How to protect against payment reductions

A developer looking to cut business costs by reducing payments to contractors may be acting illegally, warns Cerys McRobert.

In the current market, developers are understandably looking to cut their business costs as cashflow has been badly reduced. So it is perhaps not surprising that developers may be considering cutting payments to their contractors.

However, it is important for contractors to note the distinction between payment cuts on existing contracts, and developers looking to achieve savings on future contracts. The latter is permissible, the former can be very dangerous.

It has famously been said that cashflow is the 'lifeblood' of the building trade, and thus extremely important for contractors. Legislation has been developed to protect the contractor's rights to payment for works carried out.

The main piece of legislation to do this is the Housing Grants, Construction and Regeneration Act, which applies to written contracts for certain 'construction operations' and provides that if any employer wants to withhold payment, it must first serve a valid withholding notice specifying the reasons.

If such a notice is not served, then the contractor must be paid in full by the 'final date for payment', which will be a date following the 'due date', for example 14 days later. If payment is not made by this date, then the contractor can suspend work until payment is made in full, and can commence adjudication proceedings to enforce payment - with interest.

Another piece of legislation contractors should be aware of is the Late Payment of Commercial Debts Act. This provides that unless the building contract specifies a different rate, interest at 8% above base can be charged on any late payments.

Aside from such legislation that serves to protect the payee, contractors should be aware of the common law position that will also apply to construction contracts. While it is always advisable to have a formal, written contract signed by both parties for contractual certainty, there is no legal requirement for this and many construction contracts are pretty informal they may be just an exchange of letters or even a verbal agreement.

Legally binding

Regardless of any lack of formality, if there is a contract in place, there is a legally binding obligation on the contractor to carry out the work and on the developer to pay the agreed price in full. Only if there are valid grounds, such as defects in the contractor's work, can payments be reduced.

Failure of the developer to pay the full amount will usually be a breach of contract, as well as giving rise to a debt for the part of the payment that has been withheld.

To recover the balance as a debt, the contractor could issue a 'statutory demand'. This is a formal notice requiring payment within 21 days, failing which the debtor is deemed insolvent and bankruptcy or winding-up proceedings can be commenced. Usually, the threat of this leads to payment within the 21 days.

In addition, the contractor will be entitled to claim damages, which will usually be the amount that has not been paid, but in some cases the contractor may be able to recover other losses it has suffered as a result of the non-payment.

In order to avoid these consequences, the developer may want to try and negotiate a price reduction. But to impose that any agreed reduction must be recorded in writing and it may require a formal variation agreement varying the terms of the original building contract. Otherwise, at the end of the project the contractor is entitled to claim for the balance of the original purchase price, possibly by arguing the developer has used duress to get the price reduction it wanted.

Although tough negotiation is acceptable, agreements that are entered into under duress are voidable and a threat to terminate the contract or to blacklist the contractor from future projects may be enough to constitute duress.

In addition there are criminal sanctions. It is blackmail pursuant to Section 21 of the Theft Act to make an unwarranted demand with menaces, with a view to gain. A demand with menaces is unwarranted unless the person making the demand believes that he has reasonable grounds for the demand and that menaces are an appropriate means of enforcing it. A threat to terminate a contractor's employment or to blacklist him unless he agrees to a price reduction may well be blackmail and the penalty for this is up to 14 years' imprisonment.

Cerys McRobert is an Associate in Boodle Hatfield's Construction team