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‘Pay now, adjudicate later’

In a previous article, concerning the TCC judgment in Imperial Chemical Industries Limited v Merit Merrell Technology Limited [2017] EWHC 1763, I predicted that the TCC decision of ISG Construction Limited v Seevic College [2014] EWHC 4007, which opened the way for ‘smash and grab’ adjudications by payees, would be disowned.  I was right, since Mr Justice Coulson did exactly that in the TCC decision of Grove Developments Ltd v S&T (UK) Ltd [2018] EWHC 123 on 27 February 2018.  Yesterday, the Court of Appeal confirmed that decision.  The Court of Appeal’s judgment was given by former TCC judge Sir Rupert Jackson.  It provides some clarification about what the payer must do before commencing an adjudication on the ‘true value’ of an application for payment under the Housing Grants, Construction and Regeneration Act 1996 as amended by the Local Democracy Economic Development and Construction Act 2009 (generically, ‘the Act’). 

In ISG Construction Limited v Seevic College [2014] EWHC 4007, Mr Justice Edwards-Stuart decided that, where a default payment notice contained the sum due at the final date for payment, then in the absence of a Pay Less Notice, this was the contractually ‘deemed value’ of the work done at the due date.  Moreover, the Act would be undermined if the actual value of the relevant application for payment were to be the subject of a subsequent adjudication, so that was not permissible. Therefore, a payee could neither resist payment of the adjudicator’s award, but nor could the actual value of the interim application be ascertained without court proceedings or arbitration, at significant cost. Where there are no further interim valuations to occur, this could result in a windfall to the payee until such time as the final account is determined – a moveable feast in reality.

In yesterday’s Court of Appeal (‘CA’) judgment (S&T (UK) Ltd v Grove Developments Ltd [2018] EWCA Civ 2448), Sir Rupert Jackson held that Coulson J had been right not to follow ISG v Seevic at the TCC stage.  The CA considered these issues:

  1. Can the obligation to specify the basis of a payer’s calculation of the sum due in a Pay Less Notice be satisfied by referring to a separate document which previously did that (‘incorporation by reference’)?
  2. Can a payer commence an adjudication to determine the correct value of an interim application if its Payment Notice or Pay Less Notice are invalid?

  3. What timings apply to the giving of notices of a payer’s intention to deduct liquidated damages under JCT forms?

Pay Less Notice Requirements

Grove could not rely on its Payment Notice concerning S&T’s application 22, because it was late.  It therefore served a Pay Less Notice which stated the sum it considered to be due – nil -  but referred back it’s belated Payment Notice which contained the calculation.  The CA held that it was a question of ‘fact and degree’ whether the a Pay Less Notice was sufficiently specific to meet the requirements of the Act. The CA held that there was no prohibition on incorporation by reference in the Act, and that Coulson J was right to find that the belated Payment Notice was sufficiently clear to allow S&T to understand the basis of Grove’s calculation that the sum due was nil.  The CA declined to lay down hard and fast rules for the content of Pay Less Notices, which is wholly consistent with the courts’ approach to this to date (see my articles on this from 2015 and 2016).

‘True Value’ adjudications

This is the bit we were particularly looking forward to: would ISG v Seevic survive in any form, and are there any preconditions on the payer starting a second adjudication on the ‘true value’ of an interim application?

The CA held that the payment mechanism under the Act generates a provisional figure for immediate payment (‘the Notified Sum’), but that this is not definitive and, therefore, adjudication must be available to the parties to obtain a more rigorous valuation which arrives at the appropriate figure.  Coulson J’s reasoning on this in the TCC was so compelling that the CA verdict is unsurprising.  This element of the CA judgment confirms that the procedural situation which applied before 2014 has been restored.  Until ISG v Seevic, it was understood that a payer could launch its own adjudication to determine the true value of an application for payment so that the resulting award could be used to resist enforcement of any adjudicator’s award that the payee might obtain concerning the notified sum. However, Coulson J also said, most notably at paragraphs 137 - 138 of his judgment:

“On my analysis, the contractor would not be prejudiced in respect of cash-flow at all, because he would be recovering the full amount for which he had claimed in his interim application. That amount would have to be paid by the employer. So there is no threat to cash-flow….If a second adjudication took place thereafter, which concluded that the contractor had over-claimed and therefore been overpaid, the contractor would have to repay the amount of the overpayment. What could possibly be wrong with that?”

The underlining is ours; Coulson J’s expectation was than a payer would pay the notified sum before referring the true value of an interim application to adjudication.  However, dear reader, you and I know better; a payer who disputes the accuracy of an application for payment will generally do all they can to avoid paying it.  Indeed, the courts have recently indulged payers where there is some doubt about the status of a default payment notice, rather than trusting adjudicators to decide their validity, and enforcing their decisions (see the first article I referred back to).  However, on this occasion the CA has done payees a favour, because it has decided that the payer must pay the notified sum before commencing an adjudication on the true value of the payee’s application. 

