Pay first and argue later?
Following the important decision of Coulson J at first instance in Grove Developments Ltd v S&T (UK) Ltd in February of this year (which we considered in an earlier article), the eagerly awaited Court of Appeal decision following S&T (UK) Ltd's appeal has now been handed down.
S&T's appeal was unsuccessful, the Court of Appeal agreeing with Coulson J's decision at first instance. In a nutshell, the Court of Appeal said that "the employer, having failed to serve a Payment Notice or Pay Less Notice, is nevertheless entitled to adjudicate to determine the 'true value' of an interim application". This landmark judgment given by Sir Rupert Jackson (one of his last judgments prior to retirement) will have significant implications for the Construction industry.
Grove engaged S&T under a JCT Design & Build Contract to design and build a new Hotel at Heathrow Terminal 4. A dispute ensued between the parties in relation to the sum that was payable as an interim payment, following an interim application for payment by S&T, in addition issues arose as to the deduction of liquidated damages for delay.
As is well known, at first instance Coulson J overturned a number of previous authorities (including ISG V Seevic) which had held that an employer could not commence a second adjudication to determine the "true" value of an interim application for payment if the employer's Payment Notice and/or Pay Less Notice were invalid. Coulson J's view was that the absence of a Payment Notice or Pay Less Notice did not amount to agreement that an Interim Application/Valuation was correct; but rather only to "agreement" that an interim payment of that monetary value was due to be made. The distinction is made clear by the terminology utilised in the Court of Appeal's judgment of the "valuation bargain", as opposed to the "payment bargain".
The Court of Appeal's Decision
S&T's appeal put three issues before the Court of Appeal for consideration. Taking each in turn:
Issue 1:Whether Grove's Pay Less Notice complied with the requirement of the contract that payment notices need to "specify the basis of calculation" of the sum stated to be due.
Section 111 (4) of the Housing Grants, Construction and Regeneration Act 1996 (as amended), requires that a Pay Less Notice given by the employer “shall specify” both the sum that he considers to be due and “the basis on which that sum is calculated”.
Grove's Pay Less notice specified the sum that was stated to be due, but did not expressly set out how that sum had been calculated. Rather, Grove attempted to incorporate the calculation it had detailed in its earlier (invalid) Payment Notice by making reference back to that in the Pay Less Notice.
It was S&T's position that this incorporation by reference did not comply with the provisions of the 1996 Act and the provisions of the contract in that the Pay Less notice did not expressly set out the basis of the calculation on its face. The Court of Appeal however, upheld the first instance decision that the Pay Less Notice was valid, stating that there is "no bright line rule" and instead noting that "it is a question of fact and degree in each case". On the facts, the calculations contained within the Pay Less Notice were understood by S&T, and there was no rule preventing incorporation by reference. This finding may indicate a deviation from the requirement for very strict compliance with provisions as to the payment notices reflected in other recent decisions.
Issue 2: Whether an employer can commence an adjudication seeking a decision as to the "true" value of an interim application if its Payment or Pay Less Notice was invalid?
Prior to the first instance decision, it was accepted that (at least in respect of the JCT D&B 2011 contract in issue in the case) the sum to be paid by the employer was the sum "stated as due" in the Interim Application Notice and that, should the employer fail to issue a valid Payment Notice or Pay Less Notice, it would be bound to pay the sum that was stated in the contractor's interim application for payment with little scope to challenge that.
The Court of Appeal upheld Coulson J's decision that an employer is nonetheless entitled to commence an adjudication to determine the "true" value of an interim account even if it fails to issue a valid Payment Notice or Pay Less Notice, but that it can only do so only when the "notified sum" has been paid.
With one slight amendment, the Court of Appeal approved the six principles that Coulson J had identified in his judgment as supporting his conclusion that the employer had the right to adjudicate as to the true value of works. Specifically, those reasons are:
- An adjudicator has the same powers as the Court to decide all disputes, including the true value of an application;
- On interpretation of the 1996 Act and the Scheme for Construction Contracts there is no limit on the nature, scope and extent of the dispute which either party can refer to an adjudicator;
- The dispute raised by an employer in a second adjudication would be a separate issue to that being determined in the first, as it would relate to valuation rather than the validity of a notice;
- The terms of the JCT D&B 2011 Contract expressly differentiate between "the sum due" and "the sum stated as due", which leaves open the possibility of a second adjudication (although in agreement as to the point being made, the Court of Appeal referred back to the 1996 Act itself, rather than the provisions of the contract, to support the obligation on the employer to pay the "notified sum");
- A contractor can refer a dispute about the true value of a payment notice to adjudication: it would be wrong in principle to prohibit an employer from doing that which the contractor can do;
- Neither the Act nor the Scheme distinguish between interim and final applications for payment.
Often, of course, any overpayment as a result of failure to serve a Payment Notice or Pay Less Notice can be rectified at the next interim payment. However, if that is not practicable (as was the position here) it is open to the paying party to commence adjudication to determine the true value of the works.
The Court of Appeal noted that: "One important policy of the HGCRA and the Amended Act is to promote cashflow in the construction industry. In other words, there should be prompt payment followed by any necessary financial adjustments."
Consistent with such policy, the Court of Appeal stated that: "The Act has created both the prompt payment regime and the adjudication regime. The Act cannot sensibly be construed as permitting the adjudication regime to trump the prompt payment regime. Therefore, both the Act and the contract must be construed as prohibiting the employer from embarking upon an adjudication to obtain a re-valuation of the work before he has complied with his immediate payment obligation."
So, it seems clear that a party's right to adjudicate a dispute "at any time" is qualified after all. Pay first and argue later!
How this will work in practice remains to be seen. For example, it is unclear as to whether commencing "true value" adjudications will be limited to the JCT form or can operate more broadly although it can be assumed that it will be fact specific, and depend upon the contractual wording used in each case.
Issue 3: What are the timing requirements for the notification provisions before an employer is entitled to levy liquidated damages under the JCT form?
The Court of Appeal also considered the notice requirements for the levying of liquidated damages. The JCT D&B 2011 contract requires the employer to take 3 steps before it is able to deduct liquidated damages: it must first issue a Non-Completion Notice (notice 1), it must then issue a Warning Notice notifying the contractor that it may require payment of, withhold or deduct liquidated damages, followed lastly by a Deduction Notice requiring that the contractor pay the liquidated damages or it will deduct/withhold them.
Although Grove sent the Warning Notice and Deduction Notice in the correct sequence, they were sent in quick succession and so S&T argued that the Deduction Notice was invalid as it had not been notified by the Warning Notice before Grove 'gave notice' in the Deduction Notice. This argument was rejected by the Court of Appeal. It was held that, so long as both notices were sent in the correct procedural sequence - which they were - that was sufficient. It was further held that no specific time period is necessary for a party to consider the Warning Notice before the Deduction Notice is received.
The test of "fact and degree" in considering whether the Pay Less notice was valid may well cause a degree of uncertainty as to whether information that is contractually required was indeed properly incorporated by reference. This may increase the number of disputes as to whether notices are valid. Parties would therefore be advised to clearly set out the basis of calculation in their notices to avoid scope for ambiguity.
Broadly, whether this Court of Appeal judgment will reduce "smash and grab" adjudications as was initially thought following Coulson J's first instance decision, remains to be seen. The Court of Appeal's requirement for payment first may, actually, result in more adjudications (initially on the notices served, and latterly on the true value).
Whatever the outcome, there is no doubt that the Construction industry will be taking notice of the Court of Appeal's decision.
This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.