Paul Gogarty – Consulting Director, Driver Trett explores the varied methodologies and approaches for contra charging, set-off, counterclaim, and abatement and their application under construction contracts.
Contra charges are controversial. The very mention of contra charges in the UK, or anywhere, is enough to cause a quarrel between the parties to a contract; it has the potential to damage relationships, especially when deductions are made for insufficient reasons.
The raising of a contra charge by the paying party under a contract, often means that a mistake may have been made by the payee and sometimes it becomes personal. There is likely to have been a breach of contract or negligence on the part of the payee, giving rise to the contra charge by the paying party. In the same way that a payee will be expected to justify entitlement and the quantum of a change, or variation, under a contract; a paying party will be required to evidence its entitlement to set-off, contra charge, or back charge amounts against monies otherwise due to the payee, and also to provide particulars of the amount claimed.
On a typical project, where contracts exist between main and subcontractors, and where damage is caused by subcontractor A to subcontractor B’s works on a construction project, the rectification costs will often be claimed by A against the main contractor. In turn, the main contractor will seek the costs claimed by A, with an addition for its own management costs and sometimes delay or disruption related costs, by way of set-off against B. This is because there is privity of contract (where parties to a contract may sue each other but not third parties) between A and B to enable costs to be claimed or paid between them. We are all familiar with a typical occurrence, where damage occurs to say suspended ceilings or dry-lined partitions during the installation of the mechanical, electrical, or public health services because the latter works are carried out late or out of sequence.
In the past subcontractors on construction projects would sometimes come to an arrangement whereby they would compensate each other for such damage informally, or even resolve the issues by a form of bartering. This would avoid the involvement of the main contractor and all the administration and costs involved. For example, the electrical subcontractor might provide temporary festoon lighting for the ceilings subcontractor; who in return might construct a temporary office for the electrical subcontractor or rectify damage to ceilings by the electrical subcontractor when cutting holes for access in the ceiling on a ’knock for knock’ basis. Provided that the costs were not too one sided, it worked perfectly well. It is rare to find this occurring on construction sites today. Instead, it is common to find that a complex system of recording alleged breaches of contract or negligence by various parties is put in place; including the formal notification of alleged breaches and the imposition of contra charges through further notifications from the main contractor to the supply chain below. This contractual procedure is unhelpful to the smooth relationship which is required to complete the works by teamwork, it is also costly and time consuming to implement.
Following notifications of breaches of contract or negligence, a regular monthly account of contra charges is then included by the main contractor in payment notices and pay less notices compliant with the Construction Act [1]. The Act regulates the contents and prescribed periods for pay less notices, which must be served if a paying party wishes to deduct sums from amounts otherwise due to a payee under a contract. On some projects the magnitude of the set-off or contra charges can be significant and strongly disputed, prompting or leaving the payee with no alternative but to refer the dispute to an adjudicator for a temporary but interim binding decision on entitlement and quantum, or to arbitrate or litigate for a final resolution.
ABATEMENT
In contrast to set-off or counterclaim, abatement is a means of appropriately reducing a contract price where payment in full may not be justified. Abatement is in effect an adjustment of the contract price. A pay less notice is not required for an abatement to be effective. However, a paying party has the burden of proof to clearly set out the basis for making the adjustment to the price. For example, the quality of the work may not be compliant with the contract requirements (e.g. the cladding might have been installed with a paint finish whereas a powder coated finish is specified), or the area of paving laid may be less than shown on the drawings. The paying party may insist on a powder coated finish or the full extent of paving being installed, or it may reduce the cost price and accept the non-compliant works by way of an abatement to the price. Under JCT contracts the paying party may make what is known as an ‘appropriate deduction’ to compensate for the non-compliancy.
For some time, there has been debate and uncertainty as to what constitutes an appropriate deduction in the UK. In the recent case of Oksana Mul v Hutton Construction Ltd. [2], Akenhead J explained that “appropriate deduction” means what is appropriate in all the circumstances. This appears not to be too helpful on a first reading but the judge went on to explain that an appropriate deduction can be calculated by reference to one or more of the following, amongst possibly other factors:
’’a. The Contract rates/priced schedule of works/Specification; or
b. The cost to the Contractor of remedying the defect (including the sums to be paid to third party subcontractors engaged by the Contractor); or
c. The reasonable cost to the Employer of engaging another contractor to remedy the defect; or
d. The particular factual circumstances and/or expert evidence relating to each defect and/or the proposed remedial works.’’
Many paying parties incorporate terms in contracts to enable abatement. Sometimes by pre-agreed amounts, in respect of failures by a payee to provide documentation on time, for example operation and maintenance manuals, as-built drawings, collateral warranties, or manufacturer’s extended guarantees and the like.
Whether or not abatement or set-off is implemented, a paying party has the burden of proof in respect of entitlement or liability as the basis for making deductions and the quantum of contra charges or abatement.
SET-OFF OR COUNTER CLAIM
Set-off is a defence to money owed and can be deployed to reduce the amount owed or to extinguish it. It is not used where the amount claimed by the paying party is greater than the amount due to the payee. A counterclaim may be for an amount greater than the amount due to a payee. It requires that there must be a breach of contract and damages incurred. A set-off or counterclaim is sometimes labelled as contra charging or back charging. The set-off may be made under the contract or at common law, for example, in case of insolvency under statutory provisions.
Provisions are sometimes incorporated in contracts, whereby the paying party may implement a cross set-off between various contracts between the parties. In other words, a paying party may be entitled to set-off costs incurred due to breach of contract or negligence on contract A, with monies otherwise due on contract B. This may assist a paying party where it has incurred costs on contract A, but there is insufficient outstanding payment due to the payee on that contract.
In any event, as far as the paying party’s obligations are concerned, the paying party has the burden of proof. For each and every one of the allegations or claims made by the paying party against the payee, it must prove on the balance of probabilities that:
1. The payee failed in its contractual obligations to the paying party and in exactly what manner it so failed.
2. That the cost allegedly incurred by the paying party, as a consequence of the breach alleged, was incurred as a direct result of the alleged failure of the payee in the manner described.
3. The paying party has incurred the costs claimed.
For example, under a JCT subcontract, the paying party may have various remedies for breach of contract for which it may counterclaim, or contra charge the payee in respect of:
- An indemnity for any breach by the payee which is a breach under the main contract; or for losses incurred as a result of a breach of warranty or representation in respect of the Bribery Act; or for losses arising from breach of any third party agreement; or against loss and damage due to negligence or breach of duty by the payee; or in respect of costs payable to other parties as a result of non-compliant work by the payee; or, for example, in respect of liability arising from the removal of noncompliant work and reasonable opening-up works.
- An obligation on the payee to pay direct loss and expense suffered by the paying party as a consequence of the payee’s failure to complete its works on time.
- Liability for all additional costs incurred by the paying party as a result of the payee’s failure to comply with directions.
- Additional costs and losses incurred by the paying party as a consequence of works not being in accordance with the contract.
- Any sum reasonably estimated by the paying party as a result of interference by the payee of the regular progress of the main contract works.
- The cost of clearing the site of the payee’s property where the payee fails to do so.
[1] Under provisions compliant with Part 8 of the Local Democracy, Economic Development and Construction Act in relation to construction contracts entered into on or after 1 October 2011 in England and Wales, and 1 November 2011 in Scotland.
[2] [2014] EWHC 1797 (TCC)