Sir Rupert Jackson was clear on the requirement to pay, at paragraph 107 of the CA judgment:

“The Act cannot sensibly be construed as permitting the adjudication regime to trump the prompt payment regime. Therefore, both the Act and the contract must be construed as prohibiting the employer from embarking upon an adjudication to obtain a re-valuation of the work before he has complied with his immediate payment obligation.”

And at paragraph 110:

“In summary, the position is this. The judge held that the employer must make payment in accordance with clause 4.9 of the contract (or, as I would say, in accordance with section 111 of the Amended Act) before it can commence a 'true value' adjudication. I accept, as [S&T submit], that the judge did not give reasons for that conclusion. Nevertheless, I think that the judge's conclusion was right for the reasons which I have set out above.”

The underlining immediately above indicates that this position will apply to all construction operations covered by the Act, not just those governed by JCT forms of contract.  This is a caveat to section 108 of the Act, which says a party may refer a dispute to adjudication at any time, and entrenches the notified sum until it has been paid; ‘pay now, litigate later’ is also a ‘pay now, adjudicate later’ philosophy. 

Does the risk of payee insolvency make a difference?

Although neither party was, or even suggested to be, insolvent, Sir Rupert said at paragraph 109 that the requirement to pay first would apply even where the payer suspects that payee insolvency is a risk, and that payers would simply have to be diligent in serving Pay Less Notices in such circumstances.  That must be right where the payee is only suspected to be insolvent.  In such cases  – the ‘hard cases’ – a payer may be better off resisting enforcement than embarking on a second adjudication, and I will look at adjudication enforcement and payee insolvency situations (actual and suspected) in further articles.

How will the requirement to pay first be policed? 

Encouraging for payees as the CA’s judgment is, what is not clear is how this requirement to pay first will be policed.  In litigation it’s easy; if a court orders a payment into court, or an interim payment, to be made, it can suspend (‘stay’) proceedings until that happens.  In adjudications, the court has no supervision unless an application for declarations is made to the TCC mid-adjudication, under Part 8 of the Civil Procedure Rules (‘CPR’), or an application is made for enforcement of the eventual award under CPR Part 7.  In the meantime, adjudicators tend to plough on until they stop, or are stopped, with the parties incurring irrecoverable costs in the meantime.  So, what could a payee do if the payer commences an adjudication over the true value of an application without paying the notified sum? 

The payee – the responding party – could decline to participate in the adjudication and invite the adjudicator to resign, then resist enforcement of the resulting award should they fail to resign. The CA judgment indicates that an adjudicator would lack jurisdiction from the outset since, as Sir Rupert said, it would not be permissible to commence a second adjudication without paying the notified sum first. Situations where a party can decline to participate in an adjudication with 100% confidence that the resulting award is unenforceable are rare, but this might be one of them. Any decision on participation or to challenge the adjudicator’s jurisdiction must have regard to exactly what issues the payer intends to refer to adjudication, and whether any resulting adjudicator’s award that attempts to arrive at a ‘true value’ before the notified sum has been paid will be severable (so that some parts will not be enforced, whereas others will). 

Alternatively, a Part 8 declaration could be sought at short notice to seek the TCC’s guidance on the validity of the payer’s referral to adjudication.  This is likely to be necessary to resolve the status of the second adjudication where there is a dispute over the validity of a payee’s application for payment where it is the default payment notice, or a dispute about whether a payer has served a valid and timely Pay Less Notice.  Under either scenario, if the court ruled in the payer’s favour, the ‘notified sum’ contended for by the payee could not apply, and there would be no obstacle to a ‘true value’ adjudication.  Conversely, if the court found in the payee’s favour, no true value adjudication would be permissible until the notified sum had been paid, and any adjudicator appointed for that purpose would have to resign. 

Litigating and adjudicating simultaneously will be expensive for the parties.  That is not what the CA intended, and I anticipate that further clarification will be necessary from the TCC.

What does this mean for you or your business?

The CA’s decision should be welcomed by payees.  While the position on adjudicators jurisdiction which applied prior to 2014 will be resurrected, so that ‘true value’ adjudications concerning applications for payment are again possible, the requirement on payers to pay the notified sum before commencing one has been writ large.  However, payees still have to contend with challenges to enforcing payment of the notified sum, whether that be CPR Part 8 applications for declaratory relief, or challenges to the substance of an adjudicator’s award at enforcement under CPR Part 7 based on the alleged invalidity of default payment notices.  Indeed, given what the CA has said about the need to pay the notified sum before a true value adjudication can be commenced, I predict that payers will resort to these types of challenges in greater numbers. 

In relation to the deduction of liquidated damages, the CA held that there is no requirement to wait between giving the first (‘warning’) and second (deduction’) notice since the JCT forms do not say whether there should be a time lapse between them; provided they are sent in that order, this is enough.   This means that although it is a requirement, the warning notice does not help, and it is highly likely that in future there is very little warning between a certificate of non-completion being given, and the deduction of liquidated damages themselves.

 

These notes have been prepared for the purpose of articles only. They should not be regarded as a substitute for taking legal advice.