Pay less notices and preserving rights of set-off

United Kingdom

A recent Scottish decision has considered whether an employer is entitled to raise set-offs not previously raised in a pay less notice in defence of adjudication proceedings brought by a contractor for additional payment. This is the first case to consider the issue since amendments made to the Construction Act in 2011. In upholding the employer’s right to raise such set-offs, the decision would appear to mark a departure from the position under the old withholding notice scheme in existence prior to the 2011 amendments.

Section 111 of the Construction Act: now and then

Under Section 111 of the Housing Grants, Construction & Regeneration Act 1996 (as amended in 2011) (the “Construction Act”) a party must pay a “notified sum” under a construction contract on or before the final date for payment, unless it issues a valid pay less notice. A notified sum is either the amount stated in a payment notice issued by the payer or a third party certifier or, in default of such a notice, a prior payment application or subsequent payment notice issued by the payee. A pay less notice must specify the sum that the payer considers is due (even if the sum is zero) and the basis on which that sum is calculated. The effect of a pay less notice is that the “notified sum" becomes the amount which the payer is required to pay under section 111. However, the sum specified in a pay less notice, or certified by a third party or the payer in a payment notice, may still be challenged by the contractor through adjudication or court proceedings.

By contrast, prior to the 2011 amendments, the position under section 111 was that a payer “may not withhold payment…of a sum due under the contract” unless it had given a valid “withholding notice” specifying the amount(s) to be withheld and the grounds attributable to each amount.

The difference in wording is potentially important. The old section 111 specifically sought to remove a payer’s entitlement to set-off unless expressly included within a withholding notice. The new section 111 says nothing about a payer’s entitlement to withhold payment and deals only with the circumstances in which a payer is required to pay a notified sum. A question therefore arises as to whether a payer retains an entitlement to set-off where that entitlement has not been expressly referred to in a payment notice or pay less notice. Such an issue is most likely to arise where a payee brings an adjudication to challenge a payment notice or pay less notice, and the payer seeks to rely on new set-offs in defence of those proceedings.

DC Community Partnerships Limited v Renfrewshire Council

Renfrewshire Council engaged DC Community Partnerships (“DCCP”) to build a special needs school under an amended NEC3 contract.

A dispute arose over the sum the Council was due to pay in respect of payment certificate no. 33. The relevant application for payment from DCCP was for £18,971,857.23. However, in payment certificate no. 33 the project manager certified a value of £15,606,788.70. After deduction of previous payments and the retention amount, the amount certified as due was £287,075.07. The Council did not serve a pay less notice and paid this amount to DCCP.

Shortly after, DCCP commenced an adjudication claiming that certain items in payment certificate no. 33 had been undervalued and that the payment certificate should be opened up, reviewed and revised so as to increase the amount due by £821,750.04.

The Council’s primary position was that no further sums were due. However, in the alternative, it claimed an entitlement to deduct liquidated damages from any further sums the adjudicator may find due. The Council noted that "if the [Project Manager's] assessment had included the claims being sought under this adjudication, the Responding Party would have exercised its right to issue a pay less notice to limit the payment to the Referring Party".

The adjudicator concluded that DCCP was entitled to payment under the contract for additional sums of £820,425.76 in respect of the disputed items and that payment certificate no. 33 should be opened up, reviewed and revised by this amount. In his decision, the adjudicator included the statement that he had “considered all the submissions and their accompanying documents”, but did not specifically refer to the Council’s argument that it was entitled to set-off delay damages from any additional sums found to be due.

Set-off available

The Outer House of the Scottish Court of Session refused to enforce the adjudicator’s decision on the basis that the adjudicator had failed to consider the Council’s entitlement to deduct liquidated damages, which had been claimed at more than half the additional sum awarded by the adjudicator. The court considered whether section 111 of the Construction Act (as amended) and the Council’s failure to serve a pay less notice meant that it was precluded from raising its set-off defence. Lord Doherty held that the “notified sum” in section 111 could not sensibly be construed as including any additional sums that an adjudicator may later decide are due. It could only refer to the sum specified in the payment notice. Section 111 clearly distinguished between "the notified sum" and "the additional amount" which an adjudicator may decide is due.

In this case, "the notified sum" was the sum specified in payment certificate no. 33. The Council was content to pay that sum and indeed paid it. The Council's later advancement of its set-off defence did not alter its position in relation to the notified sum, as it only sought to set off delay damages against any additional sums the adjudicator might decide were payable.

Conclusion and implications

This decision clarifies that under section 111, a paying party is not precluded from raising set-offs not previously raised in a payment notice or pay less notice. The court’s decision in this respect appears to follow the change in wording made to section 111 by the 2011 amendments to the Construction Act. Some commentators have, however, expressed surprise at the court's finding suggesting that the pre-2011 position ought still to hold good. It remains to be seen whether the position reached by the Scottish court in this case will be adopted in England.

One practical result of the case is that payers need not set out all of their potential set-offs in a pay less notice. A payer might therefore list only one of several counter-claims in a pay less notice, keeping others aside until any challenge by the payee. By this means, a payer might seek to gain a tactical advantage in adjudication proceedings by surprising the payee with additional set-offs.

The decision also serves as a warning to adjudicators to ensure they address all of a party's submissions, at least to give “some brief, intelligible explanation” of why any particular points are rejected. A blanket statement that the adjudicator has considered all of the submissions will not suffice in all cases.

References: DC Community Partnerships v Renfrewshire Council [2017] CSOH 143.