Non Payment in Construction Contracts – what are my options?
Cash is king, so the old saying goes. This is certainly true in the construction industry, where margins are low and the cost and availability of material and labour is unpredictable. Indeed, often the success or failure of a construction business hinges on getting paid the right amount at the right time.
Non-payment come in different guises, including late payment, underpayment and no payment at all and there is no “one size fits all” approach; the correct course of action will depend on a number of factors, not least the relevant contractual and factual position in each case, but also the usual commercial considerations. It is likely that one or more of the following options can be used in conjunction and we recommend you take legal advice on which option is appropriate before taking any action.
1. Get your drafting right
As a preliminary point, the starting point must be to ensure that your expectations as to when you will be paid align with the contract you enter into! This may seem obvious, but clients we advise in relation to payment disputes are often surprised when we explain the payment terms on which they have actually contracted. We regularly hear phrases such as “we are supposed to get paid 14 days from month end” only to find that the contract says something entirely different.
As a refresher, the Construction Act provides that a party to a construction contract is entitled to stage payments unless the contract specifies that the duration of the works are to be less than 45 days or the parties agree that they are estimated to be less than 45 days. Further, the contract must contain an ‘adequate mechanism for payment’ which must include the following:
- a due date for each payment and a final date for payment – the parties are free to agree the period between these dates.
- a “payment notice” to be given within 5 days of the due date setting out the amount to be paid and how it is calculated.
- in the event that payer fails to serve a payment notice, the payee can serve a default payment notice or, if it was permitted to serve a payment application, that application becomes the default payment notice.
- a pay less notice if the payer wishes to pay less than the amount stated in a payment or default payment notice, to be served a certain number of days before the final date for payment (the parties may agree this time period).
- payment cannot be made conditional upon the payer being paid (pay when paid) or upon a notice being issue under a separate contract (pay when certified).
If you are uncertain as to whether the contract you are being asked to sign complies with the Construction Act and/or that it may not reflect the payment terms you have agreed, we recommend you seek advice.
2. Comply with the Contract
Once you have ensured that your contract matches your expectations, make sure you comply with it. A payee’s prospects of succeeding with the steps set out below may hinge on whether or not it has complied with its side of the bargain.
A payee should ensure it issues applications for payment on time and in the form prescribed in the contract and should also be aware of when the payer must issue the relevant notices and the final date for payment.
Section 112 of the Construction Act provides that where a notified sum is not paid by the final date for payment, the payee may suspend performance of any or all of its obligations under the contract. Some important points to note:
- you must be certain that the right to suspend has arisen to avoid the risk of being in breach of contract and making a bad situation worse;
- If the right has arisen, seven days’ notice must be given before suspending, setting out the grounds on which the payee intends to suspend;
- the payee may choose to suspend part of its obligations but not all;
- an exercise of the right to suspend entitles the payee to an extension of time for completing the works;
- the payee is entitled to recover a reasonable amount in respect of costs and expenses reasonably incurred as a result; and
- the right to suspend ceases once payment is made in full of the notified sum.
The foregoing is a statutory right and cannot be ‘contracted out’, however the parties should check the relevant contractual provisions for additional obligations which may need to be complied with.
A word of warning, the right to suspend may be affected by the provisions of the Corporate Insolvency and Governance Act 2020 in circumstances where the payer has not paid and has entered insolvency. The applicability of CIGA is outside the scope of this note and advice should be sought when an insolvency situation arises.
Section 108 of the Construction Act gives parties to a construction contract the right to refer disputes to adjudication at any time. Adjudication is a relatively quick and relatively inexpensive method of obtaining a interim binding decision and may be useful in the event of non-payment in several ways, including:
- Where the payee has issued the correct notices but has undervalued the works, the payee may wish to refer a dispute for a decision as to the proper valuation of the works, often referred to as a “true value” adjudication.
- Where the payee has failed to issue the correct notices on time, in the correct form or at all, the payee may wish to refer a dispute seeking a decision that it is entitled to be paid the notified sum. This is often referred to as a “smash and grab” adjudication as, if referred correctly, the Adjudicator will not be required to open up the value of the payment and in some circumstances the payee will be entitled to the amount contained within its application for payment. More information on smash and grab adjudications can be found in our previous blogs, here.
A payee will need to bear in mind that each party’s costs of adjudication (including legal fees) are generally speaking not recoverable from the other. Further, whilst the adjudicator has the power to award his or her fees and expenses as he so chooses, the parties remain jointly and severally liable for those fees until they are discharged. Several Adjudicator Nominating Bodies (ANB’s) now offer a capped fee structure for low value disputes, such as the RICS Low Value Dispute Adjudication. These schemes can be very useful where the amount in dispute is relatively low.
Parties must also be aware that Adjudication is an interim binding process of dispute resolution, meaning that a Decision can be enforced (subject to matters such as jurisdiction and natural justice) in the Courts, but is only binding on the parties until such time as the dispute is resolved by way of litigation or arbitration. That is not to say that the parties must take this extra step, and often adjudication is used by the parties as the final roll of the dice to resolve their dispute.
Some contracts may provide a payee with the obligation to terminate the contract in the event of non-payment. This would clearly be a drastic step and a party considering termination must tread incredibly carefully in order to avoid a claim for delays, damages and/or wrongful termination. The contract must be follows to the letter, including checking the grounds for termination reflect that contained within the contract and issuing the required notices.
Again, the Corporate Insolvency and Governance Act 2020 may prevent termination where the payer has entered insolvency and advice should be sought in this situation.
A payee who is wrongly kept from its money may be able to claim interest on those unpaid sums, either:
- As an express term of the contract – most construction contracts will contain an express right to interest, including the circumstances, rate and basis upon which it may be claimed.
- As an implied term under the Late Payment of Commercial Debts (Interest) Act 1998, which includes the right to claim simple interest on overdue sums at a rate of at least 8% per annum
7. Payment Security
Should you be concerned about the ability or willingness of the party with whom you are contracting to make payments to you in accordance with its contractual obligations, there are various ways in which you can add protection at the outset of the transaction. We regularly advice clients in relation to payment security including Parent Company Guarantees, Performance Bonds, Escrow Accounts, advanced payments, standby letters of credit and bank account charges.
Statutory demands may be used in some circumstances where a payee has not been paid, with the effect that if payment is not made within 3 weeks of a statutory demand (the debt must be over £750) the creditor becomes automatically entitled to issue a winding up petition.
However, this avenue will only be available where the debt is undisputed and the courts have been clear that a winding-up petition is inappropriate to enforce interim payment obligations where the payer challenges the value of the works or has some other genuine cross-claim to raise.
Advising construction clients that they ought to negotiate can often feel like teaching grandmother to suck eggs, such is the nature of the industry in which people negotiate on a daily basis. Having said that, even if previous negotiations have collapsed, we invariably advise clients to consider trying again either before or during any of the steps listed above.
It is sometimes the case that parties are more receptive once they realise that the payee does not intend to do nothing, and the mere threat of suspension or adjudication can sometimes force a different perspective on the dispute.