Right of Set-Off Under Building Contracts

INTRODUCTION

The Dawnays case laid down a rule for the construing building contracts where monies have been deducted from interim payments to sub-constructors. In Dawnays Court of Appeal held that when a sum is certified by an architect as due under a building contract, the employer has no right of set-off. The justification for this decision was said to be that cash flow is the lifeblood of the building trade. The principle laid down by Dawnays has been criticised by Gilbert Ash case at the House of Lords which declared that the decision in Dawnays was wrong thus the decision of the case "ought not to be allowed to stand(1)". Gilbert Ash case symbolised Dawnays case as being wrongly decided that regardless of cash flow which the sub-constructors needed in order to perform the remaining work. It was recognised that if the work is not of satisfactory or had not been completed in compliance with the terms of the contract then the constructor is entitled to set-off or deduct amounts of loss consequent to that effect(2).

THE CASE OF DAWNAYS LTD:

Dawnays concerned a building contract between a main constructor and sub-contractors for an office building. Under the arrangement and terms of the contract the constructor and the sub-constructor were entitled to interim certificate as the construction work progress. The main constructors were entitles to interim certificates by the building owners upon the issue of this certificate it was the responsibility of the main constructor to pay the interim payment to the sub-constructors. However, once the main constructors received interim certificate they refused to pay the sub-constructors contesting that they have set-off the amount off loss they suffered because of the sub-constructors' delay.

The question before the court was whether the amount certified as payable for sub-contract works was subject to deductions. The court had to decide whether the main constructors were entitled "to deduct from any money due to sub-constructors any sum which the sub-constructors is liable to pay to the constructors". Certificate was issued to the main constructors by the employer. The main constructors set-off their unquantified claim for a delay caused by the nominated sub-contractors in doing steel work properly which the main constructor suffered losses.

It was decided that only quantified ascertainable sums were deductible and furthermore the main contractors not entitled to deduct in respect of unliquidated claim subject to dispute particularly in respect of RIBA form of sub-contract. Initially a judgement was given in favour of the main constructors but on appeal Lord Dennings and other judges jointly allow the appeal of the sub-constructors on the basis that under sub-contract the only sums deductible there under from moneys due to a sub-contractor were liquidated and ascertained sums established or admitted to be payable. The interim amount was a crucial amount that was due to the sub-constructors as a cash flow of lifeblood to compensate their work activities and pay further materials to finalise their contract.

However, subsequent cases like Gilbert Ash have critically overruled the ruling of the case on the basis that it was wrongly decided.

THE CASE OF GILBERT ASH:

The Appellants were appointed by a local authority as "constructors" under "the principle contract" to perform building work. Consequently, the local authority's architect nominated the respondents as "sub-constructors". Subsequently, the constructors entered into a "sub-contract" with the sub-constructors to supply and erect certain steelwork. The principle contract contains provisions in relation to the duties of contractors to the sub-constructors, which the sub-contractors were deemed to have full knowledge of the provisions of the principle contract (Clause17).

Under Clause 30 of the principle contract, the architect was required to issue interim certificates stating the amount due to the main contractors from the local authority. The amount due from the interim certificate, contractors were to pay sub-contractors for the sum representing the work, materials and goods executed by the sub-constructors.

However, the constructors under the sub-contact were entitled to deduct from the sum payable only if (i) any retention money, which the constructors may be, entitles to deduct under the terms of the sub-contract (ii) any money, which the constructors were entitled as result of delay in the completion of sub-contract Works, or any section thereof. Furthermore, under Clause14 payments both interim and final will be made to the Sub-contractor as and when the value of such works under the terms of the Principal Contract is included in a certificate to the Contractor and the Contractor receives the monies due there under.

Additionally, the constructors could suspend or withhold the amount due to the sub-constructors in the event that sub-constructors fail to comply with the conditions of the sub-contract. The architect issued three interim certificates nonetheless; the sub-constructors only received two thirds of the amount due for the work.

