(back to preceding text)

    29.  The second question is more difficult. The relevant part of section 111(1) of the 1996 Act provides:

"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."

No notice was given in this case under either clause 30.3.3 or clause 30.3.4 of an intention to withhold payment. The final date for payment, in terms of clause 30.3.6, of the sum sued for had already passed by the date of the appointment of the receiver, which was the ground on which the contractor's employment was terminated. At first sight the situation that has arisen in this case seems plainly to fall within the words of the subsection, even though it would have been impossible for a timeous and effective notice to be given in the events that happened in this case. If that is so, the protection which the proviso to clause 27.6.5.1 gives to the employer if he determines the employment of the contractor is written out of the contract. But must the words of this subsection be taken literally?

    30.  There was a difference of opinion in the Court of Session. Lord Clarke said that sections 109 to 111 of the 1996 Act were concerned with cash flow questions arising during the course of a continuing, non-determined construction contract, not with the situation provided for in clause 27.6.5.1 as to which the parties' freedom of contract was unaffected: 2005 SLT 24, para 12. The Extra Division agreed that section 111 was a provision about cash flow: 2006 SLT 95, para 30. But they said that the sum sued for was for work already done, the "final date for payment" of which within the meaning of that section could not be altered retrospectively. The effect of section 111(1) was that, as the final date for payment had already passed without any effective notice having been given, the losses flowing from paying the sum to the insolvent contractor were to be borne by the employer as the employer under the contract.

    31.  At first sight, as I have said, the wording of the subsection seems to support the interpretation that the Extra Division gave to it. But it is a surprising result when it is applied to the situation which the proviso to clause 27.6.5.1 seeks to regulate. This raises the question whether the result was one that was intended by Parliament. To answer that question it is necessary to examine the purpose which the proviso seeks to achieve more closely, and to look more closely too at what Parliament was seeking to achieve by Part II of the 1996 Act, which is the Part that is concerned with construction contracts.

    32.  The purpose of the proviso to clause 27.6.5.1 is most easily seen by assuming that the ground for the determination of the contractor's employment is the making of a winding up order and that this is a compulsory winding up on the ground of insolvency: see clause 27.3.3. As Goudy, The Law of Bankruptcy in Scotland, 4th ed, pp 550-551 explains, the general doctrine of the law entitles a creditor upon the threatened insolvency of his debtor to attach the debtor's funds by diligence in security. But by the operation of equity this doctrine has been extended so as to entitle the creditor of a person who has become bankrupt to set off illiquid debts against the debtor's liquid claim: Bell, Commentaries on the Law of Scotland, vol ii, 122-124. This is known as compensation, or the balancing of accounts, in bankruptcy. Its purpose is to prevent the hardship of a debtor who is also a creditor being forced to pay in full, when he will come in only as a creditor for a dividend for his debt as a result of ranking pari passu with the ordinary creditors. The liquidation of a company is treated as the equivalent for this purpose as bankruptcy: Highland Engineering Ltd v Thomson, 1972 SC 87, 91, per Lord Fraser. The parties to a construction contract are entitled to the benefit of the doctrine, just like anyone else. The same result is achieved under English law by rule 4.90 of the Insolvency Rules 1986: see Bouygues (UK) Ltd v Dahl-Jensen (UK) Ltd [2000] BLR 522, paras 30-32 per Chadwick LJ, although the point was not taken in that case.

    33.  The doctrine is available only in the event of liquidation or bankruptcy. As Bell puts it in his Commentaries, vol ii, 122, the imminent necessity for the payment of the liquid debt is taken away by the bankruptcy. But there are other situations closely related to insolvency, listed in clause 27.3.1, where the employer may have good reasons for wishing to determine the contractor's employment. There may also be good reasons in those situations for thinking that the contractor, although not yet actually insolvent, is on the verge of insolvency. JCT 1998 seeks, in the employer's interest, to deal with this situation in two ways.

    34.  First, clause 27.3.4 gives the employer the right to determine the employment of the contractor in those other situations too. To this is added the right to recover from the contractor any direct loss and damage caused as a result of the determination, and to set that sum off against sums due to the contractor when the account referred to in clause 27.6.5.2 is made up. Secondly, clause 27.6.5.1 applies the principle of compensation in bankruptcy to all cases where the employer determines the employment of the contractor by giving the employer the right to withhold payment of liquid debts pending the making up of the account. But it does not drive this principle too far. It excludes payments that the employer has unreasonably not paid and which, in a case of determination on the ground of insolvency, accrued 28 days or more before the date when the employer could first have given notice to determine the employment of the contractor.

