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Key Points
Recent comments by the TCC cast doubt on the practice of linking the final date for payment to issue of a VAT invoice
If such payment provisions are rendered invalid, the provisions of the Scheme would apply instead, meaning the final date for payment is 17 days from the due date
Pay less notices issued in accordance with the subcontract conditions may, therefore, be out of time and invalid
It is always preferable for both parties to have certainty over the applicable payment terms as these are linked to remedies for non-payment.
Background
It is not uncommon for the final date for payment in a construction subcontract to be linked to the service of a VAT invoice by the subcontractor. The VAT invoice is often to be provided by the subcontractor following provision of a payment notice by the contractor. If the contractor does not provide a payment notice, the subcontractor cannot know what value to include on the VAT invoice. If no VAT invoice is submitted then seemingly, no final date for payment is set.
This practice is partly intended to help contractors circumvent their payment obligations as implied via the Construction Act[1]. Under the Construction Act, if a contractor fails to provide a payment notice or pay less notice within the appropriate timescales, they may need to pay the subcontractor the notified sum as contained within the subcontractor’s application for payment. If no final date for payment is set, however, then neither is a final date for issue of a pay less notice which is set by a prescribed period in advance of the final date for payment. Consequently, the subcontractor appears to be unable to enforce payment of its application for payment by means of a ‘smash and grab’ adjudication. Furthermore, if no final date for payment is set, the subcontractor would appear to be unable to suspend performance for non-payment. In other words, the subcontractor is left without a remedy when the contractor fails to provide a payment notice and/or pay less notice and fails to make payment.
This arrangement appears to be contrary to the main purpose of the Construction Act i.e. to improve cashflow in the construction industry. Comments made by the Technology and Construction Court (TCC) during a recent case, Rochford Construction Ltd v Kilhan Construction Ltd,[2] are, therefore, likely to be welcomed by subcontractors impacted by such payment provisions.
Rochford Construction Ltd v Kilhan Construction Ltd
Kilhan had been successful in a ‘smash and grab’ adjudication against Rochford. They were successful on the basis that Rochford had failed to provide a pay less notice in time. Initially, Rochford refused to comply with the adjudicator’s decision but eventually acquiesced and made payment after Kilhan raised enforcement proceedings.
Rochford subsequently raised part 8 proceedings in the TCC in an attempt to have the adjudicator’s decision overturned. Rochford relied on a clause from the subcontract which stated, amongst other things:
“…application date end of month…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."
Whilst the clause refers to a payment schedule, no such schedule was provided in the subcontract. This proved to be key in the court’s decision as it impeded the efficacy of the clause. Rochford contended that applications were to be submitted on the last day of the month and, therefore, because Kilhan’s application for period ending 30 April 2019 was submitted on 20 May 2019, no payment became due in the April payment cycle. Furthermore, they contended that the final date for payment was set as 30 days from service of the relevant invoice. The invoice was not served until 7 January 2020 so they argued the final date for payment was 6 February 2020. Accordingly, Rochford considered its payment notice issued on 23 October 2019 was on time.
The TCC noted that provisions such as the one in the subcontract operate in a similar way to conditions precedent and exclusion clauses which must be clear and unambiguous. The court considered the subcontract payment provision was not clear and unambiguous and noted it offered more than one interpretation. It followed that the subcontract did not provide an adequate mechanism for determining when each monthly payment became due, as required by the Construction Act, and accordingly, the relevant provision of the Scheme[3] had to be incorporated as a result. The due date was, therefore, determined to be the date on which the claim was submitted by Kilhan.
The subcontract was also unclear regarding the final date for payment, largely due to the absence of a payment schedule, and so, again, the relevant provision of the Scheme was also held to apply i.e. the final date for payment was 17 days from the due date. Rochford’s payment notice issued on 23 October 2019 was, therefore, out of time and the value in Kilhan’s application for payment was due for payment in full.
Can the final date for payment be linked to service of a VAT invoice?
The conclusion reached above was said to be reached on a “factual” basis, however, there was also a “legal” argument. The court went on to comment on the point of law, that being whether or not the Construction Act permitted the final date for payment to be determined in relation to an event other than the due date, for example, the issue of an invoice. The court commented:
“…that while a due date can be fixed by reference to, say, an invoice or a notice, the final date has to be pegged to the due date, and be a set period of time, and not an event or mechanism.”
and
“The inference is that the possibility to peg final date of payment to an event rather than a fixed period was never considered acceptable under the Act.”
Whilst these comments were obiter (passing comments) and not binding on future courts, they may still be persuasive if a similar issue arises in future and it could prove costly to ignore them. The effect may be that payment provisions linking the final date for payment to service of an invoice are held to be invalid and thus, the relevant provisions in the Scheme will apply in lieu. The Scheme provides that the final date for payment is 17 days from the due date. This means pay less notices are likely to be required earlier than most contractors anticipated, rendering those issued late invalid and leaving the contractor exposed to ‘smash and grab’ adjudication proceedings.
How to obtain certainty over payment dates
It remains to be seen whether contractors will amend their terms to remove this link, however, from a subcontractor’s perspective, these comments may serve to improve certainty over payment dates. If you do have ongoing subcontracts where the final date for payment is linked to service of an invoice, and the contractor does not provide a payment notice on time, it may be beneficial to raise a VAT invoice for the full value of your application the day after the day on which the payment notice should have been provided. This will ensure that, worst case, a final date for payment is fixed in accordance with the terms of the subcontract, should such terms be upheld. If not, the relevant dates will be calculated in accordance with the provisions of the Scheme which are likely to be more favourable for the subcontractor.
For any future subcontracts that include this link, ensure you challenge this and seek to have the final date for payment linked to the due date. Your right to suspend the works for non-payment is linked to the final date for payment so it is always better to be certain when that is. Finally, ensure all subcontracts have a valid payment schedule and ensure this payment schedule correlates with the payment clauses. This will avoid ambiguity for both parties regarding their obligations in relation to payment.
[1] Housing Grants, Construction and Regeneration Act 1996 (as amended) [2] [2020] EWHC 941 (TCC) (12 March 2020) [3] The Scheme for Construction Contracts (England and Wales) Regulations 1998
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