Subsequently, the sub-constructors issued a writ contesting the set-off by the constructors for delay and workmanship. Question before the court was whether the constructors reserved the right to deduct from payment due to sub-contractors "amount of any bona fide contra accounts and/or other claims". Sub-constructors took out a summons for summary judgement contending that there was no defence in law to their claim because the main contractors had bound themselves to pay sums in interim certificates in full without any right to set off claims.

Initially, the judge had decided in favour of the contracts as there allegation was bona fide. Subsequently, Court of Appeal reversed the judgement on the basis that under Clause14 "contra accounts and/or other claims" should be construed as "established or liquidated claims" and that Dawnays Ltd v F G Minter Ltd was in five subsequent cases determined that building or sub-contracts is intended to exclude the general principle of law relating to set-off except in respect of liquidated or ascertained sums which are established or admitted as being due. The constructors appealed against the decision by the Court of Appeal.

At the Appeal in House of Lords Lord, Viscount Dilhorne considered the implications of the Dawnays case with clear elaboration on cash flow as being a lifeblood in construction contracts. However, he further added and emphasised that "He is not entitled to be paid on interim certificates for work which is defective.(3)" Further, it was held that Dawnays was wrongly decided(4). When the case was at Court of Appeal prior to reaching the House of Lords, the Court of Appeal had not adopted the same interpretive approach laid in Dawnays which was the adopted principle for building contract followed by five other cases prior this case.

The House of Lords in affirmative concluded that there was too much of unnecessary emphasis on the definition of "deduct". Finally, it delivered its decision on the basis that "it is possible to deduct from a sum claimed any quantifiable counterclaim whether liquidated or unliquidated.(5)"

THE APPLICATION AND THE COMPLEXITY OF THE DECISION IN DAWNAYS

Following the decision in Dawnays which concerned set-offs, number of cases have applied the principle set in the case whereas other cases departed from the decision on the basis that the ordinary common law right of set-off has much application in building contracts as to contracts for the sale of goods whereby a breach of warranty may be set up in diminution of the price.

At the initial outset, the decision in Dawnays played a crucial rule all over the world as having precedence and application. Over the period of three years, many countries adopted and applied the principle in Dawnays which advanced the proposition that interim certificates particularly in building contracts were strictly enforced as an "interim certificate is to be regarded virtually as cash, like bill of exchange." This approach was applied in a many Singapore cases as in Bandar Raya Development Bhd v. Woon Hoe Kan & Sons Sdh Bhd [1972](6). Additionally, in Jersey, Dawnays' decision was wholly accepted the reasoning and the decision and adopted its application(7) in cases with similar circumstances Jersey Steel Co. Ltd v. Holdyne Ltd (1972)(8).

However, following the decision of the House of Lords in Gilbert Ash and Aries Tanker Corp v. Total Transport Ltd [1977](9) courts began to address construction disputes with a distinctive approach from the one adopted in Dawnays. As time went past it became more and more apparent that Dawnays decision was wrong.

In a quite recent case Beaufort Developments (NI) Ltd v. Gilbert-Ash Ltd [1999](10) which also considered the decision of Dawnays and Gilbert Ash; finally the case symbolised and identified that some contract terms that expressly or by implication pose a curtailment on courts from re-opening the decision embodied in a certificate but the conclusiveness or lack thereof of a certificate would depend on the terms of the contract and general principles of law relevant to interpretation of such terms.

Over a number of decades, there always appeared to be a dispute in courts over the rights of a constructor to exercise his right either under the contract or under the common law right to a set-off. Nevertheless, where the sub-contract does not expressly mention the contractor's right of set-off then the constructor is only entitled to set off if the right asserted is so intimately and directly connected to the sub-contractor's demand for payment. Thus, it would be considered unjust if the sub-constructor manifested to enforce payment from the constructor without due consideration of the constructor against any defective, delayed and not properly completed work.

In Dawnays, there was great and sharp focus on cash flow as a lifeblood of the sub-constructors, which in effect justified the way the court delivered its final decision and set the principle in the interpretation of building contracts. It was held that no automatic right of set-off existed without an express provision in the contract to the contrary.

