The complex interaction between insolvency and the enforcement of adjudicator's awards

In my May 2018 article ‘Insolvency calls time on pursuing claims’, I looked at how various moratoria apply to stop claims when a party enters into certain insolvency processes. I offered a taster when I said that adjudicator’s awards were a strange species because they are not final and binding, that this complicates their enforcement, and that I would look at the complex interaction between insolvency and the enforcement of adjudicator's awards soon. The subsequent case of Michael J Lonsdale (Electrical) Ltd v Bresco Electrical Services Ltd (In Liquidation) [2018] EWHC 2043 (TCC, 31 July 2018), means that time is now.

Section 108 of the Housing Grants Construction and Regeneration Act 1996 (as amended) (‘HGCRA') allows a party to a contract to refer a dispute to adjudication, and Part 1 paragraph 1 of the Scheme says that referral can happen ‘at any time’. The resulting adjudicator’s award is binding until the dispute is finally determined by legal proceedings, by arbitration (if applicable) or by agreement. In the meantime, the TCC will in most circumstances enforce that award. There is, therefore, no limitation in the HGCRA itself that prevents an insolvent party making a referral to adjudication. Indeed, one of the earliest reported decisions on the enforcement of an adjudicator’s award, Fastrack Contractors Ltd v Morrison Construction Ltd [2000] B.L.R. 168, shows how a liquidator could refer a dispute to adjudication. There, Thornton J had no hesitation in rejecting Morrison’s contention that the adjudicator lacked jurisdiction because the dispute had not crystallised, and Fastrack’s solvency was not an issue. Liquidators and administrators have used adjudication to maximize returns for an insolvent company’s creditors ever since. Wrenching retentions from recalcitrant main contractors would be the classic example.

Although the HGCRA touches on insolvency when it mandates certain payment terms, it is silent on the relationship between insolvency and adjudication, so over time a body of judge-made law has developed concerning when a court should enforce an adjudicator’s award in favour of a company which was, or appeared to be, insolvent. To make an enforcement case different from Fastrack, the party which has to pay the award (the payer) must have an arguable claim back against the victor (the payee). Think of an adjudicator finding in favour of the payee because the payer has failed to serve a timely Pay Less Notice against an interim payment, but no determination has yet been made of the sum properly due, or a where a completion date has been missed and the payer considers that liquidated damages are due. The payer must demonstrate that the dispute which was the subject of the award, or some other counter-claim equals or exceeds the award, is likely to be the subject of subsequent proceedings, and that the payee is, or soon will be, insolvent, and unable to repay the monies payable under the award.

The procedures that apply on insolvency need to be understood to appreciate why the courts approach the enforcement of adjudicator’s awards differently when insolvency strikes or is a real risk. Rule 14.25 of the Insolvency Rules 2016 (‘IR 16’) provides:

“14.25.—(1) This rule applies in a winding up where, before the company goes into liquidation, there have been mutual dealings between the company and a creditor of the company proving or claiming to prove for a debt in the liquidation.

(2) An account must be taken of what is due from the company and the creditor to each other in respect of their mutual dealings and the sums due from the one must be set off against the sums due from the other.

(3) If there is a balance owed to the creditor then only that balance is provable in the winding up.

(4) If there is a balance owed to the company then that must be paid to the liquidator as part of the assets.

…

(7) A sum must be treated as being due to or from the company for the purposes of paragraph (2) whether—
(a)  it is payable at present or in the future;
(b)  the obligation by virtue of which it is payable is certain or contingent; or
(c)  its amount is fixed or liquidated, or is capable of being ascertained by fixed rules or as a matter of opinion.”


These substantially replicate Rule 4.90 of the IR 86 cited in pre-2017 cases. These Rules were made pursuant to the Insolvency Act 1986 (‘IA 86’), the main pillar of insolvency legislation in the UK. 

