New payment regime in construction contracts

New payment regime in construction contracts

An employer must serve a valid withholding notice if it wishes to avoid paying a sum due under a construction contract. Recent changes to the law now mean that failure to serve valid notices may have a detrimental impact on an employer's cash flow.

The Local Democracy Economic Development and Construction Act 2009 (the New Act), came into force on 1 October 2011 to help to address problems which pervaded the payment regime under the Housing Grants, Construction and Regeneration Act 1996 (the Old Act).

The Acts apply to 'construction contracts' - and whether or not your agreement falls within the definition of a construction contract is not straightforward.

Agreements ranging from undertaking design or surveying work to those relating to advice on building, engineering, decoration or landscaping are all caught by the Acts if they relate to 'construction operations' (as defined by the Acts).

If the Acts do apply, then so do their provisions relating to payment terms. These will be implied into the contract if either the contract does not contain the terms required by the Acts or if the contract's payment terms are contrary to the Acts.

The new payment rules introduced on 1 October 2011 are more stringent on employers and they apply to construction contracts entered into on or after that date. Under the Old Act, this was not as much of a concern as explained below, but under the New Act the consequences of non-compliance will be severe.

Under both Acts an employer must serve a valid withholding notice (under the New Act a Payless Notice) if it wishes to avoid paying a 'sum due' under the contract.

The 'sum due' is usually determined by either:

  • a contractual mechanism involving a contract administrator or architect's certification of the sum due
  • if it is a construction contract governed by the Old Act, by an employer issuing a notice pursuant to the Old Act
    Under the Old Act, as there was no effective sanction imposed on the employer if it failed to issue an employer's notice, this requirement was often ignored.

In both cases, but particularly the case where there was no employer's notice, an employer would argue that there was no 'sum due' which it needed to withhold against - arguing that either the work had not been carried out or that it was defective, and as such had no value. As it had no value, there was nothing 'due' for the employer to have to withhold against.

Naturally a lot of case law arose from this state of affairs, which although binding created a great deal of uncertainty, especially for the employer.

Under construction contracts governed by the New Act, if the employer fails to issue a notice to state what sum is due, then either the contractor's application/invoice for payment or its default notice (the Contractor Notice) defines what sum is due.

Unless the employer issues a Payless Notice setting out what he disputes is due and why, the Contractor's Notice must be paid.

Although errors and overpayments may in some instances be corrected in later certificates/invoices, the effect of having to pay an invoice which contains sums that should not otherwise be due (for example by reason of work not having been carried out), is likely to have significant consequences for an employer's cash flow.

Whilst the changes may seem stringent, the employer has two chances to address what sum is due under the contract. Despite the fact that disputes as to the content and timing of notices may still exist, the amendments seek to, and will no doubt achieve, the reinforcement of the principle behind both Acts, namely to improve cash flow throughout the construction chain.

For those parties for whom construction is not a main part of their business, it is easy to get caught out unless notices are in the correct form, served on time and in the correct manner.

Shoosmiths' construction team regularly advise on the effectiveness of notices and payment disputes.