UK: Freedom of Contract and the Right to Payment After Determination

Last Updated: 17 January 2005
Article by Kenny Valentine

Originally published November 2004

In a surprising decision the Court of Session in Scotland in the case of Melville Dundas Limited v George Wimpey UK Limited (and another) [22 October 2004] has underlined the fundamental freedom of contract, which parties to a construction contract enjoy, to agree the final date when sums due under the contract become payable. This newsflash identifies a perceived tension between this decision and previous Appeal Court decisions in Scotland and England. Continued on reverse

The factual background

Melville Dundas ("the Contractor") was engaged by Wimpey ("the Employer") to carry out a housing development subject to the Standard Form of Building Contract issued by the Scottish Building Contracts Committee. This contract incorporates, subject to certain amendments, the JCT Standard Form of Building Contract (1998 Edition). It was accepted by the parties that the Contractor had received a Valuation from the Employer's agent in respect of an interim application in the sum of circa £400,000. It was accepted by the Employer that no valid notice of withholding had been issued. It was therefore accepted by the Employer that, everything else being equal, the sum of £400,000 was due to have been paid to the Contractor no later than 16 May 2003, the final date for payment.

It was also a matter of agreement between the parties that as at 22 May 2003, an insolvency event occurred, namely, Melville Dundas had receivers appointed.

The contractual provisions

It was provided that, as is common to many standard forms, in the event of insolvency, payment obligations are suspended until the Employer has completed the works and a balancing of accounts is carried out. Specifically, in Clause 27, it was provided:

" [on the occurrence of an insolvency event] the provisions of this Contract which require any further payment or any release or further release of Retention to the Contractor shall not apply; provided that [this clause] shall not be construed as to prevent the enforcement by the Contractor of any rights under this Contract in respect of amounts properly due to be paid by the Employer to the Contractor which the Employer has unreasonably not paid and which… have accrued 28 days or more before the date the Employer could first give notice to determine the employment of the Contractor."

It was a matter of agreement between the parties that the date when the Employer could first have given notice to determine the Employment of the Contractor was 22 May 2003.

The employer's argument

The position of the Employer was straightforward. It contended that the provisions meant that, while the Contractor was entitled to demand payment of sums which had become due and which had accrued to him at least 28 days before 22 May 2003, i.e. the first day upon which the Employer could have given the necessary notice, payment of sums which had not become due and accrued to the Contractor by that time, could no longer be demanded by the Contractor. The sum which the Contractor sued for, in the present case, had not accrued to the Contractor, at least 28 days before the first day on which notice of determination by the Employer could have been given, accruing as it did on 16 May 2003. Accordingly the Contractor was not presently entitled to payment.

The Contractor's Argument

The Contractor accepted, before the court, that if the question of the Contractor's entitlement to payment depended solely upon a construction of the contract then the Employer's position, as set out above, must be accepted and the Contractor would not presently be entitled to payment.

The Contractor however contended that the statutory provisions of the Housing Grants Construction and Regeneration Act 1996 must be considered in conjunction with the contractual provisions. In particular sections 109,110 and 111.

The Contractor's argument based on those provisions of the Construction Act, was to the following effect. Clause 27 of the contract operated as a suspension of payment, until the balancing exercise provided for under that clause had been carried out. That was, in effect, providing for a scheme for withholding payment. The Employer had not issued a notice of intention to withhold payment of the sum in question, in accordance with the provisions of section 111. Accordingly the sum could not be withheld.

The Employer's response to this was to focus on the wording of Section 111 of the Construction Act. Section 111 provides, amongst other things, as follows:

"(1) A party to a construction contract may not withhold payment after the final date for payment of a sum due under the contract unless he has given an effective notice of intention to withhold payment ...".

The Employer contended that the critical words in section 111(1), for the purposes of the present dispute, were "the final date for payment of a sum due under the contract." It was submitted, by the Employer, that the statutory provisions left the parties free to determine, as a matter of contract, the final date for payment. In the present case, the parties had determined, by agreement, that even if a sum was due before a receiver was appointed to the Contractor then, if the contract could be determined by the Employer as a result of the appointment of the receiver, then the only sums remaining due and payable thereafter, were those provided for under Clause 27. The statutory provisions had not restricted the parties' freedom to contract to that effect.

