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13 Jan 2020

Payment Notices – Do You Prepare and Issue Them Correctly?

by Mark Woodward-Smith, Group Managing Director -

Introduction

It may be a surprise to many construction professionals to learn there are contractors that still do not follow the basic commercial principles of preparing and issuing adequate and timely Payment Notices.  This practice results in unnecessary disputes involving, for example, incorrect amounts being paid, late payments or at worst no payment at all.  This in turn leads to a host of other more detrimental problems on construction projects, such as the erosion of trust, supply chain suspending works, reduced productivity and delays.  These unnecessary disputes are often referred to  Adjudication, tying up management resources and leading to additional, irrecoverable costs.

This article explains what a Payment Notice is, what legislation governs the need to issue them and why they are so important in the construction industry.

What is a Payment Notice?

A payment notice is a document that must be issued for every payment provided under the contract in question.  It is usually issued by the paying party following the receipt of a payment application from the payee (contractor/supply chain), however the application itself can be the payment notice, depending on the particulars and provision in the  contract in question.

All payment notices must detail:

  • the amount the issuer of the notice considers to be due or to have been due at the payment due date in respect of the payment; and
  • the basis on which that amount is calculated.

What legislation governs the need to issue a Payment Notice?

The legislation governing the payment procedure and the issuing of payment notices will depend on the country that the project in question is located in and/or the applicable law of the contract that binds the relevant parties; for the purpose of this article, we focus on the law of England and Wales.

The underlying legislation that governs the payment procedure and the issuing of payment notices in the UK is the Housing Grants, Construction and Regeneration Act 1996 (HGCRA – more commonly known as the “Construction Act”). It was enacted to provide more certainty of payments throughout the supply chain and to introduce a cost effective  dispute resolution process.

In summary, the act provides for:

  • The right to be paid in interim, periodic or stage payments.
  • The right to be informed of the amount due, or any amounts to be withheld.
  • The right to suspend performance for non-payment.
  • The right to refer a dispute to adjudication at any time.
  • Disallowing pay when paid clauses.

The Act applies to all contracts for ‘construction operations’ (including construction contracts and consultants’ appointments). The Scheme for Construction Contracts applies, should contracts fail to adequately comply with the Act.

The Act was amended in October 2011 by the Local Democracy, Economic Development and Construction Act 2009 to eliminate any shortfalls within the provisions.

The Act now applies to construction contracts including those that are not in writing. Adjudication clauses must however still be in writing, otherwise the Scheme for Construction Contracts applies.

It is no longer permissible to define within a contract who should pay the costs of the adjudication, and adjudicators now have the right to correct errors in their decision within 5 days of administering it.

Changes regarding procedures for making payment were also made, as follows:

  • The dates for payments must be clearly included in the contract (the due date).
  • The payer (or specified person) must issue a payment notice no later than 5 days after the payment due date, even if no amount is due. Alternatively, if the contract allows, the payee may make an application for payment which is treated as the payment notice.
  • The payer (or specified person) must issue a pay less notice (previously a withholding notice) if they intend to pay less than the amount set out in the payment notice, setting out the basis for its calculation.
  • The notified amount is payable by the final date for payment.
  • If the payer (or specified person) fails to issue a payment notice, the payee may issue a payment notice in default. The final date for payment is extended by the period between when the payer should have issued a payment notice and when the payee issued the payment notice in default.
  • Pay when certified clauses are no longer permitted, and the release of retention cannot be prevented by conditions within another contract. So, for example, contractors on a management contract project must have half of their retention released when their part of the works reach practical completion, not when the whole project reaches practical completion. This also applies to trade contractors on construction management contracts.
  • Changes to the right to suspend work for non-payment or to suspend part of the works and to claim costs and expenses incurred and an extension of time resulting from the suspension were also introduced.

The importance of issuing a valid Payment Notice

The importance of issuing valid and timely payment notices can be demonstrated by, for example, a JCT 2016 building contract, where a contractor has submitted a compliant payment application, and the specified person has failed to issue a payment notice in response. The specified person’s failure to issue a valid payment notice will result in the specified person being obliged to pay the entire amount applied for as per the contractor’s payment application (which will be deemed a default payment notice). Furthermore, the contractor will be entitled to suspend, adjudicate and/or recover this amount as a debt with interest, should the specified person fail to pay the amount applied for as per the contractor’s payment application at the final date for payment.

If the employer disagrees with the amount included in the contractor’s application, a pay less notice must be issued within the prescribed period; a notice issued late will be invalid.

Even if the specified person believes that nothing is due or if it intends to rely on set-off, counterclaim or abatement to reduce or nullify the amount as per the contractor’s application, the specified person must issue a payment notice/pay less notice.

If the specified person fails to issue a valid payment notice/pay less notice, he/she will have no option but to make payment to the contractor for the amount as per the contractor’s application.

Once the deadline for the issuing of a pay less notice in that payment cycle has been missed, the payer has lost the opportunity to withhold money from that payment.

Not only is it important to issue a valid payment notice/pay less notice within the prescribed timeframe, but the notice must also be in the correct form and contain the relevant details.

The importance of issuing a valid payment notice/pay less notice was demonstrated in Grove Developments Limited v S&T (UK) Limited[1] as a failure to pay the notified sum and lack of pay less notice can lead to a party starting an adjudication.  If that adjudication is successful, the losing party would have to pay the amount notified before being able to start a further adjudication to assess the true valuation.

Conclusion

In summary, it is important that a valid and timely payment notice/pay less notice is always issued, otherwise the payee in question is entitled to full payment as stated in its application. Failure to pay in accordance with the payment notice/pay less notice affords the payee the right to suspend performance of any or all of its obligations under the relevant contract and/or take action to recover what it considers to be the amount due. In the latter event, tribunals will usually favour the payee because the payer will be unlikely to have a valid defence for failing to pay the payee where a valid payment notice/pay less notice has not been issued, let alone the time and costs associated with the legal process that the payer would have to incur.

In brief, a payment notice should be issued for every payment, regardless of the amount due.

A planned post implementation review of the 2011 changes to part 2 of the HGCR act of 1996 was launched in October 2017. The deadline for responses was January 2018. As of July 2019, the outcome of this review is yet be published.

Associated documents.

There is currently a bill making its way through parliament referred to as The Construction (Retention Deposit Scheme) Bill, which proposes retention monies are retained in third party trusts, rather than by the payer. The bill was due to have its second reading in the House in October 2018. This reading has been delayed.

References

[1] [2018] EWHC 123 (TCC)

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