Introduction
It is no secret that the infrastructure sector is currently facing several challenges, none more so than the squeeze on cash flow. According to the Office for National Statistics, construction material costs are still 42.7% higher than before the pandemic in January 2020. In the infrastructure sector in particular, projects are being affected. The government has, for example, delayed work on phase 2a of HS2 and work on the £9bn Lower Thames Crossing. The government admitted that inflation is one of the principal reasons for the delay.
Predictably, cash flow issues are impacting the supply chain. According to Insolvency Services, in 2023 the total number of construction firms becoming insolvent was 4,378 which was a 5.1% increase on the insolvencies recorded in 2022 and a 36% increase from those recorded in 2019. Smaller, specialist sub-contractors accounted for around 60% of the total insolvencies and main building contractors felt this knock-on impact as they could not pass risk along the supply chain. Professor Noble Francis, Economics Director at the Construction Products Association, identified rising material costs, planning delays and skills shortages as factors contributing to this surge in insolvencies.
It seems unlikely that the current pressures on cash flow, caused by factors such as inflation, will ease in the short to medium term. Consequently, parties to construction contracts may be more inclined to be on the lookout for those easy wins by pursuing technical payment dispute (commonly referred to as a "smash and grab") adjudications which can often be viewed as an effective means of generating cash flow, even if only temporarily.
Where a party (usually the payee) is considering commencing a "smash and grab" adjudication, it is normally on the basis that that the payer has not issued a valid payment notice or payless notice (or both) in response to an interim application for payment (AFP). If so, usually this renders the sum stated as due in the AFP, due to the payee, irrespective of whether this is the correct value. However, in such circumstances, the payee should give careful thought as to whether a valid AFP has been issued in the first place, not just under the contract, but also in accordance with the Construction Act and case law. If not, the "smash and grab" adjudication is unlikely to be successful.
To serve as a brief reminder, the authors consider below the statutory rules and case law principles relevant to whether an AFP may be considered valid.
The Construction Act
For a payee to commence a "smash and grab" adjudication there must be (1) a failure by the payer to issue a valid payment notice or pay less notice and (2) the payee must themselves have issued a valid payment notice which they can rely on for sums claimed.
Under the Construction Act there are two ways for the payee to issue its own payment notice. The first is via s.110B which allows a payee to serve its own payment notice at any time after the date on which the payer must issue a payment notice (which is within 5 days of the due date ).
The second is where an AFP is made by a payee, and the payer fails to submit a payment notice, the AFP may be deemed the default payment notice provided the AFP complied with s.110B(4) and the contract permits or requires the payee to serve an AFP. The requirements s.110B(4) is that the AFP must show:
- The sum that the payee considers is due or was due at the payment due date;
- The basis on which that sum was calculated; and
- The payee gives such notification in accordance with the contract.
If the AFP becomes the default payment notice then the sum stated as due in the notice must be paid by the payer by the final date for payment, subject to any valid pay less notice.
Case law
Case law has also developed the principles of what is required for a valid AFP.
The AFP must be Issued in accordance with the contract
In ISG Retail Ltd v FK Construction Ltd [2023] EWHC 1718 (TCC), the sub-contractor submitted an interim payment application one day late and the court held that this was invalid as it failed to comply with the payment provisions of the contract.
The AFP must be clear and free from ambiguity
In Caledonian Modular Ltd v Mar City Developments Ltd [2015] EWHC 1855 (TCC) the email attaching the alleged AFP did not state that it was a new application for payment meaning the payer was not given reasonable notice that a payment period had been triggered. Coulson J stated that “…if contractors want the benefit of [the Construction Act’s payment provisions], they are obliged, in return, to set out their interim payment claims with proper clarity."
On the other hand, in Surrey and Sussex Healthcare NHS Trust v Logan Construction (South East) Ltd [2017] EWHC 17 (TCC), the document stated that it was an interim payment notice meaning the employer was provided with "reasonable notice of its content". In contrast, in Jawaby Property Investment Ltd v Interiors Group Ltd [2016] EWHC 557 (TCC) Carr J held that an interim application was invalid because it differed from previous applications in being marked as an "initial assessment".
The AFP must be "in substance, form and intent" an interim payment notice
In Henia Investments Inc v Beck Interiors Ltd [2015] EWHC 2433 (TCC) the court highlighted the importance of knowing whether a document filed by a contractor was an interim application for payment because the application became the contractor's default payment notice if the contract administrator failed to issue a payment notice in time. Akenhead J found that the application was ambiguous and could not constitute a valid application because: “…the document relied upon as an Interim Application… must be in substance, form and intent an Interim Application".
The payer should be cautious and ensure they do not take actions to confirm the validity of an AFP where it does not meet the above requirements. Where the paying party confirms the validity of an AFP, even if the above requirements are not met, the court may not allow the paying party to resile from that confirmation unless the payer has reserved their position (A & V Building Solutions Ltd v J & B Hopkins Ltd [2023] EWCA Civ 54). For example, if an invalid AFP is served and a payment notice is issued in response to it without any reference to the invalidity and reserving the party's position, this could be taken as a representation that the AFP was valid.
Practical tips
Even if successful, a "smash and grab" adjudication may only provide temporary relief to cash flow issues as the payer may seek to recover the payment by way of a true value adjudication. However, with the current economic pressures on the supply chain, even short-term temporary relief may still be of some comfort. Based on the above, some practical tips for a party considering commencing an adjudication or indeed for a party responding to the claim are as follows:
- If you are the payer and you are concerned about the validity of your payment notice or it was not issued, make sure you issue a valid pay less notice to the payee.
- Check the provisions of the contract to determine if the AFP complies with the relevant dates and applicable condition precedents (if any).
- Check whether the AFP has been clearly labelled, and the purpose of the AFP set out in the accompanying email or transmittal document so that the payer knows that a payment period has been triggered.
- Consider whether there has been a course of dealings between the parties which may undermine reliance upon the strict terms of the contract.
- Check that the AFP clearly shows the sum that the payee considers due at the payment due date and the basis on which that sum was calculated.
- Check the contract allows for AFPs to become default payment notices.
