Insolvency in construction, part 3: Adjudication and resolving disputes

Tom:

Hello and welcome to Ashurst Legal Outlook. I'm Tom Duncan, a partner in Ashurst's construction disputes team in London, and you are listening to the third podcast in our series focusing on insolvency issues in the construction sector. In our first podcast, we covered some of the challenges that construction contractors are encountering when the companies to which they supply services enter insolvency.

In our second podcast, we looked at issues when a downstream contractor becomes insolvent. Today we are going to consider the interaction between adjudication and the UK Insolvency Rules. I am joined by Dyfan Owen, a partner in our construction disputes team and by Stefan Jammes, a senior associate also in our construction disputes team. I'm sure that many of our listeners will be familiar with the adjudication as a means of resolving construction disputes, but Dyfan, perhaps you could give us a quick reminder.

Dyfan:

Thank you, Tom. Adjudication tends to be the most common way of resolving construction disputes. Its main purpose is to provide parties with a rapid and relatively inexpensive method of resolving disputes and to obtain cashflow quickly. The Construction Act gives parties two construction contracts, a statutory right to refer a dispute to adjudication at any time, and that right is often reflected in contracts. Now for those who aren't familiar with adjudication, it's relatively quick dispute resolution procedure. There's a 28-day process for resolution of disputes, although that period is often extended.

And adjudication decision is binding unless or until the dispute is finally determined by court or arbitration. And in our experience, parties are often reluctant to re-litigate an adjudicated dispute given the time and cost involved. The temporarily binding nature of adjudication decisions means that they must be adhered to and unsuccessful parties and adjudications can oppose the enforcement of the decision in court. But the grounds for doing so are very limited and courts are generally reluctant to refuse enforcements.

Tom:

Thank you, Dyfan. You mentioned that the Construction Act provides parties with the statutory right to refer a dispute to adjudication. So Stefan, how does that work in the context of insolvent parties?

Stefan:

Thanks, Tom. The interaction between adjudication and the UK Insolvency Rules has raised interesting questions in the past concerning an insolvent party's right to adjudicate in principle, and also their ability to enforce an adjudication decision in its favour against a solvent party. On the face of it, adjudication as Dyfan was explaining should be an effective tool for insolvent companies to use, given its purpose is to provide a swift and relatively inexpensive method of resolving construction disputes. But historically it was argued that adjudication didn't actually sit well with the mandatory set-off provisions within the Insolvency Rules. Now these rules operate to automatically set-off any claims and counterclaims made against the insolvent company by a third party with which the insolvent company has had dealings.

Now the result of this overall accounting exercise is a net balance in favour of either the insolvent company or the third party. And so the argument went that there was nothing to adjudicate. So in short, the right to set-off seemed to undermine the temporarily binding nature of an adjudicator's decision. But that was tested relatively recently by the Supreme Court in a case called Bresco and Lonsdale in 2020.

Tom:

Thanks Stefan. Dyfan, do you want to tell us a little bit about Bresco? Did that decide whether an insolvent party has the right to adjudicate?

Dyfan:

Yes, in short, it did provide some clarity regarding the position. In the Bresco case, Bresco entered into a subcontract with Lonsdale for electrical installation works at the site in London. And in 2014, Bresco stopped attending the site and alleged repudiatory breach of the contract by Lonsdale. And later Bresco went into a creditor's voluntary liquidation. Now the parties made a number of claims against each other and in 2018, Bresco gave notice of its intention to refer a dispute to adjudication and Lonsdale responded saying that the adjudicator had no jurisdiction as Bresco was insolvent. Lonsdale also issued proceedings in the TCC for a declaration of the adjudicator lacked jurisdiction and for an injunction restraining the further conduct of the adjudication.

The TCC initially agreed that the adjudicator did not have jurisdiction. It held that the mandatory set-off under the Insolvency Rules deprived an adjudicator of jurisdiction to discern and dispute under a construction contract involving a company in liquidation. That was because the separate claims and counterclaims under the construction contract was said to be replaced by a single net claim in one direction by the set-off mechanism that Stefan mentioned under the Insolvency Rules. If the separate claims and counterclaims were extinguished in this way, then they could not be adjudicated.

