‘Fixing’ the final date for payment under construction contracts

Parties to construction contracts are typically well aware of the payment regime the Construction Act imposes, including the employer’s obligation to pay the contractor all notified sums in full by the final date for payment.

This may create a problem for the employer if the contractor does not provide a valid VAT invoice in respect of the notified sum. The Act requires the employer to pay the sum due (including any VAT).  However, if it does not receive a valid VAT invoice, this could create VAT accounting problems for the employer and, potentially, lead to an inability to reclaim the VAT.

A common solution for employers (and for main contractors in respect of their subcontractors) is to link the final date for payment to the submission of a valid VAT invoice for the notified sum (i.e. so that it is a certain number of days following the submission of the VAT invoice). This seeks to ensure that the employer will not be obliged to pay until it knows its VAT position is covered.  However, the recent decision of the TCC in Rochford Construction Limited v Kilhan Construction Limited has arguably put an end to the validity of this practice.

The dispute in Rochford v Kilhan

The contractor, Rochford, had appointed Kilhan as its subcontractor in connection with the construction of the reinforced concrete frame on a project. The subcontractor made an application for payment for just under £1.4 million on 20 May 2019, covering the period to 30 April 2019. The contractor issued an interim payment notice on 23 October 2019, certifying just over £1.2 million.

A dispute arose and the adjudicator decided that the final date for payment in respect of the subcontractor’s application was 19 June 2019. Accordingly, the contractor’s payment notice was issued well out of time and, as a result, the contractor was required to pay the sum claimed by the subcontractor in full. The contractor complied with the adjudicator’s decision, and then brought fresh court proceedings to obtain a final decision on the matter.

This article will focus on the question as to what the final date for payment was (and therefore whether the payment notice could function as a pay less notice).

The contract terms

The contract did not contain detailed payment provisions. The relevant wording was limited to the following:

            “The brief description of subcontractor works to be carried out

Works are lump sum…RCL will issue activity schedule to KCL, application date end of month…commercial…valuations monthly as per attached payment schedule end of month. Payment terms thirty days from invoice as per attached payment schedule. S/C payment cert must be issued with invoice.”

Importantly, the payment schedule referred to in this provision was not ultimately incorporated in the contract.

Rochford’s position on the final date for payment

As the contract stated: “Payment terms thirty days from invoice as per attached payment schedule”, the contractor argued that, notwithstanding the fact that no payment schedule existed, this provision established a final date for payment which was 30 days from the date on which the subcontractor issued the corresponding invoice. As the subcontractor never issued an invoice, the payment notice could not have been issued late.

The subcontractor raised two counterarguments. The court described one of these as legal and one as essentially factual. Ultimately, although the case was decided on the factual argument, the court agreed with the subcontractor in both instances.

The factual issue

The ‘factual argument’ centred on the problem that there was no clear means for the subcontractor to determine when it was supposed to issue its invoice. The contract stated both that the invoice should be issued in accordance with a payment schedule, which did not exist, and that the payment certificate (which had not been provided) should be issued with the invoice. The contract did not spell out what the subcontractor should have done where no payment certificate was issued.

The court said that the Act was intended to ensure certainty over the dates on which sums should be paid, and that this is precisely what the contract failed to achieve. The contract referred the subcontractor to one of two items (the payment schedule or the payment certificate), neither of which existed, to determine when to issue its invoice. There was accordingly no certainty as to when the invoice should be issued, making it an unsuitable basis for determining the final date for payment. Further, the court could see no reason to excuse the contractor’s failure to issue a payment certificate, which forms part of the statutory payment regime, by reference to the non-issue of an invoice, which has no status under the statutory regime whatsoever.

The legal issue

The court was able to decide the matter on the basis of the factual argument. However, it did go on to comment on the ‘legal’ argument.

This principally related to the wording of section 110(1) of the Act, which states:

            “110     Dates for Payment

            (1) Every construction contract shall –

(a) provide an adequate mechanism for determining what payments become due under the contract, and when, and

(b) provide a final date for payment in relation to any sum which becomes due.

The parties are free to agree how long the period is to be between the date on which a sum becomes due and the final date for payment.”

The key point was that while the Act allows the contract to specify “a mechanism” to determine when payments become due, it referred to the parties agreeing “how long the period” is to be between the due date and final date for payment.

The court accepted that this permits the due date to be fixed by reference to the occurrence of an event (as is often the case for projects using milestone payments). However, when it comes to the final date for payment, this must be a fixed period of time after the due date. It cannot be set by reference to an event, or the issue of an invoice or notice.

There were two further provisions the court also found to be relevant on this point. The first was section 109(2) of the Act, which in effect gives the parties complete freedom to decide the circumstances under which stage payments become due. This was held to be in marked contrast to the wording of section 110(1)(b).

The second point was the Act’s prohibition against ‘pay when certified’ clauses and prohibition against the due date being linked to the issue of a notice by the payer.  The relevant sections make no mention of the final date for payment.  The court held that the prohibition against such clauses would be frustrated if the employer was permitted to introduce such practices as a means to determine the final date for payment. This would clearly be contrary to the aims of the Act.  The court held that the inference is that the possibility to peg the final date of payment to an event rather than a fixed period was never considered acceptable under the Act.

Consider your final date for payment terms

Many employers and main contractors will be concerned by the court’s comments in this decision, as it is common practice to link the final date for payment to the provision of a valid VAT invoice.  Although it is arguable that it is within the contractor’s power to ensure that a valid VAT invoice is issued, and it should therefore bear the cash flow risk of failing to do so, this decision appears to rule out the validity of such a practice.

Parties should therefore look closely at the final date for payment terms under their construction contracts.

Contracts that do not contain valid final date for payment provisions will have the relevant provisions replaced by the Scheme.  This provides a final date for payment 17 days after the due date, which could be significantly shorter than the period otherwise provided by the contract.  This could mean that payless notices that would otherwise be valid could be out of time, with all the consequences of smash and grab adjudications and obligations to pay the notified sum that would follow.  This is something that parties may seek to take advantage of in the event of a payment dispute.

Payers should therefore carefully consider when the period for serving a valid payless notice will actually expire if the final date for payment under their contract is replaced by the final date for payment under the Scheme.

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This article was written by Chris Hadnutt, for more information please contact Chris at christopher.hadnutt@crbslaw.com