Whereas, Gilbert-Ash the House of Lords departed from it and held that constructors does have a right of set off unless there is an express term in the contract that is contrary to the right of set-off which will restrict the constructor from right of set-off.

Following this decision, the drafters of sub-contracts began to include express provisions, which limited the principle constructors from the right of set-off. Subsequently, vast number of cases was brought before the court to deliberate on these matters by sub-contractors alleging that principle contractors have failed to operate the express terms of the sub-contract but nonetheless have set-off their claims from sums already due to the sub-contractor. Consequently, the courts have been willing to order constructors to make payments by way of summary judgements as in:

  1. Tubeworkers Ltd v. Tilbury Construction Ltd (1985)
  2. Pillar P. G. Ltd v. D. J. Higgins Construction (1986)
  3. Chatbrown v. Alfred McAlpine Construction Southern Ltd (1986)

The current situation under the common law is that the defendant may wish to set off certain amounts in diminution of a claimant's claim against him/her and this will be considered as a defence if the amount that was set-off relates to:

  1. Mutual debts, for example liquidated damages.
  2. A claim for defective work against a claim for the price of that work.
  3. Complaints closely connected with the original claim as in Rapid Building Group-v-Ealing Family Housing Association Ltd (1985).
  4. By express agreement between the parties (e.g. under the standard forms of building subcontract NSC/4 and 4a, DOM/1 and 2, NAM/SC, IN/SC and GW/S)

However, there are instances when there is no right of set off particularly where the contractual provisions for set-off have not been scrupulously adhered to by the contractor then there is no right of set-off and the subcontractor will succeed in obtaining summary judgement for the amount certified as in Tubeworkers Ltd-v-Tilbury Construction Ltd (1986).

In Mellowes Archital Ltd v Bell Products Ltd [1997]the after an appeal the Court of Appeal order a summary judgement against the constructor despite of the existence of a set-off clause in the contract. The Court of Appeal made a consideration of Gilbert-Ash with an aim to distinguish between the equitable and the common law right of set off the constructor. In reaching its conclusion, it outlined that "the main contractor's right to raise an equitable set-off is regulated by the clause but the clause does not affect the right of the main contractor to exercise any right he may have of common law abatement". In applying this principle it, allow the sub-contractors appeal for a summary judgement for the payment of the amount due to him.

This was elaborated further in a quite recent case of Mellham v Burton [2003](11) where the members of the court consider the definition of equitable set-off which have been used in number of cases as a legal discourse without due care in the application of the principle of equitable set-off. Additionally, the court approved with the approach taken by Lord Diplock in Gilbert Ash, which clarified the equitable right of set off as being restricted to the introduction of a defence to legal proceedings after action brought. Same principle was applied in Muscat v Smith [2003](12) which concerned a tenancy where the tenant kept the rent from the landlord (who had purchased the freehold property despite outstanding set off by the tenant) as a set off for a breach of covenant, the court decided in favour of the tenant that there existed a right of set off and remitted the case to the county court.

Moreover in a very resent case of Decoma UK Ltd v Haden Drysys International Ltd [2005](13) which concerned a constructor and sub-constructor for building works whereby the sub-constructor aim to exclude liability by inserting an exclusion clause into the contract but the approach adopted by Lord Diplock in Gilbert Ash was again applied in relation to commercial contracts.

CURRENT DEVELOPMENT OF CONSTRUCTION CONTRACTS

Under the current caselaw and statute law, governing the set-off situation in relation to construction contracts where it involves a constructor and a sub-constructor is far more distinct than the former decisions made by Court of Appeal and the House of Lords. Moreover, under the Housing Grants, Construction and Regeneration Act (HGCRA) 1996 which provides a definition for "construction contracts" and encapsulates on the matter that the express or implied terms of the contract is assessed in determining the time when the main employer is to make payment on an interim certificate. However, if a construction contract fails to formulate sufficient express provision as to reflect the time for payment whereby, the relevant provisions of the method for construction contracts apply under section 110(3) of the HGCRA 1996.

