Smash and Grab: The Payment Trap in Construction Contracts

The law

Payment disputes under construction contracts are all too common.  There are often different views on the nature of work carried out, how it should be valued and how a myriad of complex contractual provisions should be applied.  What often surprises those less experienced in the construction industry is the resolution, at least temporarily, of payment disputes on a “smash and grab” basis.

The Housing Grants, Construction and Regeneration Act 1996 as amended) has long established that the party paying under a construction contract must formally respond to an application for payment within a defined timescale by issuing an appropriate notice (either a payment notice or a pay less notice to use the terminology from the Act).  Any failure to issue an appropriate notice within the required timescale entitles the party to be paid to bring a “smash and grab” adjudication.

What is a “smash and grab”?

An adjudication on this basis gives no regard to the relative positions of the parties on the valuation of the works; payment of the full amount claimed in the application for payment must be made.  Only once that payment is made can the paying party bring a further adjudication to establish the “true valuation” of the works and seek to recover the monies that it has handed over.  That takes time and money and introduces the risk that the party that has been paid may become insolvent in the interim period.

What constitutes a valid notice?

The landmark decision in Grove Developments Ltd v S&T (UK) Ltd has a wide-ranging impact on payment disputes under construction contracts.  Not only does it confirm the position that a true valuation adjudication can only commence following payment of the sum due in a “smash and grab” adjudication, but it affirms the requirements for valid notices served by the party that is due to pay.

The judge confirmed that a “a pay less notice will be construed by reference to its background, in order to see how a reasonable recipient would have understood it”. As such the courts would be unimpressed by contrived or artificial arguments focussing on clerical errors that tried to invalidate a pay less notice.  Additionally, the guidance that “one way of testing to see whether the contents of the notice are adequate is to see if the notice provides an adequate agenda for a dispute” establishes that a notice must contain sufficient detail and clarity for the recipient to properly commence a true valuation adjudication.

Is the notice genuine?

In Downs Road Development LLP v Laxmanbhai Construction (UK) Ltdthe courts affirmed that notices need to set out the sum the payer genuinely considers due.  Downs issued a payment notice to Laxmanbhai stating the that £0.97 should be paid. It had adopted a consistent practice in each payment cycle, initially sending a payment notice for £1 and subsequently issuing an additional payment notice for a more accurate valuation. The notice had been sent under cover of an email, in which Downs expressly stated that a further payment notice would follow in due course.

The court decided that Downs’ payment notice was invalid because it did not state the sum Downs genuinely considered to be due. What purported to be a payment notice was merely a placeholder allowing Downs to conduct a proper valuation in its own time.

Can notices address multiple payment cycles?

In Advance JV v Enisca Ltd the court considered if a single pay less notice apply to two different applications for payment in determining the validity of a pay less notice.

In response to two applications for payment by Enisca, Advance issued a single payment certificate and a pay less notice and contended that there was nothing to preclude a pay less notice from responding to two applications. The court held, for several reasons, that Advance’s notice could not be a valid response to both applications and, as a matter of fact, a reasonable recipient would have understood the pay less notice to relate only to the second application and not the first.

Paying under construction contracts

As a minimum, any notice responding to an application for payment must:

1. Clearly be referable to a single payment cycle;
2. Set out the sum the employer genuinely considers to be due, along with the basis for its calculation; and
3. Set out an appropriate agenda for a dispute on valuation.

The failure to consider the above points could prove to be fatal to party that, for genuine reasons, disputes the valuation of works set out in an application for payment.

In short, it is vital that anyone with a payment obligation under a construction contract understands the extent to which the Act applies to their contract (there are contracts that are excluded from the operation of the Act) and how to comply with the strict notice obligations.

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