Payment notices in construction contracts – Muir Construction v Kapital Residential

The requirement for “the basis on which the sum has been calculated” to be shown in payment notices issued under construction contracts has caused some difficulty, as it is not entirely clear what constitutes a proper “basis”. However, the recent case of Muir Construction v Kapital Residential may have shed some light on the meaning of this provision of the Construction Act 1996.

2 November 2017

Many aspects of the payment provisions of the Housing Grants Construction and Regeneration Act 1996 have caused considerable debate over the years, both north and south of the border. One such provision is section 110A, which relates to the contractual requirements for valid notices to be served under construction contracts. 

By way of reminder, the provision states:

“110A Payment notices: contractual requirements

 (3) A notice complies with this subsection if it specifies - 
      (a) the sum that the payee considers to be or to have been due at the payment due date in respect of the payment, 
      (b) the basis on which that sum is calculated.”

The wording “the basis on which that sum is calculated” has caused concern within the industry, because it is unclear how the basis of the calculation should be shown and the extent of what is required. However, the recent case of Muir Construction Limited v Kapital Residential Limited [2017] CSOH 132 has provided some guidance. 

The Facts
Kapital entered into a Design and Build Contract with Muir Construction for the construction of a scheme of new-build houses in Rosyth. During the construction phase, a number of disputes arose regarding various defects in the works and the value of Muir’s final account. Various adjudications and a court action ensued as to these disputes. 

In order to try to consolidate the disputes and reach a solution, the parties entered into a Settlement Contract in April 2016. One provision of that contract was that any retentions were to be paid to Muir when the Notice of Completion of Making Good Defects was issued, or by 31 December 2016. However, if Kapital felt that defects still remained, they could issue a pay less notice and withhold payment of the retention. The contractual requirements of the pay less notice were set out at Clause 4.10.2 of the Construction Contract, which stated that the notice “…shall specify both the sum that the Contractor considers to be due to the Employer at the date the notice is given and the basis on which that sum has been calculated.” This mirrors the wording in the 1996 Act.

Kapital issued a pay less notice to Muir, claiming that various defects remained with the works; however, the notice simply stated that “We consider that the sum that is due on the date this notice is given is: Zero (£0.00)…” with no explanation of this zero figure. Muir argued that this failed to meet the requirements of a valid pay less notice under the Contract, as Kapital had failed to specify the basis on which the zero sum had been calculated. 

The Decision
Lord Bannatyne agreed with Muir’s argument that no basis for the zero figure was put forward in the pay less notice, since a reasonable recipient of the notice could not work out how this sum had been calculated. Kapital had given neither calculation of nor specification for the zero figure. Kapital’s contention was that further detail was not required in the pay less notice because the retention amount was small and a large amount of work was required to rectify the defects, therefore the rectification cost clearly exceeded the retention amount. Lord Bannatyne rejected this position.

Lord Bannatyne said that in order to provide a basis for calculation, the issuer of a pay less notice needs to at least set out the grounds for withholding as well as the sum applied to each of these grounds, with “…at least an indication of how each of these sums were arrived at.” He made reference to Maxi Construction Management Limited v Mortons Rolls Limited 2001 ScotCS 199, where Lord McFadyen said that a similar provision required “…specification of the basis of calculation of the new matter included in the application in question.” Applying this reasoning to the present case, Kapital had failed to provide a proper basis for the zero sum, and so the pay less notice was invalid. 

Although this may be an obvious example of a party failing to explain the basis for the sum in a pay less notice, since no basis was provided at all, this case is useful in providing some guidance as to the requirements of s110A of the 1996 Act. Lord Bannatyne has clarified that it is insufficient to include a sum in a pay less notice without at least some calculation and specification of how the sum was reached. The grounds for withholding the sums should be set out in the notice, along with the sums which relate to each of these grounds. On a cautious approach, as much detail as possible should be included in pay less notices. In some circumstances this may not be possible, but at the very least an explanation as to how the sum was reached is required. The level of explanation required will depend on the particular facts; erring on the side of caution is advisable.