Payment claim vs counterclaim

The Construction Contracts Act 2002 (CCA) has been in force for well over a decade and has contributed to much litigation during that time. The CCA advances a “pay now/argue later” regime and prevents set-off, crossclaims or counterclaims being raised to any debts which become due under the CCA (i.e. by virtue of an unanswered and/or unpaid payment claim, unpaid payment schedule or adjudication determination).

CCA

However, a more complicated issue which arises is whether a payer is entitled to raise any set-off or counterclaim in its payment schedule responding to a payment claim.

This article examines whether the regime set by the CCA accommodates claims for set-off or counterclaims at the payment schedule stage.

Summary of the CCA payment regime

The CCA codified a process for claiming and certifying payment in construction contracts whereby the party who carries out the work claims for payment in a “payment claim”, and the party paying for the work serves a “payment schedule” in response. The point of the payment schedule is to verify the amount the payer agrees to pay the payee. This process is largely mirrored in most standard form construction contracts.

Parties must comply with strict requirements in section 20 for payment claims and section 21 for payment schedules in order to benefit from the CCA’s default provisions for progress payments. This process for making and responding to payment claims can be viewed as the first stage of three in the CCA’s payment regime (Stage 1). The function of Stage 1 is to determine what is payable under the contract and ensure payment of that amount to the payee. If the payer does not pay, the CCA provides avenues for debt recovery (Stage 2). If the parties disagree about what is payable or dispute other rights and obligations under the construction contract, the CCA offers adjudication (Stage 3). Mediation, arbitration and civil proceedings outside the CCA remain an option for parties in dispute.

The benefits of the regime for the payee include: immediate entitlement to the claimed amount as a “debt due” if the payer either fails to provide a payment schedule within the time required by the contract or the CCA (20 working days as per section 22), or fails to pay the claimed amount within the time required (section 23). The payee is also entitled to the amount in a payment schedule if the payer fails to pay the scheduled amount in time (section 24). The payee can go to court to recover the unpaid amount (Stage 2) or refer the matter to adjudication (Stage 3), or both.

The benefits of the regime for the payer include the ability to assess and certify the amount it considers payable (which could technically be nothing) or to indicate what it will pay instead of the claimed amount (i.e. the “scheduled amount”). If the scheduled amount is less than the claimed amount, the payment schedule must indicate how it calculated the scheduled amount, why the amount is different to the claimed amount, and the reasons for withholding payment on any basis (section 21(3)).

Can payment schedules include a counterclaim, set-off or cross-demand?

While section 79 prevents parties from raising set-off or counterclaims once a debt has arisen, it does not address whether set-offs, cross-claims or counterclaims can be raised in a payment schedule, particularly where those matters concern areas of a project outside of the items claimed for in the payment claim itself.

For example, where a homeowner has contracted with a builder to construct a new garage and pool, the builder may submit monthly payment claims for the pool works and the homeowner would issue payment schedules in response. The pool is completed within five months and the builder moves on to the garage. During the first month of the garage works, cracks appear in the pool tiles. Unhappy about what appears to require remediation, the homeowner responds to this month’s payment claim (PC6) with a deduction in payment schedule #6 (PS6) for pool works invoiced and paid for in payment claim #1 (PC1). Can the homeowner reduce the claimed amount of $50,000 in PC6 to a scheduled amount of $25,000 in PS6 by way of set-off?

There is High Court authority for the proposition that a payment schedule is not invalidated by the inclusion of a claim for set-off (Cube Buildings Solutions Ltd v King HC Christchurch CIV- 2009-409-34, 17 December 2009). The principal in that case purported to deduct nine sums in the payment schedule for amounts already paid to the contractor in earlier invoices, including two set-off claims. Associate Judge Osborne recognised that in the context of developing discussions between the parties, it may be that a payer does not know whether the set-off is disputed until it provides for it in a payment schedule. The Court did not accept that claiming a set-off of itself invalidates a payment schedule, particularly given that section 79 permits a court to give effect to a counterclaim/set-off/cross-demand where there is not in fact any dispute between the parties in relation to that claim (at [62]).