What these rules mean is that in insolvency the sums due from one party shall be set off against the other and claims and cross-claims merge and are extinguished, so that there is only a single claim — represented by the balance of the account between the parties. Think of it as a big final account exercise that embraces all the parties’ dealings, at any time, over all their contracts, and that this reckoning is to be done by the insolvent party’s liquidator, acting as the responsible insolvency officer in the first instance. If a court were to compel the payer to pay an adjudicator’s award to the liquidator, the money would simply form part of the fund applicable for distribution amongst the payee’s creditors. The payer might be a creditor by virtue of its counterclaim, but like all other creditors it will receive only a dividend pro rata to the amount of that claim and would not get the benefit of set-off as Rule 14.25(2) requires. 

A court will normally uphold Parliament’s intention expressed in the HGCRA, order the adjudicator’s award to be paid, and allow the execution of that order (i.e. the seizure of assets to obtain payment if that does not happen voluntarily). However, if, at an enforcement hearing, the payer can show that ‘special circumstances’ exist which permit the court to exercise discretion to stay the execution of that order, pursuant to Civil Procedure Rules (‘CPR’) Part 83.7 (formerly Rules of Supreme Court Order 47 rule 1), then it cannot be taken for granted that the award will be enforced. A ‘serious risk’ of prejudice to payer is required to avoid enforcement (see AWG Construction Services Ltd v Rockingham Motor Speedway Ltd [2004] EWHC 888). Actual or probable payee insolvency and inability to honour any future award in subsequent proceedings constitute special circumstances and present a serious risk of prejudice to the payer. 

A decision by the court to stay the execution of an order to pay an adjudicator’s award on these grounds alone does not impugn the adjudicator’s jurisdiction, or the validity of his award, and the payee typically has liberty to apply on 7 days’ notice to lift the stay of enforcement if circumstances change. Arguably the non-monetary elements of an award remain relevant to the parties’ dealings. None of the above is new law; it has been the case since Bouygues UK Ltd v Dahl-Jensen UK Ltd [2001] 1 All ER (Comm) 1041 CA. There, it was held on appeal that an adjudicator’s award in favour of Dahl-Jensen – which had gone into liquidation prior to the referral – had been correctly upheld by the TCC, but the order to pay it should not be enforced because Dahl-Jensen was insolvent and Bouygues’ had an arguable counterclaim. Since then, where the payee is in a formal insolvency process the courts have taken this approach, and such cases are known as the ‘easy cases’. Where the payee is not in a formal process, but is likely to be insolvent, a more nuanced approach is taken – the ‘hard cases’ – which I will look at in another article.

Michael J Lonsdale (Electrical) Ltd v Bresco Electrical Services Ltd (In Liquidation) is important because it goes further than Bouygues v Dahl-Jensen. Like Dahl-Jensen, Bresco was in liquidation when it referred the dispute to adjudication. Bresco had performed electrical installation works for Lonsdale. A dispute arose and each party alleged wrongful termination of the contract against the other. Bresco went into liquidation. Lonsdale contended that it had a claim against Bresco for the cost of completing the works, whereas Bresco’s liquidator maintained that Lonsdale had committed a repudiatory breach by appointing another contractor to complete the works, owed Bresco money for work done plus loss of profit, and referred those claims to adjudication. Lonsdale demanded that due to Bresco’s being in liquidation, it should discontinue the adjudication, and the adjudicator, Tony Bingham, should resign. When neither happened, Lonsdale brought proceedings under CPR Part 8 for a declaration that the adjudication was unlawful and must stop. Mr Justice Fraser defined the issue to be decided as: ‘…whether a company in liquidation can refer a dispute to adjudication when that dispute includes (whether in whole or in part) determination of a claim for further sums said to be due to the referring party from the responding party?’ 

That is a fundamental question that goes beyond the ‘procedural’ question of whether enforcement of an adjudicator’s  award should be stayed when the payee is insolvent.  Fraser J observed, when referring back to Lord Justice Chadwick’s judgment in Bouygues v Dahl-Jensen that, “Chadwick LJ did not come to a final conclusion regarding the effect of the liquidation upon the legal nature of the dispute between the parties in terms of the jurisdiction of the adjudicator, because the point was not fully argued and there was no need for him to do so.”  Fraser J’s clear decision on the issue, as he defined it, is what takes Lonsdale v Bresco beyond the other ‘easy cases’; it concerns whether the adjudicator had jurisdiction to hear the dispute at all." 

