Jerome O’Sullivan, a Partner in Healys LLP’s Construction Litigation Department, discusses the main provisions of the Construction Act 1996 and sets out a helpful summary of the key procedures for dealing with payments under construction contracts.
The relevant contractual rights are governed by Part II of the Housing Grants, Construction and Regeneration Act 1996 (as amended), also known as the Construction Act 1996. The provisions of the Construction Act apply to all agreements for the carrying out of construction operations.
Construction operations are widely defined under Section 105 and include sub-contracting of construction operations and the provision of labour in relation to construction operations. Construction contracts are deemed to include architectural, design, surveying, engineering, decorations and landscaping works.
Section 106 confirms that the provisions do not apply to a construction contract with a residential occupier.
The Scheme for Construction Contracts (England and Wales) Regulations 1998 (SI 1998/649), also known as the Scheme for Construction Contracts 1998 (“the Scheme”), creates certain default provisions which apply if the construction contract is silent in relation to any or all of these provisions. These provisions are implied into all construction contracts by virtue of Section 114(4) of the Construction Act 1996.
Section 110(1) states that all construction contracts must set out an adequate mechanism for determining what and when payments are due and a final date for payment of any sums due. If the construction contract does not include such dates for payment, the Scheme stipulates a Due Date and a Final Date for payment.
Section 109 grants a party to a construction contract the right to payment by instalments, staged payments or other periodic payments, unless the contract works are unlikely to take longer than 45 days to complete.
Paragraph 2 of the Scheme confirms that the unpaid party is entitled to the difference between the Value of Work performed and the materials supplied to the end of the Relevant Period, plus any other sum the contract specifies is payable and the amount that has already been paid, or is due for payment.
Paragraph 12 of the Scheme defines the Value of Work as the value placed upon the work by the proper operation of the construction contract, which is often the certification process by an architect or surveyor provided for in the contract. If there is no such certification process then the contractor is entitled to the costs of the work performed, along with overheads and profit.
Paragraph 12 of the Scheme defines the Relevant Period as being the period specified in the contract and, failing that, a period of 28 days.
Paragraph 4 of the Scheme defines the Due Date for payment as being the later of:
- the expiry of 7 days following the Relevant Period or
- the date the unpaid party makes a claim.
Paragraph 8 of the Scheme confirms that the Final Date for the paying party to make a payment is 17 days from the Due Date for payment.
Paragraph 5 confirms that the Final Payment under a construction contract becomes due on the later of:
- the expiry of 30 days following completion of the works, or
- the unpaid party making a claim.
Note that under Section 116 (3) the meaning of “Days” is deemed to exclude Bank Holidays.
Section 110(A) (1) requires a construction contract to provide for the issue of a Payment Notice not later than 5 days after the payment Due Date by either:
- From the payer, or a specified person (such as an architect supervising the contract), to the payee or
- From the payee to the payer, or a specified person.
The Payment Notice must specify the sum (“the Notified Sum”) that the payer, the specified person or the payee considers was due at the payment Due Date and the basis on which that sum was calculated. A Payment Notice may show a zero sum due.
Default Payment Notice
Section 110(B) allows for an unpaid party to serve a Default Payment Notice when the paying party or the specified person fails to issue a payment notice. The unpaid party may serve its own Default Payment Notice at any time after the date the Payment Notice was due. However, the Final Date for payment would be deferred to reflect the delay in the unpaid party serving its default notice. If the unpaid party does not serve a default payment notice then:
- the paying party is not obliged to pay the unpaid party under Section 111 and there is no statutory sanction for the failure to issue a payment notice;
- the unpaid party cannot validly suspend performance of all, or any, of its obligations.
Pay Less Notice
Section 111 confirms that the paying party is required to serve a Pay Less Notice if it intends to pay less than the notified sum. Section 111(3) stipulates that the notice must set out the sum considered to be due on the date that the Pay Less Notice was served, including the basis of the calculation.
Paragraph 10 of the Scheme stipulates that the Pay Less Notice must be given no later than 7 days before the Final Date for payment.
The paying party must serve a Pay Less Notice to withhold money. If it fails to do so, the unpaid party has the right to:
- suspend performance of all, or any, of its obligations under the contract and
- give notice of its intention to refer a dispute to adjudication.
Case law has confirmed that any application for payment, which may become a default payment notice, to be “in substance, form and intent” an interim payment notice and to be clear and free from ambiguity. Also, when a party submits its application for payment (or a payment notice), it should make its intention to do so clear in any covering email or letter as per Systems Pipework Ltd v Rotary Building Services Ltd  EWHC 3235 (TCC).
