Christian Charles, Senior Associate, Fladgate LLP (email@example.com)
Tim Reinhard, Trainee Solicitor, Fladgate LLP (firstname.lastname@example.org)
In a highly anticipated and significant judgment, the Court of Appeal has upheld the decision of Coulson J (as he then was) and confirmed that an employer is entitled to commence a second adjudication to determine the “true value” of a contractor’s interim payment application even if the employer’s payment and pay less notices were ineffective.
The decision confirms a departure from the previous line of cases starting from ISG Construction Ltd v Seevic College  EWHC 4007, and provides welcome clarity on certain aspects of the Construction Act insofar as it concerns interim payments and the right to adjudicate.
The case concerned the construction of a Premier Inn at Heathrow Airport for a contract sum of circa £26 million. Shortly after practical completion, the contractor (S&T) made an application for payment which valued its works at almost £40 million and resulted in a net payment of just over £14 million. The contractor provided a detailed spreadsheet showing how that figure had been calculated. Some days later, the employer (Grove) sent a pay less notice stating that it considered the sum due was nil and that, if liquidated damages had not been deducted, the figure would have been circa £1.4 million. The basis on which that figure had been calculated was not set out in detail in the pay less notice itself, but it referred to the payment certificate which had been issued five days previously, and which showed exactly what amounts were disputed.
The first question the Court of Appeal had to consider was whether the pay less notice complied with the statutory requirement to state “the amount proposed to be withheld and the ground for withholding payment”.
Even though the grounds for withholding payment had been attached to the certificate sent five days earlier, the Court of Appeal said that the cross reference to the certificate satisfied the requirements of the Act. However, the Court of Appeal also said that referring to another document for details of the amounts withheld would not always be sufficient – it was a matter of “fact and degree”. In other words, the court has left itself some room to come to a different conclusion in other circumstances.
That decision was really the end of the dispute about the pay less notice, but the Court of Appeal went on to consider a second question of considerable importance: if the wording of the pay less notice had not been sufficient, was the employer still entitled to pursue a claim in adjudication to determine the correct value of the works on the date of the interim application?
This would not always be an issue, because any overpayment made because of a failure to serve a valid pay less notice could be adjusted on the next interim payment. In this case, though, the application for payment of the £14 million was made a few days after practical completion had finally been achieved, so that kind of adjustment was not feasible.
The practice of adjudicating on the basis of a failure to serve valid payment or pay less notices has become widely known as “smash and grab” adjudication. This issue has come before the courts on several previous occasions and there have been conflicting decisions. After a review of the relevant cases, the Court of Appeal decided that in these circumstances an alleged overpayment could be the subject of adjudication and an adjudicator could order repayment of any excess amount which had been paid to a contractor. However, in reaching its decision the Court of Appeal also confirmed that
“both the Act and the contract must be construed as prohibiting the employer from embarking upon an adjudication to obtain a revaluation of the work before he has complied with his immediate payment obligation.”
In other words, in the absence of a valid payment or pay less notice, the employer can only adjudicate to seek reimbursement of any overpayment once it has paid the sum stated in the contractor’s application. The Court of Appeal was not particularly sympathetic to the argument that this could cause problems if the contractor was or became insolvent before the adjudicator’s decision on repayment was made. The Court of Appeal said that an employer should be careful to protect itself in those circumstances by issuing a payment notice or a pay less notice in accordance with the strict requirements of the Act.
The court also considered a third question in relation to liquidated damages. This was a JCT Design and Build Contract 2011, and the usual provisions for liquidated damages applied:
In this case the employer sent a notice of non-completion in October 2016. The second notice, that the employer may require payment of or deduct liquidated damages, was sent by email 49 seconds after 5.00 p.m. on 18 April 2017. The third notice, stating the deduction, was sent 8 seconds later. The two notices arrived in the same sequence, although the third notice arrived only 7 seconds later.
A judicial eyebrow was raised at the fact that the wording of the contract did not specify any period of time between the service of the second notice and the third notice. However, the court did not think that a “reasonable” lapse of time between the notices should be implied because that would create a great deal of uncertainty. The Court of Appeal held that as long as there was ‘a scintilla’ of time between the giving of the two notices, that would be sufficient. The requirements for the deduction of liquidated damages had therefore been met.
The Court of Appeal’s decision provides welcome clarification in respect of issues which construction lawyers, adjudicators and TCC judges have to grapple with on a regular basis. However, a number of uncertainties remain.
First, it is unclear how the restriction on adjudication until after payment of the notified sum will work in practice. Does this mean that an adjudicator has no jurisdiction to determine a “true value” dispute until that payment is made? If so, how does that sit with a party’s statutory right to adjudicate “at any time”?
Secondly, far from bringing an end to the practice of “smash and grab” adjudications, it is clear that contractors can still obtain a significant tactical advantage by seeking to adjudicate on the basis of a failure to serve a valid payment or pay less notice. Whilst the employer can commence a second adjudication to determine the “true value” of the contractor’s entitlement, it can only do so once it has paid the sum stated to be due in the contractor’s application.
Finally, it remains to be seen how the TCC will approach these issues in the context of adjudication enforcement proceedings. For instance, will the Court entertain an employer’s argument that summary enforcement of a “smash and grab” decision should be stayed on the basis of a contractor’s insolvency risk? Only time will tell, but we suspect that it won’t be long before these issues come back before the courts.