The issue

The Contractor accepted that the sharp issue for the court to determine was whether, notwithstanding the provisions of section 111 of the 1996 Act, the parties, by virtue of the provisions of the contract, remain free to alter an agreed final date for payment of a sum certified to be payable under the terms of the contract, to another date, in the light of an insolvency event.

The decision

Lord Clarke decided in favour of the Employer and dismissed the Contractor's claim. Given that it had been accepted by the Contractor that the contractual provisions were clear and to the effect that the Employer need not pay the sums claimed, the clear question for the court was whether section 111 of the Construction Act subverts these contractual arrangements. Lord Clarke was satisfied that it did not. In his view Clause 111 was directed at cash flow questions during the course of a continuing construction contract, whereas Clause 27 is concerned with the situation where an Employer has legitimately determined the contract. In his Opinion the legislative provisions were not intended to regulate that situation:

"That situation is one for which the parties themselves have legislated and their freedom of contract in that respect has, in my judgment, not been affected by the legislative provisions. The parties' continuing freedom of contract is expressly recognised in section 109(2) and, even more importantly, for present purposes, in section 110(1) where it is provided as follows: "The parties are free to agree how long the period is to be between the date on which a sum became due and the final date for payment. Putting the matter another way, in the present case, the parties were free to agree that the original date for payment of sums due under the contract, could be altered in the event of the contract being determined so that "the final date for payment" of the sum in question, has not, by reason of the contractual provisions yet arrived."

Analysis and conclusion

Lord Clarke was clear that, in his judgment, all that Clause 27 of the contract did was to alter/postpone the final date for payment of the certified sum, however, the reality is that in the balancing exercise there will be a wholesale re-working of the sum due to the Contractor. To talk then of a postponement of the final date for payment may be seen as artificial.

Moreover it is difficult to reconcile this decision with the English Court of Appeal decision in Ferson Contractors Ltd v Levolux A.T. Ltd and the Scottish Inner House decision in The Construction Centre Group Limited v Highland Council. In Levolux, the Court of Appeal was asked to consider whether a provision in the subcontract stating that no further sums would be payable in the event of determination of Levolux's employment extended to cover payments due under an adjudicator's award. The court held that Levolux were entitled to payment, as decided by the adjudicator, notwithstanding the provisions of the contract and that if the provisions of the contract were in conflict with the Construction Act they would be struck down. Similarly in the Construction Centre Group case, the Inner House of the Court of Session held that a similar provision in the contract, to the effect that upon determination the Employer would not be liable to make any payment to the Contractor, would not result in a refusal to enforce a pre-existing adjudicator's award.

The distinction between these two cases and the present one is that in those cases an adjudicator had decided that sums were payable and ordered payment, whereas in the present case these is no adjudicator's decision but an undisputed debt which accrued before the insolvency event giving rise to the right to determine the contract.

The underlying rationale behind the Levolux and Construction Centre Group cases is that the contractual provisions must not circumvent and undermine the intention of Parliament as set down in the Construction Act, otherwise those contractual provisions will be struck down. Logically that rationale must apply equally to the payment provisions contained in s109 - 111 of the Act as it does to the Parliamentary intention that adjudicators awards be enforced. Section 111 (1) clearly expresses Parliament's intention that, "a party to a construction contract may not withhold payment after the final date for payment of a sum due under the contract unless he has given an effective notice of intention to withhold payment". To allow there to be a revised/postponed final date for payment, depending upon certain circumstances, would appear to run counter to that intention and circumvent that provision. In this case it should be remembered that Wimpey had no basis for refusing payment between 16 May and 22 May.

It is not yet clear whether the decision will be appealed. It may be that the decision will, in time, be seen to be limited to it's particular facts, namely determination upon the occurrence of an insolvency event, but given that the focus of Lord Clarke's reasoning is rooted in freedom of contract, could this reasoning be expanded? For example, could a provision be drafted to postpone a final date for payment in the event of latent defects materialising in the contractors works pending ascertainment of responsibility for those defects? Other examples can be envisaged.

The Construction Act undoubtedly impacted upon the principle of freedom of contract. It may be that contract draftsmen will seek to exploit the support espoused by Lord Clarke for the principle of freedom of contract at the expense of the principles underlying the Construction Act.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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