Right of Suspension
Section 112 of the Construction Act gives a party to a construction contract the right to suspend performance of his obligations if he is not paid. The unpaid party:
- has a right to suspend work if all, or part, of the Notified Sum remains unpaid by the Final Date for payment;
- may suspend performance of any, or all, of its obligation under the contract;
- is entitled to the additional time involved in suspending and re-mobilising;
- is entitled to the reasonable costs of suspension.
A statutory suspension must relate to non-payment and follow a written notice from the unpaid party. However, the paying party must have failed to pay a Notified Sum on or before the Final Date for payment in breach of Section 111(1).
A breach of contract other than non-payment will not give the innocent party a right to suspend performance. However, the innocent party may have a right to claim damages for breach of contract, or a statutory right to commence an adjudication to settle the dispute under a construction contract.
The unpaid party must still take into account any Pay Less Notice served by the paying party under Section 111.
Section 112(2) confirms that a written notice from the unpaid party must be served at least 7 days before the intention to suspend and state the grounds that will be relied upon to suspend performance. It is important that the unpaid party issues a valid notice (“Notice of Suspension”). Failing same, any suspension may amount to a repudiatory breach of contract.
The ability to suspend any or all of its obligations allows contractors to graduate the extent of the suspension. They can choose to suspend only part of their obligation before escalating to all-out suspension until the required payment is forthcoming. The right to suspend can go beyond construction work and/or construction services. For example, the obligation for a contractor to maintain certain insurances could be suspended.
The contractor has to be careful not to breach any statutory duties, for example
- its ongoing obligation to maintain employer’s liability insurance;
- its obligations under the Construction, Design and Management Regulations 2015.
Section 112(1) confirms that the statutory right to suspend is expressly without prejudice to any other legal rights and remedies that a party to a construction contract may have.
Section 112(3) confirms that the statutory suspension ends once the paying party pays the Notified Sum.
Any time limits under the Construction Contract will be adjusted by the provisions of Section 112(4). The unpaid party has the right to additional time for winding down the works and additional time for re-mobilising in consequence of the exercise of the right of suspension. All target dates or completion dates are extended by the period of a valid suspension, together with any additional period to wind down or re-mobilise the works.
Third parties directly or indirectly affected by a statutory suspension can also claim extensions of time. For example, if sub-contractor B validly suspends performance of his obligations to contractor A, if sub-contractor C’s work is delayed because he must wait for sub-contractor B to complete its work, then sub-contractor C can seek an extended time limit to its sub-contract, to the extent it is directly or indirectly affected by sub-contractor B’s suspension.
Section 112(3)(A) gives the unpaid party a right to claim a reasonable amount for the costs and expenses of the suspension, including its remobilisation costs.
Notwithstanding an unpaid person’s right to suspend performance, it may choose to enforce its rights by less draconian means, in order to maintain the commercial relationships between the parties. Such remedies can include:
- commencing an adjudication;
- claiming contractual interest, or interest under the provisions of the Late Payment of Commercial Debts (Interest Act) 1998 of 8% over Base Rate;
- issuing a Letter of Claim in compliance with the Practice Direction: Pre-Action Protocols and commence legal proceedings.
Pay when Paid Clauses
Section 113(1) of the Construction Act 1996 prohibits “pay when paid clauses” and this is reaffirmed by Paragraph 11 of the Scheme. There are exceptions in the event that one of the parties become insolvent.
Sections 110(1A) to (1D) prohibit a range of conditional clauses, including setting dates by reference to:
- Performance of obligations under other contracts
- Certification by a third party of performance of obligations under other contracts
- giving any notice to the unpaid party.
Therefore, employers should ensure that they issue timely payment notices in compliance with the Act. If employers are of the opinion that a sum of money significantly less than the contractor is anticipating is appropriate, then it would be prudent to take the initiative by issuing a Payment Notice with detailed calculations, before waiting to issue a Pay Less Notice.
A contractor should ensure that prompt and compliant Default Payment Notices are issued if the employer does not issue a Payment Notice within the requisite 5-day period.
If the contractor wishes to exercise its right to suspend all or part of the works, it must ensure that a valid Notice of Suspension is served at least 7 days before work ceases.
If a contractor does exercise its right of suspension, then it must ensure that it submits fully particularised claims in regard to any additional time and costs incurred as a result of any suspension and re-mobilisation.