Dalila Scanavacca
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June 26, 2020
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A new life for an old instrument

Office Holders of insolvent companies are afforded the use of the adjudication process under section 108 of the Housing Grants, Construction and Regeneration Act 1996 (CA 1996) as a semi-compulsory and costs neutral dispute resolution method also when cross-claims are regulated by the automatic operation of the insolvency-set off Rule 14.25 of the Insolvency (England and Wales) Rules 2016 (SI 2016/1024) (IR 2016).

This article looks at how this position changed since 31 July 2018 and to what extent the two regimes are compatible.

Background

s108 CA 1996 provides that any party to a construction contract can refer any dispute arising under that contract to an adjudicator. It is well known that Rule 14.25 of the IR 2016 regulates the operation of mutual dealings by providing for an  automatic and mandatory set-off as at the date of liquidation. This means that an account must be taken by the liquidator to establish the final net balance, which replaces all previously existing claims and cross-claims.
It is therefore the net balance only that the creditor can prove for in the liquidation, or that is due to the estate from a debtor (and the liquidator must seek to collect for the benefit of creditors, by all means available).

Following the first instance ruling of Fraser J in Michael J Lonsdale (Electrical) Ltd v Bresco Electrical Services Ltd [2018] EWHC 2043 (TCC) there has been much debate around the interplay of s108 CA 1996 and insolvency set-off where there are cross-claims between two parties of a construction contract. Particularly, emphasis has been focussed on the adjudicator’s jurisdiction (whether a claim capable of adjudication continues to exist) and whether, even if jurisdiction is established, an adjudication process has any utility at all.

Lonsdale v Bresco

Lonsdale had issued an injunction against Bresco to restrain it from pursuing adjudication.

The two companies had mutual dealings and the stance taken by Lonsdale was that Bresco’s contractual claims (including the right to adjudicate) ceased to exist as they were replaced by the right of claiming the net balance, if any, by virtue of the operation of Rule 14.25 IR.

Fraser J, who decided the matter, granted the injunction restraining Bresco from pursuing a determination through adjudication on the basis that: “A company in liquidation cannot refer a dispute to adjudication when that dispute includes (whether in whole or in part) determination of any claim for further sums said to be due to the referring party from the responding party”.

With reference to various relevant case law, Fraser J’s decision was mainly based on considerations to the effect that:

+ The adjudication process is a form of mandatory dispute resolution in construction contracts and it is seen as a temporary binding “quick fix solution” which is useful to resolve cash flow issues.

+ Whereas in comparison, the insolvency set off provided for in Rule 14.25 IR is a detailed and final account of mutual dealings between parties whereby the creditors of insolvent companies only have to prove the final net balance by way of proof of debt in order to obtain satisfaction in full or in part by way of dividend. Importantly, this security cannot be undermined by recourse to the adjudication process (which as outlined above, is only temporary).

+ The process of insolvency set-off meant that there was no longer a claim, or any construction dispute capable of referral to adjudication, under the construction contract. Simply rendering the adjudicator with no “jurisdiction”.    

+ There is “futility” in an insolvent company using adjudication because the decision would most likely not be enforced by the courts. That being the case the convenience of the recourse to the adjudication process by insolvent companies is rendered doubtable altogether.

In summary, following this first instance decision, the liquidators of insolvent companies were placed in an invidious position when considering their options. Specifically, where such options were limited between utilising the temporary adjudication process (whereby adjudicators on the face of it had no “jurisdiction” and where the adjudication was rendered “futile”) or instead to incur the significant costs of issuing proceedings.

The Court of Appeal

Bresco appealed the first instance decision and one of the points the Court of Appeal was asked to consider: why would the claim not have given rise to a jurisdictional point in an arbitration but it would if referred to adjudication?

Lonsdale’s position was based on an incompatibility between the adjudication process (being that it can only end in a temporary binding decision) and the operation of the insolvency set-off in Rule 14.25 IR 2016. Whereas in comparison arbitration leads to a final decision and as such, it was suggested, was compatible with the insolvency set-off provisions (which was termed the “jurisdiction” point).

The Court of Appeal found in favour of Bresco in respect of jurisdiction, but upheld the High Court’s judgment on the basis that allowing an insolvent company to initiate adjudication proceedings is “futile” .

On jurisdiction, Coulson LJ commented at paragraph 31 :  “On analysis, I can see no reason why, purely (as a matter of jurisdiction as opposed to utility), a reference to adjudication should be treated any differently to a reference to arbitration. If the contractual right to refer the claim to arbitration is not extinguished by the liquidation, then the underlying claim must continue to exist. Moreover it must continue to exist for all purposes. The fact that a reference to adjudication may not result in a final and binding decision cannot mean that the underlying claim is somehow extinguished. As a matter of principle, the choice of forum cannot dictate whether or not the claim exists or has been extinguished.

However, on the basis that an adjudication order in favour of a company in insolvent liquidation would be unlikely to be enforced, the first instance judgment was upheld on the basis that there was no “utility” to adjudication proceedings on the facts.

