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The Technology and Construction Court (TTC) has provided some clarification on an issue we covered in July, in discussing Melville Dundas Ltd (in receivership) & others v George Wimpey UK Ltd & others. This case considered the potential conflict between payment provisions in the Housing Grants, Construction and Regeneration Act 1996, which requires an employer to make regular instalments to a contractor, and Clause 27 of the JCT 1998 standard form of contract which states that the employer does not have to pay up if the contractor has become insolvent.

If payment is not made, a withholding notice should be issued by the employer to inform the contractor under section 111 of the act. But in Melville Dundas, the House of Lords decided that, even without a notice, an employer could rely on a contractual provision to set off losses incurred through a contractor鈥檚 insolvency.

The TTC explored the issue further in its ruling on Pierce Design International Ltd v Mark Johnston and Another [2007] EWHC 1691. Mr and Mrs Johnston entered into a JCT 鈥渨ith contractor鈥檚 design鈥�, and with amendments, with Pierce, for works at their property. They underpaid interim valuations 4, 8, 9, 10 and 12, leaving 拢93,460.33 unpaid 鈥� and they failed to serve withholding notices. Pierce sought payment with interest. However, the works were not finished by the completion date; the Johnstons complained about defects and incomplete works and served a notice of default on Pierce. Later, the Johnstons 鈥渄etermined鈥� the contract with Pierce, alleging the defects had not been remedied.

Clause 27.6.5.1 of the contract prevented the Johnstons from deferring payment on any sums that had unreasonably not been paid, and those that had accrued 28 days or more before the determination. The TCC had to consider: whether clause 27.6.5.1 is contrary to section 111 of the act, because it allows sums to be withheld where there is no withholding notice; if the clause does comply with section 111, whether it entitled Pierce to payment on the basis that they had been unreasonably withheld.

Judge Coulson held that he was bound by the Lords decision in Melville Dundas, that clause 27.6.5.1 was not contrary to section 111 of the act. So the court had to consider whether the sums claimed were amounts properly due to be paid to Pierce; whether the right to the sums had accrued more than 28 days before determination; and whether the Johnstons had unreasonably withheld the sums.

The judge decided the sums were properly due, and had accrued more than 28 days before. The question of whether they had unreasonably been withheld depended on whether a valid withholding notice had been served. In the absence of one, it was ruled that the Johnstons had acted unreasonably in failing to pay the full amounts certified and Pierce was awarded the sums claimed, plus interest.

The Department for Business, Enterprise and Regulatory Reform has issued a consultation paper on proposed reforms to the act, including that the Melville Dundas decision should be confined to cases of insolvency. However, the Pierce judgment makes clear that the decision is of much broader application, so any reform would seek to limit its impact.

It should be remembered that the decision only affects cases where a party relies on clause 27.6.5.1 of the JCT 1998 form of contract, which does not appear in the more recent JCT 2005. In its absence, the employer could have retained the outstanding sums until the final account had been agreed.

Rachel Chaplin is a solicitor with City law firm Reynolds Porter Chamberlain