Brenna Conroy - barrister at Hardwicke Chambers: The Crack Down on Contractor’s Payment Applications: Are Pay Less Notices Next?

To any employer engaged on a construction project, the consequences of failing to serve a valid payment notice or pay less notice are significant; under the Housing Grants, Construction and Regeneration Act 1996 (as amended by Part 8 of the Local Democracy, Economic Development and Construction Act 2009) (“HGCRA”), a contractor is entitled, as of right, to the sums set out in its payment application or default notice (at least on an interim basis). However, the payment notice provisions contained in construction contracts are not always straightforward to follow, with a number of disputes ending up in the Technology and Construction Court (“TCC”).

A hot topic over the past year has been the validity of a contractor’s payment application. The message from the TCC is clear: if contractors want to benefit from the payment provisions of the HGCRA, they are obliged to set out their payment applications with proper clarity.

What has not, however, been considered to date is whether the courts will take the same approach to pay less notices, particularly in light of the decision in Henia Investments Inc v Beck Interiors Ltd [2015] EWHC 2433 (TCC), which has arguably created a degree of confusion between the role of the payment notice and pay less notice regime.

Payment Notice Regime Under the HGCRA

The HGCRA provided a new regime for payment and pay less notices, which replaced the requirement to serve a ‘withholding notice’ in the event that the employer wished to set off against or make an abatement against the sums due to the contractor.

Briefly, the notice provisions of the HGCRA work as follows:

• Not later than five days after the payment due date, a “payment notice” must be served by the paying party (i.e. employer or main contractor) or a specified person (e.g. the contract administrator), specifying the sum which the party issuing the notice considered to be due at the payment due date and the basis on which that sum has been calculated.

• In the absence of such notice, the payee (i.e. contractor or sub-contractor) is entitled to serve a default notice specifying the sum it considers due, or alternatively rely on a submitted payment application as a default notice (if the contract allows), rendering the employer liable for the full amount claimed by the contractor.

• The paying party must pay the notified sum (as set out in the payment notice, default notice or payment application, whichever at the time stands) on or before the final date for payment, unless the paying party has served a notice of the payer’s intention to pay less than the notified sum or “pay less notice”, which must set out the sum the payer considers to be due on the date the notice is served, and the basis on which the sum is calculated. The sum in the pay less notice then becomes the sum due to the payee.

Henia v Beck

Prior to the decision in Henia, there had been some confusion as whether the new wording of the HGCRA allowed a payer to revalue the works in a pay less notice or whether the payer was only entitled to reduce the sums owed in a pay less notice on the basis of cross claims (as under the old withholding notice regime).

In Henia, the Court determined that the wording of the HGCRA was in fact wide enough such that “the Pay Less Notice can not only raise deductions specifically permitted by the Contract and legitimate set-offs but also deploy the Employer's own valuation of the Works” (see paragraph 32).
The TCC has therefore confirmed that there is no difference between the contents of a payment notice and pay less notice, save that the HGCRA requires that the payment notice must be served within 5 days of the payment due date, with no similar restriction on the pay less notice (which can in fact be served up to one day before the final date for payment, depending on the wording of the contract).

Practical Implications

What this means in practice is that an employer can get a second opportunity to re-value the works; if they fail to serve a payment notice, they can simply rectify the problem by serving a timeous pay less notice.

But the effect of the decision in Henia may also mean that if an employer issues a payment notice late, and fails to correct the problem by issuing a pay less notice, it may still rely on the invalid payment notice as a valid pay less notice, given that there is no difference in content between the two. There is of course no statutory requirement to identify in the notice that it is in fact a pay less notice.

The obvious confusion created by the decision is that a contractor may of course believe it is entitled to the sums set out in its own payment application or default notice, but in fact the employer can rectify its own position by relying on an invalid payment notice as a valid notice under the pay less notice regime.

In order to avoid this confusion arising, we effectively have to look at the TCC for clarity that as with a valid payment application, a pay less notice must comply with the provisions of the HGCRA but also be clear and be free from ambiguity. Given the significance to a contractor of the Employer serving a pay less notice, one would hope the TCC would follow the same logic as it has done in respect of payment applications.