Lack of interest pays off!

This article was accurate at the time of writing however more up to date information can be found in Neil's September 2017 blog post

The inability to recover costs you pay to your own advisors during the course of an adjudication is one of the pitfalls of the process, particularly in lower value disputes. Many of you will have read encouraging noises in the construction press and online about costs recovery, prompted by a recent case amusingly titled Lulu Construction v Mulalley & Co Ltd [2016] EWHC 1852.  I’ve read some of the same material, and I hate to break it to you, but let’s just say that some commentators have a vested interest in being ‘economical with the truth’.

Lulu won in the adjudication, and was also able to persuade the adjudicator to award payment of its legal costs by Mullaley, and the TCC enforced that part of the award.  This was due to changes in section 5A of the Late Payment of Commercial Debts (Interest) Act 1998 (‘the Late Payment Act’).  Since 1998, this has conferred an entitlement to interest on business to business debts arising under contracts for the supply of goods and services at 8% over Bank of England base rate.  Since 2002, it has also provided for recovery of a fixed sum of modest compensation for pursuing a qualifying debt.  It is worth quoting section 5A in full:

“5A Compensation arising out of late payment.

(1) Once statutory interest begins to run in relation to a qualifying debt, the supplier shall be entitled to a fixed sum (in addition to the statutory interest on the debt).

(2) That sum shall be– [£40 – £100 depending on the amount of the debt],

(2A) If the reasonable costs of the supplier in recovering the debt are not met by the fixed sum, the supplier shall also be entitled to a sum equivalent to the difference between the fixed sum and those costs”.

Subsection (2A) sounds great doesn’t it and, it should be acknowledged, is a consequence of an EU directive. Under it, you have the opportunity of getting your ‘reasonable costs’ of pursuing a debt, including advisor’s fees, reimbursed. It worked for Lulu.

However, crucially, not all contracts will attract the remedies provided for by the Late Payment Act.  That is because even if the debt qualifies under the Late Payment Act, section 8(2) says “Where the parties agree to a contractual remedy for late payment of the debt that is a substantial remedy, statutory interest is not carried by the debt (unless otherwise agreed).”  Here’s the rub; if your contract already provides for late payment interest and the percentage is judged to be a ‘substantial remedy’, then interest under the Late Payment Act will not begin to run, so none of section 5A applies; no fixed sum, and no money to close the gap from there to your ‘reasonable costs’ either.

Most of you will have contracted under standard forms, such as JCT contracts, and a JCT standard form provides for a contractual rate of 5% above base, which has twice been held to be a ‘substantial remedy’ for the purposes of section 8 of the Act (Walter Lilly & Company Ltd v Giles Patrick Cyril Mackay [2012 EWHC 1773 and Yuanda (UK) Co Ltd v WW Gear Construction Ltd [2010] EWHC 720).   I hear you say, “But 5% over base is not as good as 8% over base!”. In Walter Lilly, Edwards Stuart J acknowledged that, but said of the JCT rate “…that does not mean that the contractual remedy is not “substantial”. The commercial reality is that commercial lending is, depending on the creditworthiness of and security offered by the Contractor, likely to be in the area of Base Rate plus 1 to 3%. Therefore, on that basis not only is the Contractor likely to be compensated for late payment but also there is an incentive provided on the Employer to pay on time.”

So 5% over base, the JCT standard, is a ‘substantial remedy’ for late payment already, and disputes under that and most other standard forms will still involve  the parties meeting their own costs of the adjudication regardless of which of them wins. 

Other commentators have suggested that the judges’ position on recovering the costs of adjudication may be changing.  The classic statement on the prohibition of recovery of costs came from   HHJ Wilcox in Total M&E Services Limited v ABB Building Technologies Limited [2002] EWHC 248, in which he said “…since the Act does not provide for the recovery of costs the claim is misconceived. Furthermore, this claim is put as a claim for damages for breach of contract arising out of ABB’s failure to pay. Because the Statutory Scheme envisages both parties may go to Adjudication and incur costs which they cannot, under the Act recover from the other side, it follows that such costs cannot therefore arise as damages for breach….To permit such claim would be to subvert the statutory scheme under the Act.” 

However, in  National Museums and Galleries on Merseyside (Trustees of) v AEW Architects and Designers Ltd and another [2013] EWHC 2403 (TCC),  Akenhead J allowed the Museum, which lost an adjudication to a contractor because of AEW’s design failures, to recover the costs it threw away defending the contractor’s referral to adjudication, as damages against AEW.  This is not the same as an award of costs between the same parties which fought an adjudication, but it chips way at the statutory logic which HHJ Wilcox employed as grounds for refusing costs recovery in Total M&E v ABB, that the Act will always require each party to bear their own costs of adjudication unless they agree otherwise.

Other decisions have suggested that certain High Court judges do not share Akenhead J’s willingness to award the recovery of adjudication costs, and prefer the traditional ‘statutory logic’ expressed in Total M&E v ABB.  It therefore looks like further intervention by Parliament will be necessary if there is to be an automatic right for every winner to recover their reasonable adjudication costs from the loser.

What does this mean for you or your business?

This situation is arguably perverse; those who have not entered into a written contract are in a better position than those who have not because if they end up in adjudication they will get the benefit of the Late Payments Act.  The absence of a well drafted contract is likely to result in higher legal costs in a dispute, but that is mitigated by the prospect of recovering them. 

What do you need to be doing now?

To overcome this situation and you are keen to recover your legal costs in the event of adjudication, if it is agreed in your contracts, it will be enforceable.  However, it must give the adjudicator full discretion to determine who is to reimburse whom, unlike the Tolent clauses of old which always made the referring party liable for costs regardless who won.   Alternatively, the parties can confer the jurisdiction on the adjudicator to award legal costs, at any time after service of the Notice of intention to refer a dispute, but there is no compulsion so that is rarely agreed in practice. 

These notes have been prepared for the purpose of an article only. They should not be regarded as a substitute for taking legal advice.