Under Construction: Legal developments in the UK construction industry | December 2023

Construction Act compliance: deducting liquidated damages and setting the final date for payment

The recent decision in Lidl Great Britain Limited v Closed Circuit Cooling Limited t/a 3CL has provided some clarity on a number of tricky payment-related issues in the construction market, including when liquidated damages should be deducted (clue – don't use a payment notice), and whether the final date for payment under a construction contract can be linked to the submission of VAT invoices.

The case involved a framework agreement between the supermarket retailer Lidl (the Employer) and an industrial refrigeration contractor which traded as 3CL (the Contractor). The dispute centred around the 19th payment application for a works order under that framework agreement. The framework agreement was a "construction contract" for the purposes of the Housing Grants, Construction and Regeneration Act 1996 (the Construction Act), and so had to comply with the requirements of the Construction Act as regards payment terms.

Among a number of issues, the judge was asked to decide:

1. Whether a payment application was invalid because 3CL had failed to comply with all the stipulated requirements for payment applications.
2. Whether the payment notice from Lidl was also invalid because it was said to be a pay less notice as well.
3. Did the payment terms generally comply with the Construction Act if the final date for payment was set by reference to the date of delivery of a compliant VAT invoice?

Issue 1: Was the payment application valid?

Construction contracts will often come with a lengthy list of requirements for what is needed to constitute a valid payment application, but whether these constitute conditions precedent to a valid payment application or are just contractual obligations that could be breached but do not invalidate the payment application will depend on the construction of the clause.

The judge felt that the inclusion of the word "must" before a list of requirements that applied to the submission of a payment application for a payment milestone would not automatically make those requirements conditions precedent to a valid payment application. He ultimately favoured 3CL's argument that in order for the requirements to be condition precedent:

• There should be a statement that, in the absence of compliance with each and every one of these requirements, the payment application would not be an effective payment application.
• The requirements should be precise enough that should a dispute arise, it would be straightforward to decide if they had been met. While it may be tempting to include a sweeper of "any other supporting information", this would be too imprecise as to what was required from the contractor, and therefore preclude a finding that delivery of such information was a condition precedent.
• There should be a compelling reason for requiring compliance to be a condition precedent to the payment application. In this case, Lidl was also required under the same payment mechanism to inspect the works itself, so should have been able to identify itself whether the contractor had achieved the payment milestone without 3CL checking off all of the requirements required under its payment application to show it had satisfied the payment milestone.

Issue 2: Was the hybrid payment/pay less notice valid?

The judge decided that any deduction for liquidated damages should be made in a pay less notice and not in a payment notice, regardless of whether the pay less notice references the terms of the contract or the provisions of the Construction Act. In absence of any precedent on this issue, the judge took his lead from Coulson’s Construction Adjudication 4th edition, which commented that the Construction Act originally allowed for combined notices but that these provisions were deleted in their entirety in the amended Construction Act.

Lidl's payment notice described itself as pay less notice, but then set out what was required of a payment notice under the contract, while also levying liquidated damages, which was not what the contract described the payment notice should do. Both the judge and the adjudicator looked at what the reasonable recipient of such a notice would have assumed it to be. They both agreed a reasonable recipient would consider a notice labelled as a pay less notice to be a pay less notice not a payment notice. As such, the notice was not considered to be valid.

Issue 3: Did the payment terms comply with the Construction Act?

Under the contract, the final date for payment was linked to the delivery of a VAT invoice along with a copy of the corresponding payment notice. Lidl argued that the final date for payment had not arisen, as, while a VAT invoice had been received, the payment notice had not been attached by 3CL. 3CL argued that linking the final date for payment to conditions other than the due date, such as the submission of a VAT invoice, was contrary to the requirements of the Construction Act, meaning that the terms of the Scheme for Construction Contracts were implied into the contract.

If this issue sounds familiar, it is because it relates to an obiter comment in a 2020 decision in Rochford Construction Limited v Kilhan Construction Limited, where Mrs Justice Cockerill considered that a final date for payment linked to anything other than the due date would not be Construction Act compliant. The judge in this case decided he could follow Rochford as, while it was an obiter comment, it was a careful and reasoned decision on the law. He felt the Act: "allow(s) the parties a wide discretion as regards when payments become due under a contract, constrained only by the requirement that it be an adequate mechanism and the specific anti-abuse provisions of s.110(1A) and (1D), but in contrast a much narrower and more circumscribed discretion as regards the final date for payment – only as to the length of the period between the due date and the final date."

In other words, the final date for payment under a construction contract must occur by reference to a specified period between the due date and the final date for payment. A contract that connects the occurrence of the final date for payment to the happening of any other event will fall foul of the requirements of the Construction Act.

Building owner fined for 11 month delay to cladding remediation

Newham Council is the first local authority to successfully prosecute a building owner for failing to remove flammable cladding ahead of the improvement notice deadline issued by the council.

The council pursued its claim under section 30 of the Housing Act 2004 against the freehold building owner Chaplair Limited.

In September 2020, Chaplair was issued with an improvement notice that required the cladding, which had been found to be unsafe, to be removed from the building in East London. The building is a nine-storey block of flats containing 71 residential flats and there were four types of dangerous cladding used, including aluminium composite (the cladding used on Grenfell Tower). The deadline for removal was 31 March 2021. However, the remedial works did not start until May 2021, with a completion date of February 2022.