    35.  JCT 1998 is not a consumer contract. The Joint Contracts Tribunal by which this standard form is issued includes among its members contractors' representatives as well as representatives of employers. That is true also of the Scottish Building Contract Committee under whose auspices the form of contract used in this case was issued. The proviso to clause 27.6.5.1 must be taken to have the approval of both sides of the building industry. There is nothing inherently unfair in holding the parties to a building contract, who can be assumed to have equal bargaining powers, to an agreement in these terms. Why then should Parliament wish to interfere with the parties' freedom of contract as to how the potential for losses should be apportioned between them in the events that it refers to?

    36.  Part II of the 1996 Act contains a package of measures relating to construction contracts which followed upon the recommendations of Sir Michael Latham's Report Constructing the Team (HMSO 1994). His report was jointly funded by the construction industry and the Department of the Environment. In May 1995 the Department of the Environment issued a consultation paper entitled Fair Construction Contracts. It was concerned with the extent to which improved construction contracts could and should be underpinned in law: para 2. It was noted that the Latham Report had confirmed what was widely believed, that the existing arrangements militated against co-operation and teamwork, and that the reform of current contractual relations was central to the competitiveness of the industry in both the short and long term: para 4, 5. Attention was drawn to the list of principles that Constructing the Team had identified in para 5.18 as those which the most effective form of contract in modern conditions should include. Among these principles, which were set out in Annex A to the consultation paper, was the following:

"9.  Clearly setting out the period within which interim payments must be made to all participants in the process, failing which they will have an automatic right to compensation, involving payment of interest at a sufficiently heavy rate to deter slow payment."

None of the principles listed here deals with the situation referred to in the proviso to clause 27.6.5.1.

    37.  In para 23 of the consultation paper it was noted that the proposals in Constructing the Team had identified the following as essential terms in all construction contracts: dispute resolution; right of set off; prompt payment; protection against insolvency. In para 12 it was noted that legislation in this area could significantly restrict to some extent the freedom of parties to contract on any terms they chose. The first point on which the government wished to have views was whether the proposals for legislation set out in Constructing the Team and elaborated in the consultation paper were likely to improve contractual relations sufficiently to justify this regulatory intervention. So it is important to see what the consultation paper does, and does not, address.

    38.  The section of the consultation paper which deals with prompt payment refers to payments that fall to be made during the course of the project, and to the need for a clearly defined period within which interim payments must be made to all participants in the process: paras 34, 35. In para 38 it was suggested that the practice of withholding payment until payment had been received from a party higher up the chain ought not to be recognised in any statutory scheme for the approval of a standard from of building contract. The section on the right of set off refers to the widely applied practice of setting off unliquidated cross claims against sums due on interim certificates: see Modern Engineering (Bristol) Ltd v Gilbert-Ash (Northern) Ltd [1974] AC 689. Constructing the Team recommended that this right should be constrained: para 8.9. The consultation paper proposed various steps that might be taken to deal with this problem: paras 31, 32. But set-off in the circumstances referred to in clause 27.6.5.1 is not discussed. There is no indication that there was thought to be any need to constrain, or to restrict, the employer's right of set off in the event of the determination of the contractor's employment under the contract.

    39.  In the section of the consultation paper on protection against insolvency it was noted that a complication in creating trust among the members of the construction team which had attracted particular attention was the fear that during the course of the contract one of the parties, including the client, might become insolvent: para 39. In para 40 the consultation paper stated that it was not possible to give absolute protection against this risk which was a normal commercial one faced by all those doing business. It was suggested that the risk could be minimised, in the case of the client, by the use of trust funds. But there is no indication here that it was the intention to reduce the protection that it was already the practice for the employer to seek to obtain against the risk of the contractor's insolvency in the event of the determination of his employment under the contract.