Now the court of appeal overruled that finding and held that adjudication could still be validly commenced by companies in liquidation. But it agreed with the TCC that there was a basic incompatibility between adjudication and the Insolvency Rules. The Court of Appeal found that save in exceptional circumstances, an adjudication by a company liquidation would be liable to be stopped by the court as what it called an exercise in futility, where the other party had a cross claim because any adjudication decision would not be enforceable.

Tom:

Thanks Dyfan. Well I think what you're saying is the Court of Appeal said that adjudication was essentially pointless if the other party had a valid claim against the insolvent party, but we know Bresco went to the Supreme Court. So what did they have to say?

Stefan:

The Supreme Court found that a company in liquidation can in fact adjudicate even if the other party has a cross claim that engages the process of insolvency set-off. It found that construction adjudication was in fact compatible with the Insolvency Act. It also noted that difficulties in enforcing an adjudication decision because one party's insolvent shouldn't actually prevent a company in liquidation from pursuing adjudication in the first place. The court highlighted adjudication as being a mainstream method of ADR in the construction industry and highlighted that all parties should be able to access it as ADR procedure in its own right.

The court cited a number of situations in which an adjudicator's resolution of a dispute, even if it was temporary, may in fact be very useful to the conduct of the insolvency process as a whole. So for example, in situations where disputed cross claims arise under the same or even multiple different construction contracts, an adjudicator you would think is better placed than a liquidator to resolve these cross claims prior to the final set-off account being calculated. So even in circumstances where some cross claims arise outside of a construction contract, an adjudicator's resolution of that construction dispute remains useful to the liquidators' application of set-off.

Tom:

Thanks Stefan. So the Supreme Court seemed to have cleared up the issue as to whether or not adjudication is available in principle to insolvent parties. But what is the position in respect of the enforcement of an adjudication decision in favour of an insolvent party? Will the other party be required to pay even if they have a valid claim against the insolvent party of their own?

Dyfan:

When it comes to enforcement, Tom, the situation is less clear and there seems to be a high bar for an insolvent party to be able to enforce an adjudication decision. The Supreme Court in Bresco recognised that summary judgement to enforce an adjudicator's decision will frequently be unavailable when the claimant's in liquidation, with the court either refusing it outright or granting judgement with immediate stay of execution. And the question of enforcement was also considered in the 2002 Court of Appeal case of John Doyle and Erith Contractors and some further guidance was given on the circumstances in which an adjudication decision might be enforceable by a company liquidation.

That was a final account dispute in 2012, just before completion of the works. The subcontractor entered administration and stopped work and then quite a bit later in 2018, the subcontractor began adjudication seeking £4 million. The contractor argued that the subcontractor had already been paid £3 million too much and ultimately the adjudicator awarded the subcontractor £1.2 million. And the subcontractor sought summary judgement to enforce that sum and the TCC refused the application saying that the security the subcontractor had offered in respect of the £1.2 million was inadequate and that the security in respect of any future cost orders in the contractor's favour, if it made a claim for repayment based on its own set of counterclaim was also inadequate.

In the Court of Appeal, the question was the adequacy of the security offered and the Court of Appeal agreed with the TCC that the security offered by the insolvent company was inadequate and refused enforcement. It said that the security had to be clear, evidenced, and equivocal and what was required beyond all else was an undertaking by the liquidators to ring-fence the sum in force so that it wasn't available for distribution in the liquidation. And so that the risk of the contractor not recovering the sum if it was ultimately successful was also avoided.

Stefan:

I would also just add to that the court of appeal in that John Doyle construction and the Erith Contractor's case that Dyfan mentioned also noted that even when an adjudicator has dealt with all cross claims and claims and appropriate security has been offered, it wouldn't usually be appropriate to enforce an adjudication decision. This is because the court said it would still prejudice the ability of the creditor to challenge the adjudication decision and take the benefit of insolvency set-off under the Insolvency Rules. The court also said that an adjudicator's decision, as we've discussed, is provisionally or temporarily binding only and does not finally determine the net balance between the parties even if the adjudicator has considered all the relevant claims and cross claims between the parties. So the court in this case highlighted the same incompatibility between the insolvency rules and statutory adjudication, which it had brought up in the case of Bresco, but instead of preventing adjudication altogether, this was now said to preclude the enforcement of an adjudication decision.

