Section 106 of the Housing Grants, Construction and Regeneration Act 1996 (as amended) (“HGCRA”) states that the HGCRA does not apply to contracts where one party is a “residential occupier”, that is a person who lives in or intends to live in the property where the contract works are carried out. The effect of this section is that the HGCRA’s provisions relating to regular and timely payments, the right to suspend works for non-payment and the right to refer a dispute to adjudication are not implied into the contract.

Optimus Build Limited v Southall and McManus [2020] EWHC 3389 (TCC) is a good example of why parties to residential occupier contracts should agree suitable terms where their contract is not caught by the HGCRA. The decision also included helpful guidance on the percentage that can be claimed for loss of profts following termination and whether VAT should apply to that head of claim.

Facts and decision

The defendants engaged Optimus Build Limited (“Optimus”) to carry out building works at a residential property in Manchester.

As works progressed a dispute arose. There were two main elements to the dispute. Firstly, the parties disagreed on the basis of the contract and its terms. Secondly, both parties accused the other of repudiatory breach of contract. Optimus claimed some £88,000 plus VAT for works outstanding and £18,000 for loss of profits and the defendants counterclaimed for losses in connection with the works at the property not being completed by the original completion date.

The basis of the contract and its terms

Optimus claimed that the contract was a “fixed price” contract for some £170,000 plus VAT whereas the defendants contended that the contract was a “cost plus” contract where Optimus would provide copies of its costs on a monthly basis to which an addition for overheads and profit would be made.

In support of its case the defendants noted that Optimus’ pricing document was headed “budget estimate”. HHJ Stephen Davis made some interesting comments on this wording. In his view, a “budget estimate” could either be a non-binding preliminary indication of the likely cost of the works, an offer to undertake the works at a reasonable cost that is re-measurable (as the defendants contended) or a fixed price quotation representing an offer that was capable of being accepted.

Having undertaken an analysis of the “budget estimate” HHJ Stephen Davis considered that the contract was in fact a “fixed price” contract. In reaching this view the judge noted that the document contained precise figures, some provisional items (implying that the others were fixed) and included detailed notes and assumptions.

Repudiation

Having not received payment for its Valuation 3, Optimus suspended works on site. Optimus then wrote to the defendants, suggesting a meeting to resolve the payment dispute and clarify the scope of works and payment terms.

The defendants responded, stating that they would seek “alternative arrangements” and asking Optimus to collect its equipment from site. Both parties accused the other of a repudiatory breach of the contract.

HHJ Stephen Davis considered that the defendants repudiated the contract and that was accepted when Optimus later submitted its final account. The judge commented that Optimus’ actions did not amount to repudiation as it had shown a willingness to engage with the defendants to resolve the issues that existed between the parties whereas there was a finality to the defendants’ email in response. The judge therefore dismissed the defendants’ counterclaim.

Valuation and VAT

Having heard expert evidence the judge awarded Optimus some £78,000 plus VAT for works completed.

Optimus’ claim for loss of profits was based on an expected overhead and profit margin of 17.5% on the remainder of its contract works. HHJ Stephen Davis repeated the expert witness’ claim that a margin of 17.5% was “not unreasonable” on a small residential project. He subsequently awarded Optimus approximately £19,000 excluding VAT for this head of claim.

In the decision the judge queried whether claims for loss of profits should be subject to VAT, noting that the “conventional view has always been that VAT is not chargeable on damages for compensation for breach of contract”. Counsel for Optimus referred the judge to an update from HMRC in September 2020 which indicates HMRC’s view that “commercial payments, including early termination payments, will be subject to VAT.” The judge then awarded Optimus VAT on its loss of profits claim, noting that the amount was small and in any case Optimus would account to HMRC which would correct any discrepancy.

Commentary

Optimus v Southall demonstrates the dangers inherent in construction contracts where one party is a residential occupier and therefore the HGCRA does not apply. Clear terms as to payment, suspension of works, termination and dispute resolution are all desirable for both parties. In practice there are various ways to incorporate such terms. The contractor could for example refer to the provisions of the Scheme for Construction Contracts (England and Wales) Regulations 1998 (as amended) in its quotation or tender document.

The parties could also use a proprietary contract such as the JCT Homeowner form or one of Prettys’ Fixed Price Products, which are a suite of standard form contracts that can be adapted to suit the needs of each client. Those contracts are specifically designed for scenarios where one party is a residential occupier and abbreviated terms in comparison with the larger standard forms.

The judge’s comments on the loss of profit claim could also be of use to contractors carrying out residential works. Optimus provides authority that a rate of 17.5% is acceptable for works of a similar character. That percentage could be used in pricing documents, for agreeing variations or as part of claims for payment.

Given the minor consequences in the case the judge did not fully explore the point as to whether VAT applies to damages for loss of profits. The HMRC briefing note refers to a case heard in the European Court of Justice where it was decided that VAT should apply to early termination payments under a mobile phone contract. In a construction context such payments are similar to liquidated damages, where the amount is known by the parties prior to entering the contract. It therefore remains unclear whether the same principle applies to damages for loss of profits as in Optimus. The pragmatic solution for practitioners may be to reflect HHJ Stephen Davis’ approach and add VAT to such claims, allowing for the VAT to be accounted for by the claimant if possible.