    40.  That then is the background to Part II of the 1996 Act. In general its provisions follow the agenda that was indicated in the consultation paper. Legislation on trust funds to increase protection against the client's insolvency was omitted, as was the provision of a statutory right to interest for late payment. But provision was made for entitlement to stage payments (section 109), for the inclusion in every construction contract of an adequate mechanism for determining what payments become due under it and the final date for payment in relation to any sum which becomes due (section 110), for notice to be given of an intention to withhold payment (section 111), for a right to suspend performance for non-payment (section 112) and for the prohibition of provisions making payment conditional on payment received from a third person (section 113). Leaving aside the small print, there is nothing in this part of the Act that would surprise anyone who had engaged in the consultation process that preceded it. Nor is there anything to suggest that regulatory intervention had been resorted to on matters that had not been put out for consultation with the construction industry.

    41.  In the light of this background I would give a purposive construction to section 111(1), although it does not contain any obvious ambiguity. The mischief that it addresses is that of the withholding payment without notice of stage payments or other periodic payments (see section 109(1)), not the withholding of payment of sums already due in the event of the determination of the contractor's employment pending the making up of an account to identify the balance, if any, due to either party once the loss and damage caused to the employer as a result of the determination has been taken into account. The parties' freedom of contract as to the circumstances in which the contractor's employment may be terminated and, if so, with what consequences has not been affected.

    42.  As the commentator in Current Law Statutes indicates, section 111 is primarily designed to reduce the incidence of set-off abuse by formalising the process by which the payer claims to be entitled to pay less than expected by the payee. Construing it in its context, section 111(1) is concerned with the entitlement to stage payments referred to in clause 109. The procedure that applies where an effective notice of intention to withhold payment is given in terms of section 111(4) supports this approach. That subsection envisages that the only issue, if the matter is referred to adjudication, will be whether the whole or part of the amount withheld should be paid and that payment will be made within a very short time thereafter. I agree with Lord Clarke that section 111(1) does not apply to the situation where the employer wishes to exercise the right of set-off that he is given by clause 27.6.5.1 when he has determined the contractor's employment under the contract.

    43.  For these reasons, and for those given by Lord Hoffmann (except for his doubt as to whether section 111(1) applies only during the currency of the employment under the contract - a determination for breach under clause 27.2.2 will always have been preceded by a notice under clause 27.2.1 specifying the default or defaults, which will give the contractor an opportunity to refer the matter to adjudication within the period of 14 days referred to in clause 27.2.2), I would allow the appeal, recall the Extra Division's interlocutor, restore the interlocutor of the Lord Ordinary and dismiss the action.

My Lords,

    44.  I have had the great advantage of reading in draft the opinion of my noble and learned friend Lord Hoffmann. I am in full agreement with it and for the reasons given by Lord Hoffmann I would allow this appeal.

LORD MANCE

My Lords,

    45.  I have had the benefit of reading in draft the opinions prepared by my noble and learned friends, Lord Hoffmann, Lord Hope of Craighead and Lord Neuberger of Abbotsbury.

    46.  The first issue is whether, putting the Housing Grants, Construction and Regeneration Act 1996 on one side, clause 27.6.5.1 of the JCT Standard Form is in its terms apt to enable the appellant to withhold payment of the instalment which became finally due on 16th May 2003. In agreement with the reasoning of all of your Lordships, in my opinion it is.

    47.  On the second issue I agree with the reasoning and conclusion of Lord Neuberger. This issue turns on the effect of the 1996 Act, particularly section 111 read in the context of sections 108-113. The House was informed that clause 27.6.5.1 of the JCT Form dates from long before the 1996 Act. Other clauses in the JCT Form have been introduced or amended to reflect the statutory concepts of that Act. The retention unaltered of clause 27.6.5.1 no doubt witnesses the JCT draftsmen's belief, or hope, that its provisions were consistent with the statute. But one cannot approach the present problem with any pre-conception that the statute should be construed to validate them.

    48.  It is, I think, accepted on all sides that the terms of section 111(1) are on their face unambiguous and unqualified. Their evident aim was to crystallise a time after which a payment becoming due under a contract would have to be made, regardless of any ground for refusal of payment which might otherwise have existed, unless the ground had been raised by notice complying with the requirements in and time limit prescribed under section 111(2). This is underlined by paragraph 35 of the Department of the Environment's consultation paper, to which Lord Neuberger refers, which contemplated that the legislative provisions covering prompt payment of interim payments would provide "an automatic right to compensation", and that "any attempt to amend or delete them should be invalid".

