Payment schedules: are you in “Grove danger”?

If you are unaware of the recent decision in Grove Developments Ltd v Balfour Beatty Regional Construction Ltd [2016] EWHC 168 (TCC) then take note. This is a decision that could have a significant impact on the construction industry.

The statutory payment regime

Despite Parliament’s best intentions, the statutory payment regime required by the Housing Grants, Construction and Regeneration Act 1996 (as amended by Part 8 of the Local Democracy, Economic Development and Construction Act 2009) (Construction Act 1996) is about as straightforward as the name of the legislation that introduced it!

Parties are required to follow the monthly payment process prescribed by the Construction Act 1996, which provides for separate dates by when:

• the contractor must submit its application, if the contract allows or requires it to do so (as many standard form contracts do);
• the employer must notify the contractor of its assessment of the interim payment to be made that month (the “payment notice“);
• the notified sum becomes “due”;
• the employer can issue a notice that it intends to pay less than the notified sum (a “pay less notice“); and
• the notified sum must be paid.

The potential consequences of getting those dates wrong can be significant. An employer’s failure to serve a payment notice on time can mean it must, subject to issuing a pay less notice, pay the sum stated as due in the contractor’s application (provided that application complies with section 110B(4)). It also means that the employer is deemed to have agreed to the value of the works claimed in the application (ISG Construction Ltd v Seevic College and Galliford Try Building Ltd v Estura Ltd). The employer could not, therefore, adjudicate over the proper value of the interim payment.

On the other side of the coin, a contractor’s failure to serve an application on the right date can mean it loses its right to payment in that month (Leeds City Council v Waco UK Ltd).

As a result, it has become common practice for parties to a construction contract to include a payment schedule in their contract mapping out who needs to do what and by when. This is a sensible measure, designed to simplify matters. As you would expect, payment schedules typically identify the relevant dates for the monthly payment cycle up until the date of completion. But what happens when there is a delay to the project and the works continue beyond the dates set out in the payment schedule?

What was the dispute about, and what did the court decide?

In Grove Developments v Balfour Beatty, the parties had agreed a payment schedule that provided for the contractor to make 23 interim applications, covering the period from September 2013 to July 2015. The project was delayed and works were still on-going after July 2015, by which time the contractor had already issued 23 interim applications. However, the contractor continued to issue interim applications. Interim application 24 (IA 24) was issued in August 2015, claiming £23,166,425.92.

The employer challenged the validity of IA 24 in Part 8 proceedings and Stuart-Smith J found in the employer’s favour. The contractor had no entitlement to be paid in respect of IA 24, nor any subsequent applications.

What does this mean for contractors and employers?

As a result of this decision, where parties include a payment schedule in their contract that does not make express provision for further interim payments should the works be delayed, the contractor is only entitled to apply for the specified payments prior to the final payment mechanism kicking-in after practical completion.

To put it another way, if the works were to be completed in 12 months and the parties provided for 12 interim payments, that is all the contractor is entitled to apply for. If the works are delayed for any reason, the contractor is not entitled to make further applications.

Analysis

On the face of it, the decision seems harsh (albeit there is a complicated factual background that may have had an impact).

In order to reach his decision, Stuart-Smith J was unwilling to accept the defendant’s arguments that:

• Section 109(1) of the Construction Act 1996 requires installment payments to be made for all work under a construction contract lasting more than 45 days and thus the provisions of the Scheme for Construction Contracts 1998 must be imported. Stuart-Smith J considered that this would be a draconian restriction on the freedom of commercial parties to contract on terms of their choosing and, further, section 109(2) allows parties to agree the amounts of the payments and the intervals at which, or circumstances in which, they became due.
• There was an implied term that interim payments would continue. This was said to be inconsistent with the contract’s express terms and commercial common sense did not demand or justify the implication of such a term.
• The schedule was varied by correspondence between the parties regarding an extension to it (which broke down due to lack of agreement on the payment dates). Stuart-Smith J held that there was a lack of sufficient agreement at all times as the prospect of further interim payments was inextricably linked with agreeing the terms on which they would be made.
• The employer was estopped from contending that the contractor was not entitled to make a further interim application because it had issued payment certificates in respect of the contractor’s applications made after the expiry of the schedule. Stuart-Smith J held that this was not right because:
  • it was a classic example of an attempt to use estoppel as a sword rather than a shield; and
  • the issuing of the payment certificates was equivocal and was consistent with the employer “going along” with the contractor issuing applications as it “did not wish to alienate a contractor who was already in delay”.

The parties had originally indicated in the contract particulars to their amended JCT Design and Build Contract, 2011 Edition (DB 2011) that they had elected for stage payments. Therefore, one might think that this had an impact on the decision: by electing for stage payments and adopting the payment schedule, the parties had limited themselves to 23 payments. Not so. Stuart-Smith J dealt with this issue as part of his comprehensive judgment. He held that, on the facts, by agreeing to the payment schedule, the parties had made a specific amendment to the contract and “Alternative A” was no longer the chosen alternative. In other words, they had reverted to periodic interim payments.

The significance of this is that if parties adopt a payment schedule, even in the context of an interim payment regime (as opposed to stage payments), it seems to mean that they will be taken to have limited themselves to the interim payments set out in the schedule.

What should contractors do to avoid this issue?

This decision is likely to have a widespread impact on the construction industry, where payment schedules are commonplace. The solution should be relatively simple. Where a payment schedule is included, provide for it to be extended (on the same terms) for subsequent months should the works be delayed. This will not help those contractors who have already exceeded the payment schedules in their contracts. However, where the contract is still within its original schedule, employers may agree to vary the terms of the contract, rather than setting up an inevitable conflict in the event of any delay to the completion date.

This decision is also consistent with a recent trend of cases where the courts have shown a reluctance to allow a contractor or sub-contractor to recover an amount stated in its application, despite the absence of valid payment or pay less notices. For example, see:

• Leeds City Council v Waco UK Ltd and Caledonian Modular Ltd v Mar City Developments Ltd, where the interim application was invalid as it had been delivered prematurely.
• Henia Investments Inc v Beck Interiors Ltd, where the interim application was held to be ineffective as it did not clearly state the sum that would become due on the “relevant payment date”, as the contract required.
• Severfield (UK) Ltd v Duro Felguera UK Ltd, where an interim application was invalid because it contained works excluded from the scope of the Construction Act 1996’s payment regime.

The clear message from these cases is that if a contractor or sub-contractor wishes to rely on its interim application as a default payment notice then it must be made on time and be clear and unambiguous. Applications should, for example, clearly set out what it is, the date on which it is made (as opposed to the date of submission), the total amount due, amounts previously paid, the net payment due, and the basis on which it is calculated.

The statutory payment regime may be complicated but, as all of these recent cases demonstrate, the consequences of getting it wrong (particularly for the payer) are potentially very serious.

This article was originally published on Practical Law’s Construction Blog.