Cube is helpful for the homeowner in the pool example, as it confirms that, at least in some circumstances, claims for set-off can fall within the legitimate ambit of the Stage 1 payment claim/payment schedule process. The homeowner should be clear that it is not seeking to enforce the set-off of $25,000 against the builder’s claim as such – rather, the existence of a counterclaim for defective works is the “reason” for paying less than the claimed amount (section 21(3)(b)). The “manner” of calculating the scheduled amount of $25,000 is indicated by way of deduction for set-off against PC1 (section 21(3)(a)). Provided PS6 is a valid payment schedule in all other respects (i.e. served in time), it is difficult to establish, from the perspective of section 21, how section 79’s general prohibition on courts giving effect to a set-off in Stage 2 proceedings prevents payers from raising set-off as a “reason” in Stage 1.

However, PS6 would probably be invalid according to Associate Judge Christiansen’s reasoning in Canam Construction Ltd v George Developments Ltd HC Auckland CIV 2004- 404-3565, 10 November 2004. In his Honour’s opinion, section 21 “makes it clear any payment schedule is confined in scope to claims raised upon the payment claim” (at [46]). PS6 has not cross-referenced to items of garage works claimed in PC6 and instead alleged deductions relating to pool works claimed in PC1. A court following the “confined scope” reasoning might consider the set-off of $25,000 to be a “broadly cast claim relevant to the contract as a whole” and therefore not a proper or appropriate deduction (at [45]).

The Court of Appeal commented on this issue in SOL Trustees Ltd v Giles Civil Ltd [2015] 2 NZLR 482 at [43]-[44]. Without hearing the full argument on the point, the Court considered that it would appear to be inconsistent with the purposes of the CCA if a counterclaim or set-off that is excluded by section 79 could be relied on as a response to a payment claim issued earlier. The Court cited Metalcraft Industries Ltd v Christie (HC Whangarei CIV-2006-488-645, 15 February 2007), where Harrison J held that, in light of Parliament’s intention in enacting section 79, a principal’s denial of liability for a payment claim on the basis that a right of set-off exists is insufficient.

With respect, the Court of Appeal did not cite the remainder of Harrison J’s comment at [28] in Metalcraft where his Honour recognised that a payment schedule that “properly quantifies the amount incurred by a principal in remedying the allegedly defective workmanship by a contractor may ... constitute a valid reason for withholding payment for that amount”. Accordingly, the homeowner in the pool example needs to properly quantify and justify his reasons for paying less in the payment schedule, ideally by giving “full and unequivocal notice” of all areas of difference/ dispute to enable the payee to assess its options (Metalcraft at [15]).

To estimate and quantify the amount of a counterclaim or set-off can be challenging when the relevant information is in the payee’s possession, or the payer has not yet engaged experts to consider the financial consequences of delay, breach of contract or remedying defective works. For those reasons, commentators have argued that it is unfair to require payers to provide “full particulars” of the scheduled amount within the time allowed to prepare a payment schedule (see John Ren “What it takes to be a valid payment schedule under the Construction Contracts Act 2002” (2008) 14 NZBLQ 78).

Helpfully for payers, judicial decisions have consistently acknowledged that the requirement is to “indicate” reasons for withholding payment rather than to state, specify or set out reasons. That suggests a degree of flexibility or that some lack of precision or particularity is permissible (Manchester Industrial Holdings Ltd v Andrew G Hazelton [2016] NZHC 211 at [34]). However, the Court in Manchester dismissed the owner’s application for judicial review of a determination on the basis that the adjudicator was right to find that the asserted payment schedule (an email) had insufficient detail to indicate the owner’s reasons for refusing to pay the claimed amount. The email provided no indication of any calculations relied on to quantify the owner’s counterclaims, or how those counterclaims related to the extent specified in the payment claim (at [34]).

Conclusion

A payment schedule is not invalid simply because the payer included a counterclaim, set-off or cross-demand (Cube at [67]). Section 79 should not apply to Stage 1 as indicated by the Court of Appeal in SOL Trustees, and the CCA’s purpose in facilitating payment is not threatened by payers who calculate the scheduled amount with reference to a legitimate claim for setoff. To reduce the invalidity risk under section 21, payers should quantify and justify their counterclaims as best they can in the time available.

Proponents of section 79 are misguided if they believe that this proposition cuts across the “pay now/argue later” regime in the CCA. Stage 1 is concerned with statutory compliance; Stage 2 is concerned with debt recovery; and Stage 3 is concerned with speedy resolution of disputes. Payers can raise a set-off as a reason for paying less in their payment schedule in Stage 1, and they can debate the substantive merits of the claim in Stage 3. Stage 2 proceedings do not accommodate claims for set-off as this would be in breach of section 79.

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