In particular, the Court of Appeal held that:

+ There is a general incompatibility between adjudication and the insolvency regime. The former is a temporary binding “rough and ready process” that in most cases forms only a part of a larger ongoing dispute; mainly designed to quickly and cheaply tackle cash flow issues. Whereas the latter is conceived as a final detailed accounting exercise, that will ultimately settle all of the mutual dealings between the parties in order to allow Liquidators to recover assets and make distributions. As such the adjudicator’s findings could only form part of the accounting exercise under the insolvency set off doctrine at best, but are not necessarily capable of forming part of the calculation of the net balance under Rule 14.25 IR 2016.

+ If the adjudicator was to find in favour of the insolvent company, then the creditor with a cross claim would be deprived of the security granted by the insolvency set off, as it would only receive a dividend (if any at all).

+ Liquidators should not waste limited resources to make claims where enforcement would only be granted in exceptional circumstances.

+ The responding party should not have to incur the costs of defending an adjudication when it knows that in most cases it would be able to resist summary judgment or enforcement. To do so would be a waste of costs.

+ The risk is to place an unnecessary burden on the TCC and court resources should not be strained.

In short, a welcomed partial turn in favour of insolvent companies using the adjudication process, but even so Liquidators were still left in an uncertain position as to how in practice the “futility” point could be successfully overcome.

The Supreme Court

Bresco appealed and Lonsdale cross appealed on the jurisdiction point. Judgment was handed down by the Supreme Court on 17 June 2020.

On the jurisdiction point, Lonsdale’s main submission was that claims and cross-claims are automatically replaced by a dispute to be resolved only under the insolvency regime, as they would cease to exist in their own contractual right. Lonsdale’s point was dismissed and so was its cross appeal. In respect of the adjudicator’s jurisdiction, this was confirmed by the Supreme Court.

When addressing Lonsdale’s main submission, the Supreme Court found that it would be an “over-literal reading of the language of Lord Hoffmann’s speech in Stein v Blake, that the claims and cross claims which fall within insolvency set-off lose their separate identity for all purposes”.  This is particularly relevant where claims are assigned by Liquidators, because by saying so the Supreme Court effectively confirmed obiter dicta that the only chose in action that can be assigned when the insolvency set off applies is the claim to a net balance .

Most importantly, the Supreme Court placed great emphasis on the fact that adjudication is a form of compulsory dispute resolution either contractually or statutorily granted, with many positive features such as speed and cost effectiveness. Meaning there are now no reasons why on the one hand liquidators could resort to arbitration, but on the other hand be prevented from using adjudication as a form of ADR (which is common practice in the construction industry).

The Supreme Court then turned to the “futility” point and stressed that courts should be careful before interfering with insolvent companies’ contractual and statutory rights to adjudicate. In particular, where adjudication is a speedy and cost effective form of ADR with a final effect in the vast majority of the cases, the futility argument is simply wrong. The referral of a construction dispute to an expert specialised in the handling such matters within his field can only be considered as added value. This, more importantly, in a context where in most cases mutual dealings stem from the same contract and even if there is more than one contract in place the adjudicator will not be necessarily prevented from considering them all.

Further, and crucially “it will not be in every case that summary enforcement will be inappropriate”  where appropriate security is provided.

What is more, the Supreme Court considered and overruled various wider points taken into account by the Court of Appeal such as the cost point (whereby embarking on adjudication in these circumstances would seemingly be a waste of costs for parties) or indeed the perceived risk of placing an unnecessary burden on TCC courts with speculative claims being initiated by insolvent companies. With regards to the former, it found that the cost neutrality of adjudication is common to many other ADR and it may well be a feature key to its very own success. With regards to the latter, in affording Liquidators the option to choose a form of ADR which is carried out by a construction expert, would most likely be a great incentive to reach a settlement agreement with a lesser rather than a greater burden on the TCC.

Conclusion

Each case will of course turn on its own facts, especially in circumstances where an agreement will not necessarily be reached at the conclusion of the adjudication proceedings and where the responding party will resist enforcement.

There has been limited guidance available so far as to how insolvent companies that have won an adjudication award will be able to successfully enforce. On this point, it is only Meadowside v Hill Street and Balfour Beatty v. Astec Projects Limited (in liquidation) [2020] EWHC 796  which highlights what the courts might consider “exceptional circumstances” to be where an insolvent company can enforce an adjudicator’s award and be granted summary judgment. Those “exceptional circumstances” being  when:

+ the final net position has been determined under the relevant contract; and

+ satisfactory security is provided in respect of the sum awarded and costs related to the enforcement stage and the subsequent litigation and/or arbitration (which could include: ATE insurance, a third party guarantee or a bond and/or the liquidator’s undertaking to ring-fence the sum available).

It is clear that adjudication is a useful tool aimed at quickly settling disputes also in insolvency contexts. Liquidators should look to take advantage of this effective option, particularly where this has been positively viewed by the Supreme Court in that it achieves (in the vast majority of cases) a “de facto final resolution of the underlying dispute”  and the enforceability of the award is not necessarily precluded by the insolvency regime when adequate security is put in place.

Finally, whilst the focus in Bresco has been centered around companies in liquidation (and the operation of Rule 14.25 IR), by analogy it is possible that adjudications are also available to companies in administration (where similar set-off provisions are applicable by virtue of Rule 14.24 IR). In fact, as contemplated by the Supreme Court the two rules achieves the same objective  and “substantially the same scheme governs the insolvency process in both liquidation (voluntary or compulsory) and in a distributing administration” .

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