Payment Mechanisms – What are your legal requirements as a client or developer?

Payment in the construction industry is always a hot topic. The government’s recent drive to restrict bidders for government contracts based on their payment practices is very telling. This, coupled with the fact that some major contractors been recently been placed into administration by their financiers, goes to show that whilst revenue is important, as is a strong order book, without substantial cash at hand to finance operations, construction businesses can quickly come under pressure.

The important legislation to note when talking about the importance of fair payment is:

• The Housing Grants, Construction and Regeneration Act 1996
• The Late Payment of Commercial Debts Act 2013
• Construction Supply Chain Fair Payment Charter
• Small Business, Enterprise and Employment Act 2015

Most construction contracts put an onus on payers to make interim payments so that payees are not financing the works through to completion.

As payment is a formal contractual process, the timeframes in the contract must be adhered to with payment made strictly in accordance with the contract conditions. Dependent on the form of contract there will be a process and criteria stated as to how payment should be assessed, notified, and paid.

Most contracts operate on a monthly or four weekly cycle, but what complicates matters is the scope of the works and ensuring that payments made are reflective of the works carried out to date. In the case of variations to the design, quantities or working conditions, and the ensuing claims or instructions that follow, it can be difficult to quote and agree these events in the timeframes set down in the contract and get paid for them in a reasonable period.

In the event that a gap should open up between that claimed by the payee and the amount certified by the payer, it could quickly lead to a dispute and the breakdown of a working relationship. Therefore, it’s important to understand payment mechanisms, including what you are legally obligated to provide and what happens if you do not.

The payment process – what are you legally obligated to provide?

The Construction Act is legislation passed by parliament that states, for all construction contracts greater than 45 days long, they must provide for interim payments. They must also include descriptions as to how the sum due is calculated, the due date for payment, and the final date for payment.

In terms of what projects the Construction Act applies to, it is for any contract that includes ‘construction operations’. If a contract does not meet these requirements, then it will default to The Scheme for Construction Contracts (England and Wales) Regulations.

The Construction Act requires the following when making payments:

• The Client must issue a payment notice even if no amount is due
• The Client must issue a pay less notice if they intend to pay less than the amount set out in the payment notice
• The notified sum is payable by the final date for payment

Notwithstanding the above, the Construction Act also makes provision for:

• Section 109: The right to be paid in interim payments, ‘A party to a construction contract is entitled to payment by installations, stage payments or other periodic payments for any work’
• The right to suspend performance for non-payment and to claim costs and expenses incurred and extension of time resulting from the suspension
• Pay when paid clauses are not allowed in individual contracts including the release of retention

Does the form of contract make a difference and what about the Construction Act?

Whilst the Construction Act stipulates what should be included in a construction contract in terms of payment, it does not stipulate payment timescales, therefore parties are clear to agree terms between themselves. However, the individual form of contract can make a difference, for example:

• Standard NEC ECC Contracts operate on payment within 21 days of the assessment date which is typically the end of the month.
• JCT 2016 also operates on payment within 21 days of the ‘interim valuation date’ but JCT 2011 included different requirements for interim and final payments.

Furthermore, the Government issued the Construction Supply Chain Fair Payment Charter in 2016 with the drive being to shorten these payment terms even more to provide better cashflow for subcontractors and sub-subcontractors all receiving payment within a thirty-day period.

However, many contracts still contain long payment terms of up to 60 or even 90-day payment terms. For example, Network Rail used to typically pay on 60 days, and it was only in their current control period of 2019 to 2024 where they advocated 28-day payment terms. In the previous scenario sub-subcontractors may see terms of payment of 120 days.

Also, ‘pay when paid’ clauses in construction contracts were outlawed by the Construction Act. As an example of what this means; subcontractors and sub-subcontractors will only be paid for variations once the client pays the main contractor despite their being clear grounds for entitlement.

You receive an invoice or application from a supplier – what happens if you do nothing?

What you should do is issue a payment notice (first payment notice) or, in the event that you wish to pay less than the amount due, issue a payless notice. However, should you fail to do either then the payee can issue you with a default payment notice (second payment notice).

If the default payment notice is correctly issued by stating the sum due and how that sum has been calculated, then it becomes payable by the Final Date for Payment. The ability for the payee to issue a default payment notice and then such notice becoming the amount due is arguably the biggest change in the 2011 Construction Act amendments and puts a lot of power back to the supply chain.

To examine this process more closely, if the payer fails to issue the first payment notice within 5 days of the Due Date the payee can issue their own payment notice as long as they do so before the final date for payment. In most cases they will resubmit their first invoice or application along with the default payment notice with the amount claimed now being due for payment. It should be noted the final date for payment starts from the serving of the default payment notice.