Fraser J decided that he did not, because the effective date for the evaluation of the parties’ mutual dealings and the reckoning of the balance due from one party to the other under the insolvency rules is the date on which the payee goes into liquidation.  As a result, claims by either party under a particular contract become just one part of a bigger picture, and are no longer capable of being referred to adjudication. Fraser J said, in relation to the apparent conflict between the HGCRA and the IR 16:

“The phrase “a dispute arising under the contract” in the Act, or “any dispute under the contract” in the Scheme both include the important words “under the contract”. Upon the appointment of the liquidator, any number of disputes between the parties to a construction contract, becomes a single one, namely a dispute relating to the account under the Insolvency Rules. It becomes a claim for the net balance under Rule 14.25(2) of the 2016 Rules. ….This analysis makes it clear that this is the only claim that can exist. I do not consider such a dispute in relation to the taking of an Insolvency Rules’ account to be “a dispute arising under the contract” to use the wording in the Act, or “any dispute under the contract” to use the wording of the Scheme. It is a dispute arising in the liquidation. I do not consider that Parliament, in enacting both the Housing Grants Construction and Regeneration Act 1996 and its successors, has given adjudicators the power to resolve disputes in the taking of the account required by the Insolvency Rules, either the 1986 Rules or the 2016 Rules. Clear words in the statute would be required to impose such a change on the law of insolvency. Further, the 1996 Act post-dates the Insolvency Act 1986 by a decade. Primary legislation is presumed to be consistent with, and is to be construed in accordance with, existing primary legislation. There is nothing included in any of the statutes that deal with adjudication in construction contracts to suggest such a sweeping change was imposed, or even contemplated.” 

In deciding this question, Fraser J acknowledged that he had been shown the lead by Coulson J in Enterprise Managed Services v Tony McFadden Utilities Ltd [2009] EWHC 3222. There, Utilities had sought to enforce an adjudicator’s award in respect of a claim previously pursued by Tony McFadden Limited (‘TML’) arising under its subcontract with Enterprise. Utilities thought it could go to adjudication because although TML had gone into liquidation before the referral, Utilities had taken an assignment from TML’s liquidators of the right to pursue the net sum due to TML from Enterprise, assessed under Rule 4.90, which, Utilities said, must include the sum in dispute. Coulson J refused to enforce the adjudicator’s award because the claim under that subcontract had ceased to exist on TML’s liquidation and could not be adjudicated upon. Moreover, the net sum due to TML under Rule 4.90 could not be adjudicated upon either because the parties’ mutual dealings embraced four subcontracts between TML and Enterprise, and the HGCRA only empowers adjudicators to deal with one dispute under one contract in one referral. 
 
Either by reason of the age of the decision or its peculiarities (the ‘composite’ debt arising under Rule 4.90, and the assignment of it), many practitioners have overlooked Coulson J’s key finding that the subcontract dispute simply no longer existed. Indeed, Bresco’s barrister sought to distinguish Enterprise v McFadden; it was, he said, different because Bresco’s referral to adjudication was made by its liquidator, only concerned one contract and there was no assignment.  However, Fraser J pointed out that he too had missed the core jurisdictional objection to using adjudication in these circumstances; neither TML’s liquidator, nor Utilities, nor Bresco’s liquidator could make a referral to adjudication because when liquidation occurs, the disputes which the HGCRA envisages may be referred to adjudication no longer exist, so an adjudicator cannot have jurisdiction to determine them.

