UK court considers validity of payment notices under 'hybrid' contracts

Mrs Justice O'Farrell ruled that a contractor need not separately identify the sums due in respect of construction and non-construction operations, where the Construction Act-compliant payment mechanism set out in the hybrid contract covers both types of activity.

Construction disputes expert Michael Hopkins of Pinsent Masons, the law firm behind Out-Law, said that the judgment was "in effect a pragmatic solution to the illogical and uncommercial impact of section 104(5) of the Act", which limits the application of the statutory payment requirements to construction operations.

"If parties agree a payment scheme that complies with, or mirrors, the statutory scheme in respect of both construction and non-construction operations, the cash flow benefits conferred by the Act are simply extended to cover those additional works," he said.

"The case takes the law forward from the previous leading decisions in Cleveland Bridge and Severfield. In the judge’s view these cases are authorities for the proposition that the payment provisions in the Act apply only to that part of a hybrid contract that concerns construction operations. The Act contemplates that separate payment or adjudication provisions may apply to construction operations and non-construction operations under a single, hybrid contract. If separate schemes apply in such a hybrid contract, it is essential for an interim payment applicant to identify the sum claimed in respect of the part of the works covered by the Act, so that he can take advantage of the scheme provisions, including the default provisions in section 111 of the Act. However, the judge made clear that those cases do not provide support for the proposition that parties to a hybrid contract cannot agree a single adjudication or payment scheme that is applicable to construction and other operations and capable of achieving compliance with the Act," he said.

C Spencer Ltd (CSL) was engaged by main contractor MW High Tech Projects UK Ltd (MW) to design and construct the civil, structural and architectural works associated with a new 'energy from waste' power plant. The subcontract was a 'hybrid' contract as it incorporated construction operations as defined by the Construction Act, as well as the assembly of plant and erection of steelwork to provide support or access to plant and machinery, activities which fall outside of the scope of the Act.

Under the terms of the subcontract, MW was required to make periodic interim payments to CSL. The parties did not initially distinguish between construction operations and other works in their payment applications or payment notices. In 2018, a dispute arose between the parties in respect of one of CSL's interim payment applications. CSL sought to refer the dispute to adjudication, but withdrew its claim following a challenge by MW. MW had raised a jurisdictional challenge on the grounds that the dispute failed to distinguish between construction operations to which, it argued, the contractual adjudication provisions applied, and other works.

In February 2019, CSL issued its next application for interim payment. In its application, it split the sums due in respect of construction operations and in respect of other works "following the abortive adjudication of last year". MW, in its payment notice in response, did not separate out the sums. In March, CSL issued a claim for the amount set out in its interim payment application, on the grounds that it had not received a valid payment notice or pay less notice.

The court first considered whether the parties were free to agree that non-construction operations should be subject to the same requirements imposed on construction operations by the Construction Act. Mrs Justice O'Farrell found that the parties were not "precluded" from so agreeing. She then considered whether, in cases involving hybrid contracts, the parties were required to separately state the sums due in respect of construction operations. She concluded that this was not the case.

Referring to the "express words" of the Construction Act payment provisions, the judge said they "do not stipulate separate identification of the sums due in respect of construction operations". The requirement to state the sum due "may be satisfied by stating the overall sum considered due in response to the relevant application", she said.

The judge added that it was "open to the parties to agree a payment scheme that sits alongside the statutory provisions, such that it complies with the statutory provisions in respect of construction operations and mirrors those provisions in respect of other operations". Had the parties agreed to separate payment mechanisms in respect of construction and non-construction operations, it would have been necessary to distinguish each type of payment. However, they had not done so in this case, she said.

MW pleaded estoppel by convention against CSL's claim that its payment notice was invalid as it did not distinguish between construction and non-construction operations, given that neither party had done so in respect of more than 30 previous interim payments. The judge found that CSL would not have been estopped, as any "shared assumption" created in respect of the previous payments would have been brought to an end by the terms of CSL's February 2019 application for payment. However, her comments on this point were obiter, meaning that they did not form part of her judgment.