    49.  I see no room for reading into section 111 some exception in respect of grounds subsequently arising. I cannot think that Parliament can have overlooked the fact that grounds for withholding payment could arise after the cut off date for a notice under section 111. Neither the statutory nor the JCT scheme appears to me consistent with the appellant's submission that a sum due under the contract can be provided to become retrospectively "undue". The phrase "after the final date for payment of a sum due under the contract" in section 111(1) refers simply to the contractual time stated in the contract in compliance with section 110(1)(b); it does not enable a revisiting of the question whether there is still a sum due, to take into account events subsequent to the expiry of the period for notice prescribed under paragraph 111(2).

    50.  Equally, I cannot see any basis for carving out of the operation of section 111 situations defined by reference to a subsequent claim by the employer to have determined the contractor's employment or by reference to some general conception of insolvency. Situations of true insolvency carry, of course, their own different statutory scheme, to which others of your Lordships refer in their opinions. But we are concerned not with a situation of statutory insolvency, but with a contractual scheme. In this connection, it is relevant to note that clause 27.6.5.1 is not in terms limited to cases of contractual determination on account of insolvency (or financial difficulty, such as those leading to appointment of a receiver: cf clause 27.3.3). It is also liable to be triggered in cases of contractual determination for alleged default (cf clauses 27.2.3 and 27.3.3). The cash flow which section 111 aims to protect is clearly engaged for the benefit of the contractor (and others relying on the contractor for payment in the ordinary course of business) in the latter case, even if in the former case any payment made by the employer may well only benefit the contractor's bank or general body of creditors. As I have indicated, I cannot in fact see any basis for excluding either case from the clear operation of section 111.

    51.  I would therefore dismiss this appeal.

LORD NEUBERGER OF ABBOTSBURY

My Lords,

    52.  The appellant, as employer, and the respondent, as contractor, entered into a building contract on 11 April 2000 (the "Contract") for the design and construction of houses at Ayr Road, Whitecraigs, Glasgow. The contract sum was around £7.1m. The contract incorporated (with variations irrelevant for present purposes) the terms of the JCT Standard Form of Building Contract With Contractor's Design, 1998 Edition.

    53.  Clause 27 was headed "Termination by the Employer", and it included a right to determine in the event of the contractor being in persistent default of its contractual obligations (clause 27.2), going into liquidation, or having a receiver, administrator or administrative receiver appointed (clause 27.3), or being involved in corruption (clause 27.4). Under clause 27.3, liquidation automatically determined the contract (clause 27.3.3), whereas the other events gave the Employer a right to determine by notice (clause 27.3.4). Clause 27.6 contained provisions which applied if the contract was determined pursuant to these provisions. It included clause 27.6.5.1, which is quoted by my noble and learned friend, Lord Hoffmann, whose speech I have had the privilege of reading in draft.

    54.  Clause 30 was concerned with "Payment", and clause 30.3 dealt with the contractor's right to apply for interim payments on a monthly basis. Clause 30.3.2 provided that the contractor could render periodic applications for interim payments. Clause 30.3.3 entitled the employer to give notice, within five days of the receipt of an application, specifying the amount the employer proposed to pay on the application, and the basis upon which that amount is assessed. It also provided that that amount, subject to clause 30.3.4, should be paid by the employer "no later than the final date for payment". Clause 30.3.4 provided that "not later than 5 days before the final date for payment", the employer should give notice of "any amount proposed to be withheld and/or deducted from" the sum otherwise payable under clause 30.3.3, and the reasons for any such withholding or deduction. In the absence of an employer's notice under clauses 30.3.3 or 30.3.4, clause 30.3.5 provided that the amount sought in the application for interim payment should be paid by the employer. Clause 30.3.6 provided that "the final date for payment shall be 14 days from the date of [the] Application for Interim Payment".

    55.  The provisions of clause 30 which I have just referred to were no doubt formulated so as to comply with sections 110 and 111 of Housing Grants, Construction and Regeneration Act 1996 ("the 1996 Act"), the relevant parts of which are quoted in the speech of Lord Hoffmann, and do not need to be repeated. They are to be read together with sections 109 and 112 to 113, and constitute a group of five sections in the 1996 Act, which are under the heading "Payment".

