Serve a pay-less notice – don’t be caught out

Jon Mahony is partner and head of dispute resolution at law firm Harold Benjamin

What is a pay-less notice? Payment under construction contracts is regulated by Part II of the Housing Grants Construction and Regeneration Act 1996 (“the Construction Act”) and the Scheme for Construction Contract (England and Wales) Regulations 1998 (“the Scheme”).

“Is the pay-less notice procedure a charter for the employer to arbitrarily reduce the amounts otherwise payable to contractors? No, it is not”

The Construction Act and the Scheme set out the payment, notice and adjudication procedures that are included (either expressly or by implication) in all construction contracts, other than some rarefied activities such as nuclear plants and manufacture/delivery of materials and contracts relating to work to dwellings where their occupier is the employer (although it is commonly contractually incorporated into the occupier’s contracts).

At its heart, the Construction Act and the Scheme were intended to improve cashflow to receiving parties (contractors) by preventing paying parties (employers) from withholding payments from them without good reason and allowing the contractor an easy route to recovering payment for work that has been undertaken.

In brief, the payment mechanism under the Scheme provides that when the contractor submits a payment application in compliance with the contract terms, if the employer wishes to pay a lower sum, then it must serve a pay-less notice on the contractor within the strict time limits set out in the contract (or, if none, the Scheme).

Consequences of getting it wrong

If the employer fails to serve a pay-less notice correctly (or at all), then the amount that the employer must pay is the sum set out in the contractor’s payment application and no deduction can be made. The pay-less notice procedure is therefore vitally important to employers who wish to control their cashflow and ensure that they are only paying for work that has been actually and correctly undertaken by the contractor.

Even though the pay-less notice process (and that of its predecessor, the withholding notice) has been in place for more than 20 years, employers frequently either overlook or, by ignoring the procedure, invalidate this important tool. Common mistakes include:

  • failing to set out the sum considered to be payable and/or a calculation of that sum;
  • incorrect method of service of the notice;
  • serving the notice on the wrong entity; and
  • failing to comply with the time limits for service.

Any of these errors is likely to be fatal to the notice and leave the employer exposed to paying the full amount of the contractor’s payment application. The consequences of any error become more acute where it concerns a final (rather than interim) payment application, as the employer cannot make up for the mistake by serving pay-less notices in subsequent applications, leaving litigation or adjudication as the only recourse for recovering any overpayment.

Errors in pay-less notices are fertile ground for legal disputes. Adjudicators are frequently required to decide upon whether a pay-less notice has been correctly drafted and the process for service adhered to. Where successful, a challenge by the contractor would result in the employer paying the full payment of the contractor’s payment application, as well as paying its own legal costs and the adjudicator’s fees.

In the present economic climate, where both parties are keen to protect cashflow, attempts to challenge pay-less notices are likely to increase. Therefore, as soon as a payment application is received, there are a number of steps that the employer should take, including:

  • Review the contractor’s payment application and decide whether it complies with the contract and whether a reduced sum should be payable.
  • Check the contract for the relevant time limit for service of the pay-less notice (or, if none, the Scheme implies the time limit as seven days before the final date for payment) and ensure that date is diarised and complied with.
  • Check the contract for any provisions relating the method and address for service of notices on the contractor, always bearing in mind the above time limits by which service must be effected.
  • Ensure that the pay-less notice contains the sum that the employer considers is payable, together with a clear and unambiguous explanation of how that sum is calculated.

Is the pay-less notice procedure a charter for the employer to arbitrarily reduce the amounts otherwise payable to contractors? No, it is not. As set out above, for a pay-less notice to be valid, it must include the basis of the calculation of the lower sum to be paid, and that explanation must be clear and unambiguous. An unjustifiable reduction is likely to be challenged in adjudication by the contractor.

  • Note: the above is intended to provide a brief general overview of pay-less notices. Questions regarding the validity of a pay-less notice are fact-sensitive and will vary from case to case
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