Tom:

Thank you both. That's interesting. What is clear it seems is that technically an insolvent company can still adjudicate and this might be useful to the application of set-off within the insolvency process as a whole. But clearly there are still risks on enforcement and it seems that a decision will only be enforced in exceptional circumstances, including where it concerns the net position between the parties and where the insolvent party is able to provide adequate security.

So we've talked in this section about adjudication by an insolvent party, but what about adjudicating against an insolvent party? Is that possible? Dyfan, perhaps you could answer that.

Dyfan:

Sure, Tom. I think the first point to raise is that there's a need to consider the benefits and ultimate utility of adjudicating against an insolvent party, given the cost and time involved and the risk that the insolvent party won't be able to satisfy any decision. But there may be reasons why adjudicating against an insolvent party would be a good idea. So for example, if there's going to be a material return available to creditors in the insolvency process and having an adjudication decision in your favour might help to establish the debt, that might be one reason. Or if obtaining a positive decision might be useful for the purpose of making a direct claim under the insolvent company's PI insurance policy, pursuant to the third party's rights against the Insurance Act.

But in answer to your question as to whether you can adjudicate against an insolvent company, there are various types of insolvency procedures for companies and the impact on any legal proceedings varies according to the type. It's very important to always engage an insolvency specialist when faced with this sort of scenario. Some insolvency processes, including administration, trigger an automatic moratorium or stay of legal proceedings against the insolvent party and the Insolvency Act provides that no legal process may be proceeded with against the company and administration. And that protects the company and provides it with some breathing space in order for it to take some positive action. Now, the exception to that moratorium is if the administrators have given their consent for the proceedings to proceed or the court has given its permission.

Tom:

Thanks Dyfan. So is adjudication a legal process for the purpose of the Insolvency Act? So is it caught by the moratorium?

Stefan:

It's not completely clear, Tom, whether adjudication would constitute a legal process and so be caught by the moratorium. But in our view it almost certainly would be. There are cases which have considered the meaning of the phrase legal process in other contexts, and these cases suggest that adjudication would be captured. I also note the case of [inaudible 00:15:50] Developments, which considered the old version of the Insolvency Act, found that adjudication would fall within the scope of the administration moratorium based on the old wording of the equivalent section in the act. So starting an adjudication against the company and administration may be met by the company challenging the other party's right to do so given this moratorium. Now this could either result in the appointing body, refusing to appoint an adjudicator in the first place or any adjudicator that is appointed resigning because of a lack of jurisdiction.

Tom:

Thanks Stefan. So if a party applied to court to lift the moratorium, what would a court take into account in that application?

Stefan:

The court will likely carry out a balancing exercise weighing up the interest of the party wanting to commence the adjudication against those of the company's other creditors. And in doing this exercise, the court will consider various things including, for example, whether a significant loss would be caused to the creditor by refusal and also whether the purpose of the insolvency process would be impeded by the commencement of the proposed adjudication. There are limited cases considering this in the specific context of adjudication. In the [inaudible 00:17:06] Developments case I mentioned earlier, the court refused permission for the adjudication to proceed in light of the moratorium, but that was because the employer's set-off claim which it was seeking to have resolved by an adjudication, would in any event be determined as part of the ordinary process to adjudicate creditors claims and the contractor's administration. So in that case, there was no need in practical terms for the employee's adjudication to proceed.

Tom:

Thank you, Stefan. I think from what we've heard today, it's clear that adjudicating construction disputes involving insolvent companies raises complex issues and parties considering it should carefully consider the merits of doing so and take advice. I'm very grateful to both Dyfan and Stefan for providing their insights. If you have any questions, please do get in touch with us.

Dyfan:

Thanks, Tom.

Stefan:

Thanks very much Tom.

Tom:

Thank you for listening to Ashurst Legal Outlook. This was the final session in the series and the other sessions are available on Ashurst Legal Outlook via Apple Podcasts, Spotify, or your usual podcast provider. Thank you for listening and goodbye.