Chaplair blamed delays on:

1. disagreements over contractual terms with the initial contractor, Willmott Dixon (which had also been the building's initial design and build contractor), that Chaplair deemed to be unacceptable;
2. government funding issues; that is, the Building Safety Fund (BSF);
3. a delay in gaining permission from Network Rail to carry out certain works; and
4. the Newham Council's failure to properly consider a request for an extension to the deadline.

None of these reasons were considered to constitute a "reasonable excuse" by the Court for the delay in complying with the improvement notice. On point two, the judge considered Chaplair to be taking a gamble on the government eventually picking up the bill under the BSF, and this was not reasonable justification for delay. On 22 October 2023, Chaplair was found guilty and at a sentencing hearing shortly after Chaplair was fined £30,000 in addition to being ordered to pay a £30,000 contribution towards the council's costs, therefore totalling £60,000.

The decision is the first prosecution for failure to remove cladding and sends an important message to the industry that improvement notices under the Housing Act 2004 must be taken seriously. While all reasonable excuse cases are unique to their own facts, in this case the court has demonstrated an unsympathetic approach to delaying safety-critical works while seeking to secure public funding or negotiating contract terms.

Defining what is deleterious

Against a high-profile backdrop of claims relating to fire safety, and the structural integrity of schools and other public buildings constructed from reinforced autoclaved aerated concrete (RAAC), the issue of whether the materials used in a building's construction are suitable has become increasingly contentious.

The language used in consultancy agreements and building contracts is key to determining who bears the contractual responsibility for the specification and use of deleterious materials. As employers and contractors pore over historic contracts in order to determine contractual liabilities for the use of the deleterious materials currently hitting the headlines, the provisions of contracts being entered into now need to be scrutinised. Do the provisions in those contracts provide sufficient protection against specification and use of deleterious materials in projects which have not yet been constructed?

RAAC was used in the construction industry for several decades from the 1950s onwards, but the risks associated with it aren't new. By all accounts, RAAC was only ever intended to have a lifespan of 30 years, but the problems associated with it crumbling were not widely recognised until the 1990s, and the Department for Education had been issuing warnings to stakeholders for several years prior to the recent controversy. So one could say that RAAC has been generally known as a deleterious material for a number of years.

Ultimately, if a design appointment or contract specifies a standard of care that the party should use when carrying out their obligations, then that is likely to be the standard of care that they will be held to – regardless of any additional wording around the current standards of specification in respect of deleterious materials. In other words, if a prudent and experienced design consultant wouldn't have specified it in the circumstances, the consultant or contractor would be in breach of their standard of care to the client in respect of design.

Nevertheless, it is still good practice to include a statement that the design consultant or contractor has not specified any "deleterious materials" and will immediately notify the client should it becomes aware of any such substance being used in the project. What will be considered deleterious is usually in reference to the following:

• materials or substances harmful to health and safety or the durability of the project;
• materials or substances which are not in accordance with British Standards, codes of practice or good building practice or techniques; and
• usually in the case of projects in the development sector, a reference to materials or substances identified in the latest edition of the BCO's guide "Good practice in the selection of construction materials".

How the current understanding at the time of specification is captured in the appointment will be the most contentious point of any negotiation between client, consultant and their insurers. The consultant will always want it to be at the point of specification, whereas the contractor may well be tied to when the material is used; but, either way, the insurer will inevitably want all of this to be limited to those materials that are known at the time of specification as being deleterious. However, from the perspective of a client who is paying the consultant or contractor for their expertise, the expectation would be those materials "generally known" or "would be expected to be known" using the standard of care in the appointment.

Status quo maintained of giving primacy to an adjudicator's decision

The recent case of Bexhill Construction Ltd v Kingsmead Homes Ltd affirms the continuing trend of the Courts in generally upholding adjudicators' decisions. Where all arguments advanced have been taken into account, even if those arguments are not explicitly referred to in the reasoned award, the threshold to successfully challenge these decisions remains high.

Bexhill Construction Limited was awarded £49,664.80 in an adjudication decision against Kingsmead Homes Ltd, arising from an unpaid payment application.

Bexhill applied for a summary judgment to enforce the adjudicator's award. Kingsmead resisted, arguing that such enforcement would constitute a breach of natural justice. Kingsmead requested that matter be stayed, on the basis that:

1. the adjudicator failed to take account of certain arguments in its response; and
2. there was a probable risk that Bexhill would not be able to repay the judgment sum if later required as a result of insolvency. Kingsmead was relying on a breach of natural justice argument.

Since the case of Pilon Ltd v Breyer Group plc, the question for the Court has been: has the adjudicator failed to consider the questions referred to him, as opposed to whether the issues have been correctly decided.

The adjudicator confirmed that he had taken account of all the arguments advanced by Kingsmead and the Court found there to be no evidence to suggest the contrary. Further, on the facts it was found that on balance there was insufficient evidence to establish a probable risk of insolvency. In short, the Court did not consider the adjudicator to have breached the rules of natural justice.

Her Honour Judge Kelly's judgement affirms the continuing trend of the Court towards upholding the adjudicator's decision in circumstances where all arguments advanced have been taken into account, even if those arguments are not explicitly referred to in the reasoned award. In short, the threshold remains high to resist enforcement of an adjudicator's decision.