Payment Notices: Heading off the 'smash and grab'

Kirsti Olson, Partner at Dentons UK and Middle East LLPA takes a look at why it is crucial to ensure payment and pay less notices are served correctly.

Whether, when and how payment and pay less notices are served is an issue that we all in the construction industry grapple with regularly. The consequences of getting the timing or content of these notices wrong or of failing to comply with the relevant requirements for service can be severe. There is also the added difficulty that sometimes what needs to be done is not clear, either from the terms of the contract or the way in which the parties have behaved. Guidance from the courts is therefore always welcome.

Content

The courts in England and Scotland take a pragmatic approach to the content of payment notices and pay less notices.

In the Scottish case of Muir Construction Limited v. Kapital Residential Limited [2017] CSOH 132, Lord Bannatyne decided that a pay less notice, simply stating that zero was due, was inadequate. It was not possible from any of the information provided for the reasonable recipient to work out the basis on which the zero sum figure was calculated.

In C Spencer Limited v. M W High Tech Project UK Limited [2019] EWHC 2547, the contract was a hybrid covering construction and non-construction operations. In the TCC, O'Farrell J found that a payment notice did not need to separately identify the sum due for construction operations. However, she also confirmed that a negative valuation in a payment notice cannot be relied upon as a pay less notice for the purposes of set-off or a counterclaim. A pay less notice will still be required.

In Grove Developments Limited v. S & T (UK) Limited [2018] EWHC 123, guidance from the court was sought on a number of issues, including whether a pay less notice was valid. In that case, the pay less notice cross-referred to another document, which set out the basis upon which the sum due was calculated, that the contractor had received earlier.

At first instance, Coulson J decided that the pay less notice was valid. The Court of Appeal agreed (S&T (UK) Ltd v. Grove Developments Ltd [2018] EWCA Civ 2448). It is therefore permissible to cross refer in a pay less notice to another document for the calculation of the basis of the sum due. However, whether such notices are sufficient will always be a question of fact and degree. There is also the risk that a document referred to in a notice may not have been received in the first place.

At first instance in Grove, Coulson J offered the following general guidance (at paragraph 26): "A pay less notice will be construed by reference to its background, in order to see how a reasonable recipient would have understood it. The court will be unimpressed by nice points of textual analysis, or arguments which seek to condemn the notice on an artificial or contrived basis. 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 about valuation and/or any cross claims available to the employer".

The judge was of the view that this approach should apply equally to payment notices and pay less notices.

Timing

Whether a payment notice or a pay less notice is served on time will depend on what the contract requires. A point often forgotten is that many time-related words and phrases used in construction contracts (such as "before", "after", "from", "within", "not less than", "by", "not earlier than", "not later than", "at", "at least" and "on") have a specific legal meaning (and sometimes that is different between jurisdictions).

Section 116 of the 1996 Act gives guidance on the calculation of time periods when the words "within", "after" and "from" are used. It also confirms that certain days will be excluded from the calculation of periods of time.

The parties to a contract should also be mindful of deemed receipt provisions.

Service

Ideally, payment notices and pay less notices will be served strictly in accordance with the terms of the contract. But that does not always happen.

However, failure to follow the service requirements for notices in a contract will not always be fatal.

In the Scottish case of Hoe International Limited v. Andersen and Aykroyd [2017] CSIH 9, a notice under a share purchase agreement, which should have been served by recorded delivery, first class post or by hand, was sent by DX. The court found that the notice had been validly served. The court was of the view that the requirements of a notices clause should be interpreted in a practical and reasonable manner. Provided the notice is received by a responsible person, with authority to act on behalf of the recipient, the means of delivery is of no real significance. Absence of material prejudice on the part of the recipient was also considered to be a key factor.

In England, the leading case on notices is the decision of the House of Lords in Mannai Investment Co Ltd v. Eagle Star Life Assurance Co Ltd [1997] UKHL 19. Although the basic rule is that the notice requirements of a contract should be strictly complied with, minor defects will not necessarily invalidate the notice if the reasonable recipient, with knowledge of the relevant factual background to the notice and its context, would have understood it.  

When can you get the money back?

In the absence of a payment notice, a higher sum than the contractor has applied for may become due for payment. If a pay less notice is not then served, the payer will be exposed to the risk of a smash and grab adjudication. This is emotive terminology used to describe a situation where a contractor takes advantage of a failure to serve a pay less notice and seeks an order from an adjudicator for payment of the sum he has applied for.

Assuming that the process breaks down in this way and a contractor becomes entitled to be paid more than the true value of the work, the final key question is when a separate adjudication can be commenced to get the money back.

In the Grove case (mentioned earlier) which concerned an interim payment application, Grove was found to be entitled to commence a second "true value" adjudication as soon as payment of the sum due in the first adjudication had been made.

This was contrary to the approach previously taken in the TCC in the cases of ISG Construction Limited v. Seevic College [2014] EWHC 4007 and Galliford Try Building Limited v. Estura Limited [2015] EWHC 412 (where failure to serve an adequate pay less notice was deemed to be agreement by the employer that the amount applied for was the "true value").

M Davenport Builders Ltd v. Greer & another [2019] EWHC 318 concerned a final payment application. Mr and Mrs Greer (who had lost a smash and grab adjudication) started a "true value" adjudication without making payment first. They then tried to rely on the second adjudicator's decision to defend enforcement proceedings. The judge in the TCC applied Grove and enforced the first adjudicator's decision.

If payment has to be made following a first adjudication before a "true value" adjudication can take place, clearly there is an insolvency risk.

Payers should therefore be extra vigilant about ensuring that payment notices and pay less notices contain the right information, are properly served on time and are in the correct form, in order to avoid a smash and grab adjudication happening in the first place.

Interestingly, the judge in Davenport did suggest that in limited circumstances it might be possible for the paying party to start a "true value" adjudication before making payment. But the judge did not elaborate further. So, it is not clear yet in what circumstances that will be possible. We will have to wait and see what happens next.