The latest House of Lords decision to spell out the rights and wrongs of the Construction Act, and the JCT, was based on sound commercial logic

The second House of Lords case to put the Construction Act (and the JCT’s interpretation of it) under the judicial microscope, has drawn rather mixed reviews, in particular from Tony Bingham who regards the decision as flying in the face of common sense (20 March, page 62).

Readers will recall the background to the decision: the employer under a JCT98 contract had issued a withholding notice, based on an architect’s non-completion certificate, which entitled it to levy liquidated damages. But before the final date for payment of the next interim certificate, an extension of time was given that cancelled the non-completion certificate. Was the employer justified in paying only the reduced amount?

Trying to follow the arguments about this can easily distract our attention from what the case was really about. It was not the familiar story of an aggrieved contractor complaining that it was being starved of funds, or a claim for interest on late repayment of liquidated damages. The case concerned whether the contractor had validly terminated its contract, and that turned on whether the employer was in default on the final date for payment.

Terminating a building contract is of course a serious step, and can only be justified if there is a clearly established breach followed by a default notice giving the defaulting party the chance to put things right, and ultimately a valid termination notice.

Any case which goes the distance to the House of Lords will have plausible arguments on either side. And there is an obvious attractiveness to the contractor’s argument that if the justification for the withholding notice, that is, the non-completion certificate, has been removed by the later fixing of an extension of time, then the withholding notice too has been undermined and the full certified sum should be paid. But the contract does not say this. The employer’s right to damages sits astride a three-legged stool: the first is the non-completion certificate, the second is the notice of intention to deduct, and the third is the statutory withholding notice. If the first leg falls off, is the statutory right of deduction lost?

All the contract says is that if the non-completion certificate is cancelled, the notice of intention to deduct remains valid for any subsequent reduced (or enhanced) deduction that may be made later on. But nothing is said about the status of the withholding notice.

In the Court of Appeal, Lord Justice Dyson was quite clear that where the contract conditions were satisfied, the right to deduct liquidated damages crystallised when the notice was given. Nothing that happened afterwards could upset it retrospectively. This approach has the merit of not exposing an employer to an opportunistic termination by the contractor.

The concept of rights crystallising on the issue of the withholding notice means that everyone knows where they stand.

It also resolves the dilemma that bothered Lord Neuberger in the House of Lords, who declined to decide what the position would have been if the new extension had been given before the employer paid the certificate rather than afterwards, as occurred in this case. If rights have crystallised when a valid notice is given, what happens afterwards is irrelevant.

This approach is not unfair to the contractor. If a new extension is given after damages become due, the obligation to repay kicks in straightaway. In Reinwood the employer paid them back a week after the final date for payment, together with interest.

The House of Lords’ decision that the employer was not in default is based on a sound analysis of the JCT contract which applies also to the 2005 edition. It is commercially sound because the concept of rights crystallising on the issue of the withholding notice means that everyone knows where they stand. There can be no default if the employer acts upon that notice unless and until an adjudicator decides the notice was not justified under the contract, and in that event the employer’s default would only arise if he failed to comply with the decision.

For a truly "uncommercial" approach to the Construction Act we need look no further than the first House of Lords decision in Melville Dundas. The interpretation there given by Lord Hoffman to s.111 (the withholding notice provision) was that it did not apply to a lawful ground for withholding payment where it was not possible for the notice to have been given within the statutory time frame.

In other words the employer who has not given a withholding notice and who nonetheless, in breach of contract, fails to pay on the final date for payment can retrospectively justify his breach of contract. The obvious example would be his subsequent discovery of defects in the works.

This surely undermines the objective of the act to introduce certainty into the operation of payment provisions in building contracts, and is likely to promote further litigation in the future. By contrast the decision in Reinwood will enable advisers to give clear guidance to their clients when issues arise concerning liquidated damages.