Construction and Engineering Alert
May 2007
Authors:
Andrew H. Davies
+44.20.7360.8190
andrew.davies@klgates.com
Inga Hall
+44.(0)20.7360.8137
inga.hall@klgates.com
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Withholding payment in the event of insolvency
Since the Housing Grants Construction and Regeneration Act 1996 (‘the Construction
Act’) came into force in 1998 the construction industry has known that in order to withhold
payment of a sum due under a construction contract, the paying party must serve a valid
withholding notice.
On 25 April 2007 however, the House of Lords in Melville Dundas Limited (in receivership)
v. George Wimpey UK Limited decided that there is a limited exception to this general rule
in the case of a contractor’s insolvency.
This is the first occasion on which the House of Lords has considered the Construction Act
and their Lordships’ finding that a withholding notice is not required in all circumstances
may cause some surprise in light of the various decisions in lower courts (including Rupert
Morgan Building Services (LLC) Limited v. David Jervis and Harriet Jervis) which have
established that a withholding notice should always be given.
Facts
Wimpey engaged Melville Dundas to construct a housing development in Glasgow under a
Scottish JCT 1998 Contract (‘the Contract’), which provided that the final date for payment
of an interim payment was 14 days after receipt of an application. Melville Dundas applied
for an interim payment on 2 May 2003, making the final date for payment 16 May 2003.
Wimpey did not pay and served no withholding notice. Six days later, on 22 May 2003,
Melville Dundas’ bank appointed administrative receivers.
The Contract provided that if Melville Dundas appointed an administrative receiver, Wimpey
was entitled to determine the employment of the contractor under the Contract. Wimpey
did so, bringing into effect clause 27.6.5.1, which provided that on the occurrence of an
insolvency event (which included the appointment of administrative receivers):
“the provisions of this Contract which require any further payment…to the Contractor shall
not apply; provided that [this clause] shall not be construed so 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 [where an administrative receiver has been appointed] have accrued 28
days or more before the date when…the Employer could first give notice to determine the
employment of the Contractor”.
This clause was central to the dispute and Wimpey relied on it in support of its contention
that it was not required to pay Melville Dundas despite not serving a withholding notice.
Melville Dundas issued proceedings claiming payment.
Construction and Engineering Alert
Scottish Court Decisions
The Scottish courts examined the apparent conflict
between this clause and section 111(1) of the
Construction Act, which clearly provides 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”.
The first instance decision (that there was no conflict)
was overturned in the Scottish appeal court which
decided at the end of 2005 that Wimpey could not
refuse payment as the Contract did not comply with
section 111(1) of the Construction Act. This decision
was seen as consistent with the general trend in how the
courts were dealing with withholding notices. Wimpey
appealed to the House of Lords.
House of Lords Decision
The House of Lords (by a three to two majority)
reversed the decision and held that no payment was
due to Melville Dundas for two main reasons.
Interpretation of clause 27
Melville Dundas argued that once a sum had become
due under a contract it could not cease to become due. It
argued that the words “any further payment” in clause
27.6.5.1 should not therefore be read as including
an interim payment which the employer was already
obliged to pay because the final date for payment had
passed (without the issue of a valid withholding notice)
by the date of the determination of the contractor’s
employment. Their Lordships did not agree. The words
“any further payment” are unqualified and their plain
meaning is that (until the final accounting which the
contract also provides for), the employer is not required
to pay any more money whether or not the money was
already due. Wimpey was not therefore required to pay
Melville Dundas interim payments that had become
due before the determination of the Contract.
Potential conflict with the Construction Act
Their Lordships then considered whether clause
27.6.5.1 was invalidated by the Construction Act and
held that there was no conflict. Sections 109 to 110(1)
of the Construction Act were drafted to introduce
clarity and certainty as to the terms of a construction
contract and require only that the contractor should
be entitled to payment by instalments and that there
should be an adequate mechanism for determining
what he was entitled to be paid and when. Section
109(2) says:
“The parties are free to agree the amounts of the
payments and the intervals at which, or circumstances
in which, they become due”
Lord Hoffman in particular considered that this
reference to circumstances shows that Parliament
did not require that stage payments should become
“inexorably due” at fixed intervals but that liability
to pay could be contingent on other events (such as
intervening insolvency).
Melville Dundas also sought to rely on section 111(1)
of the Construction Act as Wimpey had failed to serve
a withholding notice before the final date for payment.
Their Lordships found that it would not have been
possible for Wimpey to serve a notice by this date (16
May 2003) as it only became entitled to withhold the
interim payment when Melville Dundas’ receivers were
appointed six days later.
Their Lordships held that section 111(1) had to be
construed to allow clause 27.6.5.1 to operate and not
so as to require a withholding notice to be served when
it not possible for Wimpey to have done so within
the relevant time period. The alternative construction
would mean that the parties were not free to enter
May 2007 | 2
Construction and Engineering Alert
into a contract as a result of statutory machinery, the
operation of which would serve no practical purpose.
The House of Lords allowed Wimpey’s appeal and
confirmed that commercial parties are free to agree
contractual terms that suit their business interests
and that Parliament was not able to interfere in such
dealings.
Conclusion
due without issuing a withholding notice. Although
this decision is final as far as clause 27 of the JCT
form of contract is concerned, parties seeking to rely
on this decision in the context of different contracts
or factual situations (such as where it is feasible to
issue a withholding notice before the final date for
payment) should still serve a valid withholding notice.
Even in the JCT insolvency situation, if you are able
to serve a withholding notice, this will strengthen your
position.
This important decision means that if a contractor with
whom you have a contract becomes insolvent, and
provided that the contract allows you to determine the
contractor’s employment in such circumstances, you
can withhold payment that might otherwise have been
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