How to deduct LADs

Before an employer can deduct liquidated and ascertained damages (LADs) under a JCT form of contract, he has to satisfy three conditions:

1. There must be in existence a Certificate of Non-Completion issued by the architect or contract administrator;
2. The employer must inform the contractor in writing of his intention to deduct LADs (Notice 1); and
3. The employer must serve a notice of withholding under the Housing Grants, Construction and Regeneration Act 1996 at least five days before the final date for payment of the interim certificate against which he intends to deduct the LADs (Notice 2).

What happens if, after these notices have been served, but before the date for payment of the interim certificate, the architect or contract administrator gives an extension of time which substantially reduces the LADs overall? Can the employer still make the deduction and "correct" the LAD position on the next interim certificate? Or can the contractor argue that no deduction can be made at all, and that the interim certificate must be paid in full, with a (smaller) deduction of LADs being made on the following interim certificate?

Last week in Reinwood Ltd v L Brown & Sons Ltd [2007] the Court of Appeal dealt with exactly this argument in relation to a JCT 98 contract. The point was particularly crucial for the employer, who had lost before the trial judge and was now appealing. The judge had held that, not only was the employer not entitled to deduct the LADs, but that this was a breach of its payment obligations that contributed to the contractor being entitled later to terminate the whole contract.

The Facts

The parties entered into a contract for the construction of 59 apartments in Manchester. The form of contract was a standard JCT form, 1998 Edition with Quantities. The date for completion was 18 October 2004. However, the project was still not complete by December 2005, at which point the architect issued a Certificate of Non-Completion. This met the first of the three conditions described above.

On 11 January 2006, the architect issued interim certificate no. 29. It was agreed that the final date for payment of the sum due under this certificate was 25 January.

On 17 January the employer issued two further notices, namely a notice of its intention to deduct LADs and a notice of withholding (Notices 1 and 2 above). The employer had now met all three of the conditions referred to above. It therefore paid over the value of interim certificate no. 29 less the LADs (which totalled £61,629) that it had referred to in the notices.

However, on 23 January, the architect granted a substantial extension of time (up to 10 January 2006). This meant that the LADs due to the employer were now only £12,326. The employer was of course willing to repay the balance of some £49,303, and in fact did shortly afterwards. But the contractor argued that the effect of the extension of time was to invalidate the employer's Notices 1 and 2 such that the deduction of LADs was also now invalid.

The Decision

As the court noted, if the contractor's argument was right, the employer would be in an impossible position. Although the contract made provision for the possibility of a fresh Certificate of Non-Completion to be issued by the architect (such that the Notice 1 could then remain in being) there was no similar provision that would rescue the employer's Notice 2. There simply would be no time for the employer to issue a further notice of withholding (Notice 2) in the required time ie five days before the certificate was due to be paid. That date had already passed by the time that the architect gave the extension of time.

As the court further noted, in cases where an architect reviewed the date for completion to an earlier date than before (eg where there had been an instruction for an omission of work) the position would be even more anomalous. Here, the employer would have obtained an entitlement to an even greater deduction of LADs than featured in his notices, but would now not be able to deduct any LADs at all - according to the contractor's argument.

The court held that the sensible commercial scheme, which was one that was probably intended in the contract, is that the employer's right to deduct LADs crystallises as soon as the three conditions (above) have been satisfied. It then does not matter if the underlying conditions for the issue of either of the relevant notices no longer subsists at the final date for payment of the interim certificate.

The court went on to say that, of course, the employer must repay any LADs which, following the extension of time, are now due back to the contractor (in fact the JCT contract provides for this). Such repayment must be made, said the court, within a reasonable time, which would often be a matter of a few days.

Comment

Two points may be noted.

First, if the contractor's argument had succeeded, the employer would have lost its right to deduct any LADs whenever the architect or contract administrator happened to choose an inopportune time (ie five days or fewer before the final date for payment of an interim certificate) to give an extension of time. The court's interpretation of the contract is therefore one that accords with commercial reality.

Secondly, in relation to the JCT 05 forms, there are clauses that bolster the employer's position, at least in relation to the Notice 1 above. These clauses (2.32.1.4 of the standard form and 2.29.1.4 of the design and build contract) make clear that the Notice 1 is not invalidated whenever a new extension of time (and therefore a fresh Certificate of Non-Completion) is granted.