Payment Notices: Construction’s harshest lesson – and you’re paying for it

Cash flow is widely recognised as the lifeblood of the construction industry. The significance of preserving it continues to lead to disputes in relation to interim payments.

The statutory provisions relating to interim payments introduced by the Housing Grants, Construction and Regeneration Act 1996 (as amended) (“Construction Act” or the “Act”) were designed to promote certainty and preserve cash flow for live projects.

In practice, however, the Act’s provisions have created a system in which administrative failures can have significant financial consequences. One of those consequences is the “smash and grab” adjudication; a claim by a ‘payee’ (i.e. party seeking payment (e.g. a Contractor)) to recover a “Notified Sum” based on the paying party’s failure to serve a valid Payment or Pay Less Notice on time.

What are the notice provisions?

Sections 109 to 113 of the Construction Act establishes a ‘benchmark’ framework concerning the entitlement to payment, the timing of payments, and the administrative functions of the notice regime. Central to that framework is the right under Section 109 of the Act to ‘staged payments’ as works progress under a live project.

To comply with Section 110 of the Act, a construction contract must include an “adequate mechanism” for determining when payment becomes due, and when, and a final date for payment. S110A requires a construction contract to contain compliant provisions for “Payment Notices”. Where a contract fails to comply with these requirements, the relevant provisions of the Scheme for Construction Contracts (Scotland) Regulations 1998 (the “Scheme”) fill the gaps.

Under the Scheme, payment becomes due 7 days after the valuation date or the making of a claim (whichever is later). This is known as the “Due Date”. The “Final Date for Payment” is 17 days after the Due Date. The Final Date for Payment is to be taken literally – it is designed to act as ‘long stop’ for sums outstanding.

An example of a mechanism not being ‘adequate’ can be found in Lidl Great Britain Limited v Closed Circuit Cooling Limited (t/a 3CL) [2023] EWHC 2243 (TCC). In that case, the contract’s mechanism for determining the Final Date for Payment was conditional on the submission of a VAT invoice by the Contractor. It was held this requirement was non-compliant with Section 110 as the Final Date for Payment must be calculated with reference to a specified period after the Due Date, rather than being triggered by an event (or mechanism) which is not compliant with the Act.

The Act and Scheme’s provisions are designed to operate in a sequenced and time-sensitive format, which can be broken down as follows:

• Application for Payment

  • If the contract provides for it, an “Application for Payment” is served by the payee.
  • The Application for Payment sets out the sum the payee considers is due and explains how that sum has been calculated.

• Payment Notice

  • In response (or, by default, if there was no obligation in the contract for the Contractor to serve an Application for Payment), the payer must serve a “Payment Notice”.
  • In order to be deemed valid, Section 110A of the Act stipulates that a Payment Notice must be:
    • served no later than 5 days after the Due Date
    • state the sum that the payer considers is due
    • and explain how that sum was calculated (e.g. simply stating a value without explanation is generally deemed as making it invalid).
  • NOTE: If the payer fails to validly serve the Payment Notice in time, then per Section 110B of the Act, the Contractor can serve a “Default Payment Notice” at “any time after” the Payment Notice was due to be served by the paying party. The sum contained within the payee’s Default Payment Notice then becomes the Notified Sum.

• Pay Less Notice

  • If no Payment Notice was served – or even if it was – the paying party has a further chance to have its say on the Notified Sum by serving a “Pay Less Notice” in accordance with Section 111(3) of the Act.

• • A Pay Less Notice must be:
    • issued no later than the “prescribed period” – which can be agreed between the parties under contract or, failing which, set by the Scheme to be 7 days before the Final Date for Payment
    • and specify the basis of which that sum is calculated (i.e. specifying – with accompanying calculations – the proposed deductions, such as for example, any contractually agreed Liquidated and Ascertained Damages or ‘LADs’ for short).

What makes a notice valid?

For each notice referred to above, the recurring mandatory requirement is serving a valid notice. The obvious question is: what makes a notice valid? In practical terms, the following are key requirements:

• Timing of service

  • Serving a Payment and/or Pay Less Notice late makes it invalid.
  • The procedure is sequenced and time sensitive for the purposes of preserving the cashflow of a live project.
  • A notice must be received within the prescribed timeframe, and parties must have regard to the time sensitivity of the notice provisions.

• Method of service

  • Most construction contracts specify how a Notice must be served.
  • Provisions for permitted methods of service may include service by email, post, project management systems/portals, to a specified recipient or address, and when service is deemed to take effect.
  • A Notice sent to the wrong person, to an incorrect address, or by an unauthorised method may be invalid, regardless of its content.

• Detail

  • As outlined above, Payment and/or Pay Less Notices must be clear.
  • They should state the sum considered to be due together with a basis behind that sum. If the Notice is vague or could be mistaken/interpreted for something else (e.g. an invoice), it may be deemed to be invalid.

What are the consequences of failing to comply?

Failure to adhere to the notice provisions/make payment of the Notified Sum, can have significant impacts on a project for the paying party.

Under Section 112, the payee has the right to “suspend performance” (i.e. down tools) if they have not received payment, provided that the payee gives the paying party – who is now in default – 7 days’ notice of its intention and its reasoning for doing so. The paying party may also be liable, in addition to paying the Notified Sum, for the payee’s reasonable costs and expenses as a result of suspending performance. The payee’s right to suspend performance ends once the paying party makes payment in full.

Another implication is the so-called smash and grab adjudication. The Adjudicator’s role in such an adjudication is deliberately narrow. As established in S&T (UK) Ltd v Grove Developments Ltd [2018] EWCA Civ 2448, the adjudicator will not simultaneously consider the ‘true value’ of what should be paid to the payee, but rather whether the paying party is contractually/statutorily obligated to make the payment.

Vast sums have been awarded simply based on these technicalities, which serve as the industry’s harshest lesson. All of this is not to say the Notified Sum represents the final determination of what is owed. Per Grove, the paying party retains the right to challenge the true value of the work carried out by the payee, but only after first discharging its immediate obligation to pay the Notified Sum. The paying party must pay the Notified Sum before launching its own “true value adjudication”. This is known as the “pay first, challenge later” principle.

The consequences of falling short are unforgiving, however, arguably, it is supposed to be unforgiving when considering the industry’s focus on preserving cash flow. Disputes over payment cannot be eliminated entirely, however, in the context of payment provisions, they can often be avoided through careful contract administration. Active management of payment cycles, monitoring of key dates, and ensuring compliance can help mitigate against the risk of payment disputes arising and preserving a project’s viability by avoiding costly delays caused by suspension of works and/or smash and grab adjudications.

How we can help

Our Construction Disputes team regularly advises employers, contractors and subcontractors on payment and notice provisions, including pursuing and defending smash and grab/true value adjudications. Whether you are seeking to avoid a dispute or respond to one, early intervention and legal advice can prove to be critical with respect to managing the dispute and navigating the next steps effectively.

If you have any queries relating to payment notices, adjudications, or any issues arising from payment disputes under construction contracts, please contact Ayub Ahmed or a member of our Construction Disputes team.