Payment procedures

Set-off, counterclaim and abatement is a complicated area. If a contractor enters into an agreement to do work for payment and the employer is unhappy with its performance for whatever reason, the usual course of action is to deduct money from the next payment due to the contractor.

In the construction industry, this action is variously known as set-off, cross claim, counterclaim, contra charge or abatement. These terms have different meanings, so it is important to be aware of the correct legal terminology, which is: set-off, counterclaim and abatement.

The terms defined

Abatement is the easiest of the terms to define. If the contractor asks for more money than the actual value of the work executed, the employer has the right to pay the correct amount, with the difference between that requested and that paid representing an abatement.

This happens quite frequently during the preparation of interim payments and may be because there are defects in some of the work that has been included in the application.

The distinction between set-off and counterclaim can be complex and is simplified for the purposes of this article. If the claim amounts to a set-off in law, the employer can withhold the value of that set-off from money otherwise due to the contractor. If the claim does not amount to set-off in law this will be a counterclaim. There is no general right to withhold the amount of the counterclaim from money otherwise due to the contractor. In this instance the counterclaim will be dealt with by way of a separate claim in the usual way.

It will be seen, therefore, that the right to set-off, is important for cash flow reasons. However, with the rights given by the Construction Act, any counterclaim that is disputed by the contractor can now be referred to adjudication, with a decision usually given within 28 days following the appointment of an adjudicator.

The act of payment

The Construction Act, together with the Scheme for Construction Contracts, provides a mechanism for payment within most written construction contracts (other than for residential occupiers). This includes the opportunity for the payer, or employer, to issue a Withholding Notice against amounts to be paid, which in effect is a set-off or abatement to the sum due.

There are a variety of reasons for reducing a payment, including: defective work; disagreement over the value of work executed; a claim by the payer that the contractor has caused disruption or delay to the work that has incurred it an extra cost; a problem on another project where both parties have a contract; liquidated and ascertained damages.

Section 111 of the Construction Act sets out the procedure for issuing a Withholding Notice. Not surprisingly, this is frequently referred to by lawyers and other dispute professionals as a Section 111 Notice. This is in effect an abatement or set-off Notice. The Act says that to be effective a Withholding Notice must specify:

• the amount proposed to be withheld and the ground for withholding payment; or
• if there is more than one ground, each ground and the amount contributable to it.

The title Withholding Notice is unfortunate as it implies withholding an amount that is actually due and payable, which is not usually the case. It is in fact providing the opportunity for the payer to either abate or set-off against an application because that amount is not due to the contractor.

It is worth restating that because this procedure is enshrined in legislation, it is not possible to ignore or contract out of the process. If the agreement between the two parties is silent on the matter then the Scheme for Construction Contracts will usually apply. If a Withholding Notice is not issued the payer will have no legal right to abate or set-off.

Section 110 of the Construction Act appears to recognise the right for cross contract set-off. This occurs when the two parties are working together on more than one project. Money can be set-off against one project where there is not a problem to take account of money claimed on another contract where a problem exists.

This practice was condemned as far back as 1994 by Sir Michael Latham in his Constructing the team report. It is an issue that the SEC Group has again raised as part of its lobbying of government during the current review of the Construction Act.