the Construction Act.

It serves as an important reminder to all payers to serve their payment and pay-less notices in accordance with their contract and the act.

In this case, Mr Justice Edwards-Stuart held that:

• As the first adjudicator had determined that the sum claimed by the contractor was the sum due, the second adjudicator’s decision on the actual value of works in the same application could not be enforced, as it decided the same dispute  
• This was on the basis that the employer’s failure to serve either a payment notice or a pay-less notice in response to a contractor’s interim application for payment meant that it had agreed the value of the works claimed by the contractor in its application.  

In practical terms this meant that:

• The contractor was entitled to a payment of £1,097,696, being the amount it was awarded in the initial adjudication solely on the basis that the employer had failed to serve any payment and pay-less notices (commonly referred to as a “smash and grab” adjudication)  
• The employer was not entitled to deduct £768,525 from that amount, being “the overpayment” the second adjudicator determined on the assumption that the £1,097,696 had been paid based on the actual value of the works in the same application (the “value adjudication”).

Given the wording and intention of the Construction Act, the result that the contractor was entitled to the amount claimed in its interim application in the absence of any payment or pay-less notice is not surprising.

What may be surprising to some is that the employer could not then set off any overpayment based on the adjudicator’s determination of the actual value of the works. The use of such “value” adjudications in response to “smash and grab” adjudications had previously been a common tactic to try and avoid interim windfalls to payees. 

The judge’s rationale that, in the absence of a payment or pay-less notice, the payer is taken to have agreed the value in the contractor’s application, will also create a stir. The wording of the Construction Act and the JCT Design & Build contract only provide that, in the absence of a payment or pay-less notice, the sum stated in the contractor’s application becomes due. There is nothing to suggest that the value of the works then also becomes agreed.

The decision appears to leave open the possibility that a payer can correct any overpayment in subsequent interim valuations. However, there is a risk that to do this a payer could have to wait until the final payment under a contract (which may be some time away) if:

• The payee subsequently chooses not to make any further interim applications
• Where the contract does not provide a right for the payer to claim an overpayment back until the final payment, and there is an insufficient amount due to the payee in the subsequent interim applications from which the payer can deduct the overpayment.

As such the risk of a payee gaining an interim windfall will be higher towards the end of the works. In our experience, it is at exactly this time when payers seem to fail to respond to interim applications.

This is either because they are busy trying to resolve the final account position with the payee, or because the status of the document provided by the payee is not always clear (that is, whether it is an interim application or final account submission).

What is not clear from the decision is the consequence of failing to serve any payment or pay-less notice in the final payment process. Would this mean that the value of all the works is deemed to be agreed such that the payer would then be prevented from recovering
any overpayment upon a final determination of the actual value either in litigation or arbitration? 

A case decided by the same judge in the previous week (Matthew Harding, t/a M J Harding Contractors, vs Gary George Leslie Paice, Kim Springall), in respect of a failure to serve a pay-less notice apropos of a payment on termination suggests that this would not be the position.

The employer is seeking permission to appeal this case and so hopefully this will give us some further clarity. Nevertheless, the case reminds us of the importance of issuing payment and pay-less notices, especially towards the end of the works and in any final payment process. Although doing so may not always avoid a dispute on the value of the works, it should prevent the payee from obtaining an interim windfall.

Helen Stuart is a senior associate at Trowers & Hamlins