Payment notices and pay less notices – You’d better believe it!

If a party to a construction contract wants to be paid for work they have completed they have to submit an application for payment to the paying party. Unless the paying party issues a payment notice or a pay less notice setting out the sum they consider to be due in response to the application, they are going to be obliged by the Housing Grants, Construction and Regeneration Act 1996 (“the Act”), if not their contract, to pay the whole of the sum applied for.

If the paying party fails to serve a payment or pay less notice the receiving party can pursue payment through what is generally known as a “smash & grab” adjudication. (This is an oddly pejorative description for what is actually the Act working in the way it was intended and is a procedure widely accepted to have ameliorated cashflow difficulties in the construction industry.)  Even if the paying party does issue a payment notice or pay less notice, the receiving party can still challenge the notice in adjudication; this is usually on one of three grounds:

• Timing – the (contractual or, in default, statutory) deadlines for serving such notices are absolute. A notice that is one day late is ineffective.
• The notice failed to set out “the basis on which that sum is calculated”. It is insufficient for the paying party merely to stipulate a headline figure; the notice must provide an agenda for adjudication.
• Quantum – the receiving party doesn’t accept that the valuation of the works by the paying party is accurate.

As a result of the recent case of Downs Road Development LLP v Laxmanbhai Construction (U.K.) Limited [2021] EWHC 2441 (TCC) however, there may be a new ground for challenging a paying party’s notice – that there is no genuine belief by the paying party as to the sum considered to be due.

The facts

So far as this point is concerned, the background is straightforward.

Downs appointed Laxmanbhai to act as contractor in the construction of four blocks of flats in East London. The contract took the form of an amended 2011 JCT Design and Build Contract. 

On 26 February 2021, Laxmanbhai submitted an interim application. The sum stated to be due was £1,888,660.70.

On 3 March 2021, the Employer’s Agent issued a payment notice stating that £0.97 was due. As he had done previously in several payment cycles, the Employer’s Agent explained in his covering email that it had taken longer than anticipated to assess Laxmanbhai’s application because it was sent on the due date and the volume and form of information provided made it difficult to complete the valuation in a timely manner. Accordingly, it was said that “a further Payment Notice will be issued to you in due course and will not affect your payment date.”

On 9 March 2021, the Employer’s Agent issued a second payment notice to Laxmanbhai. In that, the amount due for payment was £657,218.50, which was subsequently paid on 26 March 2021.

Laxmanbhai commenced an adjudication in relation to the February interim payment and the matter ultimately came before the TCC on an enforcement hearing. One issue before the court was whether the initial payment notice on 3 March 2021 had been validly given.

Downs conceded that its second payment notice (dated 9 March 2021) was out of time and therefore invalid. However, it argued that its first payment notice was valid as it set out the amount that the employer contended was due and said why that sum was due.  

Subjective requirement upheld

The court found Downs’ first payment notice to be invalid also. Both the relevant contract and the Act require notices to set out what the paying party “considers” to be due.

The court held that Downs’ first payment notice did not set out the amount it genuinely considered to be due because:

1. the covering email stated that a second payment notice would be issued;
2. Downs clearly envisaged that the second payment notice would set out a different figure; and
3. Whilst Downs may not have formed a view as to the precise amount it believed was due at the time of giving the first payment notice, it was not credible to suggest it did not realise that a substantially greater sum was due.

The court also found it was not necessary to establish that, in failing to state the amount genuinely considered to be due, the notice giver was acting in bad faith.

Conclusions and implications

This appears to be the first decision to deal with the subjective requirements for payment notices and pay less notices arising from the use of the word “considers” in the Construction Act. The same wording is also found in the JCT standard form contracts for payment and pay less notices.  The upholding of a subjective requirement raises a number of issues for employers and contractors alike. Employers now have an additional requirement to meet when issuing payment and pay less notices and should be wary of giving any indication that the amount stated in a notice is subject to revision or merely a holding measure. It is also no longer valid (if it ever was) to take a tokenistic approach to preparing valuations for payment and pay less notices.

The decision is likely to result in an increase in “smash and grab” adjudications, commenced on the basis that an employer’s payment notice or pay less notice has failed to meet the subjective requirement of genuine belief as to the sum considered to be due and is therefore invalid. This in turn is likely to involve factual investigations into the employer’s state of mind. In the present case, the court relied heavily on the Employer’s Agent’s covering email which expressly stated that it had not had enough time to assess the amount due. However, it should be noted that the court also referred to the considerable difference between the value of the first and second payment notices, which were given within a week.

Contractors should be aware that the same requirement also applies to payment applications under the Act as the requirement in section 110A(3) is for a payment notice to specify the sum the receiving party considers to be due. The JCT and NEC standard forms use the same language in relation to applications for payment. Applications which become a payee notice in default of a payer’s notice could be open to the same challenge of there being no genuine belief as to the sum considered to be due.

This article is for general information only and does not, and is not intended to, amount to legal advice and should not be relied upon as such. If you have any questions relating to your particular circumstances, you should seek independent legal advice.