The genuine article? Does a valid payment notice need to set out the sum the payer genuinely considers due?
The requirement that a valid payment notice must set out “the sum the payer considers due” is often at the centre of payment disputes. The recent decision in Downs Road Development LLP v Laxmanbhai Construction (UK) Ltd, provides a necessary clarification around what this actually means, confirming that a valid payment notice must set out the sum the payer genuinely considers due.
In addition, the court refused to enforce the adjudicator’s decision, because the failure to consider a cross claim was a breach of the rules of natural justice and the decision could not be severed.
The employer, Downs Road Development LLP, engaged the contractor, Laxamanbhai Construction (UK) Ltd, to carry out construction services relating to the development of four buildings containing 79 residential units in London, using an amended JCT Design and Build Contract, 2011 Edition.
Unusually, at some point, the employer had adopted an approach of sending two payment notices in each payment cycle. The first payment notice was more of a holding response than a notice, certifying a sum due of £1 and letting the contractor know that a further payment notice would soon be issued. This was followed by a second notice setting out the actual valuation of the contractor’s interim application.
Matters came to a head when the contractor submitted interim application 34 (IA 34) for a payment of £1,888,660.70. As usual, the employer issued the “first” payment notice 34 to the contractor showing the net amount for payment of £0.97. In the covering email, the employer confirmed that a further payment notice would soon follow, and that “it will not affect [the contractor’s] payment date”. In the covering email, the employer explained that it had been “difficult to get the valuations assessed in a timely manner” due to the application being made on the due date, combined with the volume and form of the supporting information provided. Six days later, as promised, the employer issued a second payment notice 34a to the contractor, certifying a sum of £657,218.50, which was significantly less than what the contractor had applied for.
The contractor commenced an adjudication to determine the correct sum due and seeking payment of the balance. The employer advanced a cross claim in its defence, alleging that it had suffered losses because the contractor had failed to build a capping beam in accordance with the contract.
In the adjudicator’s view, his task was limited exclusively to the proper valuation of the interim application. Accordingly, he declined to consider the cross claim as part of the true value assessment on the basis that he did not have jurisdiction to determine the issue and held that the contractor was entitled to a further amount of £103,826.
Following the adjudication, the employer commenced a Part 8 claim, arguing the adjudicator’s failure to consider its cross claim was a breach of the rules of natural justice, but that the gross valuation was severable and was binding as it was a distinct and separate issue.
Was the first payment notice for £0.97 valid?
The court had little difficulty in finding that the employer’s first payment notice was invalid because it did not state the sum the employer genuinely considered to be due.
This was because the employer’s own email stated that it had been experiencing difficulties in assessing the valuations in a timely manner and a substantially larger sum was awarded under payment notice 34a only six days later.
Against that background, the court found that the employer could not realistically contend that it genuinely considered the sum of £0.97 to be due. In addition, payment notice 34 did not set out the basis on which the sum had been calculated.
The court emphasised that, in order to comply with section 110A(2) of the Construction Act 1996, a valid payment notice must set out the sum that the employer genuinely considers due at the payment due date, together with the basis on which that sum is calculated. The court noted that such requirements are “neither removed nor diminished by the knowledge that the figure may be altered subsequently” and must be complied with. In this case, this meant the payment notice was invalid.
Had there been a breach of natural justice?
There is a lesson for all of us here – deliberate failure by the adjudicator to address a material issue within an adjudicator’s jurisdiction constitutes a breach of the rules of natural justice and could render an entire decision unenforceable.
Here, the court found that the adjudicator had adopted too narrow a view of his jurisdiction in thinking that it was to “take a snapshot of the position between the Parties at the time [of the payment notice]”. The court explained that the capping beam claim was being put forward as a matter the employer said reduced the amount that was due in that cycle, and therefore was raised as a defence in respect of the matter in issue. It rejected the argument that the capping beam issue was not part of the valuation process under the contract, as this did not go to jurisdiction.
The court made it clear that, had the adjudicator considered the cross claim and concluded that it did not reduce the amount due to the contractor, the decision would have been fully enforceable, right or wrong. Unfortunately, the adjudicator had declined to consider it in this case, in breach of the rules of natural justice, which meant his decision was unenforceable.
Was any part of the adjudicator’s decision enforceable?
The court referred to the Scottish decision of Dickie & Moore Ltd v McLeish, which identified the general rule that severance of an adjudicator’s decision is possible where the valid parts of the decision are not significantly tainted by the invalid parts.
The court also noted that the policy underlying the Construction Act 1996 and the Scheme is to maintain cash flow in the construction industry and that severance of decisions into a partial enforcement can be compatible with that policy. But this would not be the case where this created an artificial outcome that could not have been the result of a proper decision by an adjudicator.
The dispute at hand concerned a single dispute over the correct sum due to the contractor and the adjudicator’s decision was a “continuous chain of reasoning”. The court therefore refused to sever the decision as that created a risk of imposing an outcome that could not have resulted from the adjudication.
So, the payment notice was invalid but there was also a breach of the rules of natural justice and the adjudicator’s decision was therefore not enforced. It was argued at the hearing that this meant that IA 34 became the notified sum, but the judge noted that neither party had asked for a decision on this point and that a payment dispute may now arise in relation to interim application 35, which had also been certified.
I, for one, am particularly interested to see what happens in the realm of disputes about payment notices going forward. The facts here were perhaps unusual, but the new found need to consider whether the person issuing the payment notice or pay less notice “genuinely believed” the sum it “considered to be due at the time” provides another potential ground for challenging the validity of payment notices. This may well lead to further “smash and grab” adjudications.
How an adjudicator can assess what is a genuine assessment is not clear and will no doubt be challenging when the assessment is not as unusual as in this case. As always, meeting the basic requirements as required under section 110A of the Construction Act 1996 will help reduce the risk of such arguments. This means issuing the payment notice on time and setting out the details of how the sum has been calculated. The latter will be particularly helpful evidence in demonstrating that the sum noted in the payment notice is a product of a genuine belief in the amount stated as due.
In addition, this decision highlights the risks of creating new payment procedures and, in this case, using holding notices as a way to delay making payment. Following the contract and providing a genuine, and substantiated, assessment is the best way to achieve certainty and avoid disputes about the validity of notices.