    56.  On 2 May 2003, the respondent contractor applied for an interim payment of £396,630 ("the sum"). No notice was served by the appellant employer under clause 30.3.3 - which reflects section 110(2) - or under clause 30.3.4 - which reflects section 111(2). Accordingly, the final date for payment of the sum, by virtue of clause 30.3.6 - reflecting section 111(1) - was 16 May 2003. The appellant did not pay the sum. On 22 May, an administrative receiver was appointed in respect of the respondent, and, on 30 May, the appellant exercised its consequent right to determine the contract under clause 27.3.4.

    57.  The appellant contends that it is, and has been since 30 May 2003, entitled to withhold the payment of the sum, notwithstanding that its obligation to pay it by the "final date" of 16 May 2003 had arisen pursuant to the provisions of clauses 30.3.5 and 30.3.6. The reason the appellant so contends is that it determined the contract on 30 May pursuant to clause 27.3.4, and it therefore argues that it can rely on clause 27.6.5.1, and in particular the proviso thereto.

    58.  The respondent puts forward two arguments in reply. The first is that, on its true construction, clause 27.6.5.1 does not, at least on the facts of this case, have the effect of enabling the appellant to avoid having to pay the sum. In the alternative, if clause 27.6.5.1 does have the effect for which the appellant contends as a matter of contract, it falls foul of the provisions of the 1996 Act, and in particular, section 111(1).

    59.  So far as the respondent's first point is concerned, Mr Robert Howie QC contends that clause 27.6.5.1 could not avail an employer who relied on a determining event (as identified in clauses 27.2, 27.3.3, 27.3.4 or 27.4, as mentioned in clause 27.6) to avoid payment of a sum, the "final date for payment" for which had arisen under clause 30.3.6 before the determining event. It may be that that contention could have been made out in the absence of the proviso to clause 27.6.5.1, but it appears to me that the proviso renders the contention unarguable.

    60.  The opening part of clause 27.6.5.1 provides that, once the contract is determined on one or more of the grounds identified in clause 27.6, the employer is effectively discharged from having to make "any further payment"(subject to clauses 27.5.3 and 27.6.5.2). In the absence of the proviso to clause 27.6.5.1, there might well have been room for argument that "further payment" was intended to be limited to sums that had not fallen due for payment, or at any rate, in respect of which a "final date for payment" has not yet arisen. However, at least on the basis of the arguments advanced before your Lordships, I do not see how such an interpretation of the opening part of clause 27.6.5.1 could be maintained in the light of the proviso and, in particular, to its extending the opening part of the clause (albeit through a double negative) to "amounts…which…have accrued [less than]" 28 days before the date when the employer could first have given notice under clause 27.3.4, or, where that clause does not apply, 28 days before the employer determined the contract.

    61.  It appears that this point was conceded by the respondent both in the Outer House (see paragraph 7 of the Opinion of Lord Clarke and paragraph 21 of the Opinion of the Inner House) and in the Inner House (see paragraph 27 of the Opinion of the Inner House). In my view, that concession was rightly made.

    62.  Accordingly my Lords, it appears to me that the real issue in this case centres on the effect of sections 110 and 111 which, as Lord Hoffmann says, do not appear to have been conspicuously well drafted. Thus, it is by no means clear why the legislature has seen fit to provide for two separate notices, the first under section 110(2) and the second under section 111(1), particularly given that second sentence of the latter subsection appears to accept a section 110 notice can also function as a section 111 notice.

    63.  As I see it, the respondent's case is very simple, and it proceeds as follows. Section 110(1)(b) requires a construction contract to "provide a final date for payment in relation to any sum which becomes due". In this case, the contract complied with this requirement in relation to interim payments through the medium of clause 30.3.6. On the facts of this case, the "final date" for the payment of the sum was 16 May 2003. Section 111(1) prohibits the appellant from "withhold[ing] payment …" after "the final date for payment of a sum due under the contract". In this case, that must mean that the appellant "may not withhold payment" of the sum after 16 May 2003. Accordingly, in so far as clause 27.6.5.1 has the effect of permitting the appellant to withhold payment of the sum, it is purporting to permit that which section 111(1) prohibits. Therefore, to that extent, it is ineffective. That simple approach commended itself to the Inner House.