Payment notices and pay less notices: genuine belief required

A recent TCC decision appears to be the first to consider the subjective requirement for a valid payment notice under the Construction Act. This decision makes clear that any payment notice which does not set out the amount genuinely considered to be due is likely to be invalid, leaving an employer at risk of a “smash and grab” adjudication. The decision is likely to apply equally to payment applications and pay less notices and may herald a new form of “smash and grab” adjudication involving complex factual disputes over an employer’s state of mind.

Payment notices and pay less notices: an overview

The Housing Grants, Construction and Regeneration Act 1996 (as amended) (the “Construction Act”) sets out certain notice requirements in relation to payments under construction contracts. Payment notices and pay less notices may be given, usually by the paying party, which state the sum the party “considers” to be due as well as the basis on which that sum is calculated. Such notices define the “notified sum” which must be paid under section 111 of the Construction Act.

Where a construction contract provides for a payment application to be made by the contractor, the failure to serve a payment notice or pay less notice – or the giving of an invalid notice – will usually result in the amount stated in the payment application becoming the “notified sum” required to be paid under section 111. Adjudications commenced by contractors on this basis are sometimes referred to as “smash and grab” adjudications.

The rise of “smash and grab” adjudications has led to a number of cases considering the requirements for a valid payment notice or pay less notice, including their content, form and method of delivery. There has, however, been very little consideration of the requirement that the amount stated as due be what the giver of the notice “considers” to be due. Whether or not this word imposes a subjective threshold for a valid notice was the subject of a TCC decision discussed below.

Downs Road Development LLP v Laxmanbhai Construction

Downs appointed Laxmanbhai to act as contractor in the construction of 4 blocks of flats in East London. The contract took the form of an amended 2011 JCT Design and Build Contract.

The dispute concerned Laxmanbhai’s February 2021 interim payment. They key facts are set out below.

• The due date was 26 February 2021.
• On 26 February 2021, Laxmanbhai submitted an interim application. The sum stated to be due was £1,888,660.70.
• On 3 March 2021, the Employer’s Agent issued a payment notice stating that £0.97 was due.The Employer’s Agent explained in its covering email that it had taken longer than anticipated to assess Laxmanbhai’s application because it was sent on the due date and the volume and form of information provided made it difficult to complete the valuation in a timely manner. Accordingly, it was said that “a further Payment Notice will be issued to you in due course and will not affect your payment date."
• On 9 March 2021, the Employer’s Agent issued a second payment notice to Laxmanbhai.In that, the amount due for payment was £657,218.50, which was subsequently paid on 26 March 2021.

Laxmanbhai commenced an adjudication in relation to the February interim payment and the matter ultimately came before the TCC on an enforcement hearing. One issue before the court was whether the initial payment notice on 3 March 2021 had been validly given.

Downs conceded that its second payment notice (dated 9 March 2021) was out of time and therefore invalid. However, it argued that its first payment notice was valid as it set out an “agenda for adjudication”. This phrase had been used in previous cases (such as Henia Investments v Beck) as providing a test for the validity of a payment notice. Downs claimed that it was the sole test for determining whether a payment notice satisfied the requirements of the Construction Act.

Subjective requirement upheld

The court found Downs’ first payment notice to be invalid and rejected Downs’ argument based on the Henia line of cases. The court noted that Henia was concerned with whether the notice in question set out the basis upon which the sum due had been calculated, not whether the giving party genuinely considered the amount stated to be due. A payment notice must satisfy both requirements.

The court held that Downs’ first payment notice did not set out the amount it genuinely considered to be due because:

1. the covering email stated that a second payment notice would be issued;
2. Downs clearly envisaged that the second payment notice would set out a different figure; and
3. Whilst Downs may not have formed a view as to the precise amount it believed was due at the time of giving the first payment notice, it was not credible to suggest it did not realise that a substantially greater sum was due.

The court also found it was not necessary to establish that, in failing to state the amount genuinely considered to be due, the notice giver was acting in bad faith.

Conclusions and implications

This appears to be the first decision to deal with the subjective requirements for payment notices and pay less notices arising from the use of the word “considers” in the Construction Act. The same wording is also found in the JCT standard form contracts for payment and pay less notices. The upholding of a subjective requirement raises a number of issues for employers and contractors alike. Employers now have an additional requirement to meet when issuing payment and pay less notices and should be wary of giving any indication that the amount stated in a notice is subject to revision or merely a holding measure.

The decision is likely to result in an increase in “smash and grab” adjudications, commenced on the basis that an employer’s payment notice or pay less notice has failed to meet the subjective requirement of genuine belief as to the sum considered to be due and is therefore invalid. This in turn is likely to involve factual investigations into the employer’s state of mind. In the present case, the court relied heavily on the Employer’s Agent’s covering email which expressly stated that it had not had enough time to assess the amount due. However, it should be noted that the court also referred to the considerable difference between the value of the first and second payment notices, which were given within a week. In practice, the subjective and objective requirements will often go hand-in-hand, as the greater the level of detail showing how the sum due has been calculated, the more difficult it is likely to be (absent direct evidence to the contrary) to argue that the notice giver did not have a genuine belief in the amount stated as due.

The need to consider such evidence is likely to considerably increase the time and costs involved with “smash and grab” adjudications without any corresponding benefit to the parties’ understanding of the merits of the dispute. Further guidance from the TCC as to how adjudicators are to approach such arguments may well prove necessary.

Contractors should be aware that the same requirement also applies to payment applications under the Construction Act as the requirement in section 110A(3) is for a payment notice to specify the sum the payee considers to be due. The JCT and NEC standard forms use the same language in relation to applications for payment. Applications which become a payee notice in default of a payer’s notice could be open to the same challenge of there being no genuine belief as to the sum considered to be due.

References

Downs Road Development LLP v Laxmanbhai Construction (U.K) Limited [2021] EWHC 2441 (TCC)

Henia Investments v Beck Interiors Ltd [2015] EWHC 2433 (TCC)