Generally, cases concerning set-off and counterclaim, in vast number of cases, an unliquidated cross-claim for defective work or delay arising out of the performance of the contract by the sub-constructor will inevitably provide an employer with a defence by way of set-off to a claim by a contractor as outlined in Hanak v. Green [1958] prior to Dawnays case(14). Conversely, in the event that a contract coherently and unambiguously asserts to exclude or restrict the right of set-off the courts will give effect to such a provision but this follows the principle in Gilbert Ash rather than following the principle of Dawnays.

The current situation and the implementation of statutory law that triggers to address set-off disputes signifies that courts are departing from the former decisions of on set-off. Currently, there is more focus on common law and equitable right of set-off along with statutory provisions that greatly assist courts to reach a decision without embarking on the critical examination of Gilbert Ash and Dawnays. These two cases are seem to be a history and not regularly applied but considered in the deliberation of legal proceedings as a little taste to litigation.

In set-off cases the constructor/ employer is only permitted to deduct sums permitted under the terms of the contract. Far as the law is concerned, it is establish that Gilbert Ash has overruled Dawnays on the point that an employer can raise unliquidated damages for delay or defective work as a defence to a claim brought on interim certificates by way of set-off or abatement. Nevertheless, under a construction contract, the constructor's defence of set-off is subject to the notification as to the effect that the constructor is withholding the amount due as a set-off as under section 111 of the HGCRA 1996 as demonstrated in the cases of Northern Developments (Cumbria) Ltd v. J & J Nichol [2000](15) and VHE Construction plc v RBSTB Trust Co Ltd [2000](16).

Generally, in building contracts, the contracting parties may agree by the terms of the contract to include a party to it from exercising his/her right for a set-off and counterclaim. However, there is no general principle that an architect's certificate must be honoured in full without the right to exercise the power to set off and counterclaim or to apply for a stay of proceedings pending recourse to arbitration where there is an arbitration clause as identified in Gilbert Ash.

The right to have a price abated as a consequence of a contractual breach is distinct from a right to a proper set-off under a construction contract demonstrated in Gilbert Ash and followed in other cases such as Acsim (Southern) Ltd v Dancon Danish Contracting and Development Co Ltd (1989)(17) and CA Duquemin v Raymond Slater (1993)(18) and Mellowes Archital Ltd v Bell Projects Ltd (1997)(19).

The authority laid down by the House of Lord in Gilbert Ash creates a presumption that a building contract does entitle a party to the remedies that would arise by operation of law, including the rights of abatement and set-off. The remedy of set-off under the right specified in Gilbert Ash is only subject to exclusion by way of elimination from the contract in clear unequivocal words as applied in Connaught Restaurants Ltd v Indoor Leisure Ltd [1994](20). Nevertheless, after the final date of payment the main constructor cannot withhold payment without giving or serving effective notice of intention to the sub-constructor. Such notice is necessary in set-off cases as in Northern Developments (Cumbria) Ltd v J & J Nichol [2000](21).

Subjectively speaking, it is evident that there is an acceptable theoretical orthodox in the judgement delivered by Lord Denning in Dawnays on the basis of cash flow of lifeblood of sub-constructors. In effect, there is a degree of justification behind his principle that sub-constructors require interim payments for the smooth operation of further work and if the payment withheld from the sub-constructors then this will be an impediment on their work activities causing further breach of the contract. On that ground, it may be sensible to reach the same or similar conclusion delivered by Lord Denning.

Conversely, It may also be arguable that if such injustices are allow it will give a flood gate of cases where main constructors have to chase after their money due from the sub-constructors as a resulting from delay or improperly completed work. This argument also bears a significant rational movement in protecting the interest of the constructor for not having to pay for work that is not properly completed.

In the current era, there seems to be more improved approach under recently implemented statute law regulating the grounds for set-off and the specific procedures. In that respect, the court is less concerned with having to apply or distinguish cases like Gilbert Ash and Dawnays but on occasions tend to use it in the deliberation of the case.

Bibliograpy

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