Payment and rights to withhold

Even where a valid withholding notice or pay less notice has been issued, the grounds set out in the notice must themselves be valid. If they are not, they are unlikely to withstand challenge in adjudication, arbitration or litigation.

Leaving aside cases where the payer disagrees with the certified or claimed value of the works, the most common reason why sums are withheld against an interim payment application or certificate is that the payer has a cross-claim against the payee which it wishes to set off against the amount certified. The cross-claim may be for liquidated damages for delay, or for losses caused to the payer as a result of other breaches of contract by the payee.

Subject to the terms of the contract, cross-claims can generally only be deducted against payments which are otherwise due to the contractor if they can be relied upon by way of abatement, or as an equitable, legal or contractual set-off.

Abatement

The doctrine of abatement allows a party to a contract for the sale of goods or the supply of materials and labour (such as a building contract) to defend a claim for payment of the price by showing that the goods or works are worth less than the contractual price as a result of breaches of contract by the seller or supplier.

In the context of a building contract, this means that the employer can claim a reduction in the amount due to the contractor on an application for payment by showing that the work is worth less than the amount claimed, e.g. because of defects. It is, in effect, an alternative to claiming damages in respect of defects in the work. The amount of the reduction is the amount by which the value of work is diminished as a result of the breach of contract. In the case of defects, this will normally be the cost of remedial works, although each case depends on its facts.

The doctrine of abatement appears not to contracts for professional services. This means that in a design and build contract, an abatement might succeed for defects in materials or building is unlikely in respect of defective design work.

Equitable set-off

An equitable set-off arises where the cross-claim is so closely connected to the payee's claim for payment that it would be manifestly unjust to allow the claim without taking into account the cross-claim. This will be the case for most cross-claims which arise under the same contract as the payee's claim for payment.

Legal set-off

A legal set-off does not require there to be a close connection between the two claims. It simply requires that both the contractor's claim and the employer's cross-claim are for liquidated amounts which are known or can readily be ascertained, even if entitlement is disputed. This will be the case, for example, where a contractor is seeking payment of a certified sum.

Similarly, an employer's claim for liquidated damages at the contractual rate is a liquidated claim whose amount can readily be ascertained, even though their entitlement to recover that amount may be disputed, for example, because the contractor claims an extension of time. Therefore, in a contractor's claim for payment of a certified sum, the employer may seek to rely on a legal set-off of his or her liquidated damages claim even if the liquidated damages claim relates to a separate project.

In contrast, an employer's claim for damages in respect of defects is not a claim for a liquidated amount which can be readily ascertained with certainty. The proper amount of the claim can only be ascertained by litigation or arbitration. Therefore, this claim could not be relied on as a legal set-off against the contractor's claim for the certified sum.

Contractual set-off

A contractual set-off arises where the terms of the contract expressly allow the employer to deduct cross-claims arising out of particular matters.

Contract administrators should be aware that some contracts limit or extend the parties' rights of set-off. In addition, the terms of the contract may provide the employer with further grounds for withholding payment which do not rely on set-off. This again underlines the importance of studying and understanding the terms of the contract before advising on whether a withholding notice or pay less notice should be issued.