However, all is not lost for the payer as they can still issue a ‘pay less notice’ providing it is issued in the correct number of days before the Final Date for Payment. Again, it must clearly state the sum due and how that sum has been derived. Failure to do so could, in the event of a dispute, mean the pay less notice is treated as invalid.

What if you disagree with the value claimed – what are your options?

If the payee has issued an application for payment, then as payer you should issue a payment notice that reflects your assessment of the amount due, including a payless notice if you intend to pay less than the notified sum.

If you consider the application for payment to be over measured for example, then you must make your own assessment ideally in the same way the application was received or using information provided in the application to make your assessment. In the event the payee wishes to dispute your assessment they could do so easily if they are able to establish that your payment notice and payless notice does not set out the amount due.

You want to issue your own assessment of the amount due – what should you provide?

If the payer intends to pay less than the notified sum, they must provide the basis on which that sum has been calculated in their payment notice. Note that dependent on the conditions of any individual contract, it may be that issuing of a payless notice can be given by someone nominated on behalf of the Employer e.g. a Quantity Surveyor or Employers Representative as long as those carrying out the work have been authorised by the Employer and communicated to the Contractor.

If you are working on a contract that uses a bill of quantities for example, then upon making your own assessment you should provide details as to how you have arrived at your assessment of the measured works to date. However, if you are working on a cost reimbursable form of contract then as a payer you will be looking to check that any costs claimed have been fully substantiated before issuing any payment notices. If you consider the costs claimed have not been substantiated, then as part of any pay less notice you should clearly list what you have excluded and your grounds for doing so.

What is the difference between a payment notice, payless notice and the notified sum?

If, as a client, you receive an application for payment on the assessment date then you are required to provide a payment notice on the payment due date. Failure to issue a payment notice by the payment due date means the payee can claim their application is effectively the notified sum and is due for payment, this being the default payment notice. The final date for payment is taken from either the client/payers payment notice, or the date of the default payment notice being issued.

However, as the client and payer you have one further chance if you have been issued with a default payment notice and that is to issue a payless notice, as long as it is issued so many days before the final date for payment. The contract conditions will determine how many days but five is typical. If nothing is stated then Scheme for Construction Contracts applies which is seven days before the final date for payment.

You issued or received a payment notice but payment was not on time – what are you entitled to?

In the case whereby a payment notice and/or a payless notice has been issued but the actual payment itself was late then two options are open to the payee:

1. The Late Payment of Commercial Debts (Interest) Act provides for simple interest to be payable on outstanding debts at a penal rate of 8% above the Bank of England base rate. Additional penalties can also be levied. Introduced in 2013, The Late Payment of Commercial Debts Regulations reinforce the provisions of the Late Payment of Commercial Debts (Interest) Act
2. Check the form of contract used as most will stipulate interest charges above the Bank of England base rate the sum of which is compounded annually.

However, it should be noted that despite there being financial remedies for the effect of late payment, the acceptance of interest payments by the payee does not waive their right to suspend performance of the works and claim costs and expenses resulting from the suspension.

Relevant case law payment notice

In the event the payer does not issue a payment notice and/or payless notice in time to a payees’ default payment notice the payee adjudicates in order to have their payment notice enforced. This is commonly known as a ‘smash and grab’ adjudication. The payer responds with a counter adjudication claiming the value of works has not been properly determined and asking the adjudicator to redress the value the works.

However, in the case of ISG Construction vs Seevic College (2014), ISG obtained an adjudicators decision to enforce their default payment notice of circa £1m. However, when Seevic College launched a counter adjudication and won, which ordered ISG to repay £768k, ISG contested the adjudicators decision and the case was heard at the Technology & Construction Court (TCC) whereby they agreed with ISG on the basis that in the absence of any payment notice or pay less notice from the Employer they had agreed to the value of works and therefore the counter adjudication was unenforceable.

Conclusion

The Construction Act amendments in 2011 have put significant emphasis on the importance of issuing payment notices on time. The drive behind these legislative amendments is the government’s Construction 2025 industrial strategy and long-term vision for the industry. In the executive summary of their ‘Construction 2025’ 2013 publication, it states a commitment to realise one of their visions as follows:

“Create conditions for construction supply chains to thrive by addressing access to finance and payment practices.”

Whether you are a payer or a payee in the supply chain, it is important to know, understand and administer your contractual rights concerning payment.

About Dean Suttling

A member of the Royal Institution of Chartered Surveyors, Dean has twenty years of experience in commercial management and quantity surveying, undertaking roles for contractors, clients, and consultants.