Fraser J explicitly addressed insolvency practitioners’ continued use of adjudication despite Enterprise v McFadden in 2009:

“[Bresco say that]…liquidators across the country regularly refer disputes to adjudication either separately to taking the account under the Insolvency Rules, as part of taking that account, or as practical steps to determine disputes between the company in liquidation and its counter-party to construction contracts. That may very well be the case; some liquidators may do that. The court can only address such disputes that come before it, and the practical behaviour of liquidators (and parties against whom companies in liquidation adjudicate, and the adjudicators themselves) cannot affect the correct legal characterisation of disputes and mutual dealings which are set down in the Insolvency Rules, which have statutory force. I would be surprised if many, or indeed any, adjudicators would decline to resign if a responding party brought the relevant passages of Bouygues, Enterprise or indeed this case to his or her attention during an adjudication. This case is sufficient to demonstrate that not all tribunals react the same way, however, and the practical behaviour of liquidators (and adjudicators) does not outweigh what I consider to be the correct legal analysis.”

Fraser J concluded by answering the question he had defined:

“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.”

What does this mean for you or your business?

So what does Bresco mean for insolvent parties looking to resolve a dispute, or those who may owe them money? 

It clearly means that a company in liquidation should not make a referral to adjudication to obtain payment. Where bankruptcy strikes Sole Traders and Partnerships, s.323 Insolvency Act 1986 means the same reckoning of mutual debts must occur on the making of a bankruptcy order, so the same logic as Bresco should apply. What is the effect of Bresco on an adjudicator’s jurisdiction if the payee goes into liquidation after the referral has been made but before the adjudicator serves his decision?  My instinct is that since IR 16 has immediate effect when a winding up order is made, and the contractual dispute is extinguished, the adjudicator’s jurisdiction ends with it and the adjudication should cease. In any event, the award would fall into the ‘easy cases’ category, and enforcement of it would probably be stayed.  Where this leaves the burden of paying the adjudicator’s fees is for another day!

In relation to administration, Rule 14.24 of IR16 makes similar provision as Rule 14.25, but in administration the reckoning of mutual dealings does not occur when the administration order or appointment is made, but when “…the administrator intends to make a distribution and has delivered a notice [to creditors]”, so it is not necessarily the case that an adjudicator would lack jurisdiction to resolve a dispute referred to him by an administrator prior to a distribution. However, since they fall into the ‘easy cases’ category, payees in administration have been likely to see enforcement stayed for some time now (see Rainford House Ltd (In Administrative Receivership) v Cadogan Ltd  [2001] BLR 416 and Straw Realisations (No.1) Ltd v Shaftsbury House (Developments) Ltd [2010] EWHC 2597), which calls into question the cost-benefit analysis of making a referral to obtain payment in those circumstances.  

CVAs and IVAs are not ‘easy cases’, since the supervisor does not have the same powers and responsibilities as a liquidator and administrator, so they fall into the ‘hard cases’ category.

You will note that I underlined part of Fraser J’s conclusion above (“…any claim for further sums said to be due to the referring party from the responding party”). Bresco does not tell us whether a liquidator could make a referral to adjudication to obtain a declaration for something other than money or, say, to resolve a creditor’s ‘proof of debt’ claim for money on the liquidation. However, my instinct is that once IR 16 kicks in, even if the referring party is not seeking payment, adjudication is not the way to go because of the provisional nature of the resulting award. Instead, the liquidator should make his assessment of the creditor’s proof of debt as IR 16 Rule 14.25 requires, and if the creditor does not like it, it is for the creditor to challenge that by way of an application to court under IR 16 Rule 14.8 within 21 days of the liquidator’s decision.  The dispute would then be resolved by an insolvency judge and, in heavyweight cases, be referred on to the TCC.

What do you need to be doing now?

Prior to entering into contracts, carry out those checks and try to agree those contractual safeguards for payment outlined at the end of my May 2018 article ‘Insolvency calls time on pursuing claims’. Payers should seek to ensure their contracts include the widest definition of insolvency possible, so that they may terminate contracts sooner, so that the entitlement to further interim payments ceases, and any final payment is postponed until completion of the works by an alternative contractor (see my January 2018 article on Insolvency and payment terms).

In the event of a dispute with a party which is in liquidation, Bresco indicates that adjudication is not an appropriate method of forcing payment, so challenges to the jurisdiction of the adjudicator should be raised at the earliest opportunity. Any participation in the adjudication should be strictly without prejudice to that challenge. Bresco also indicates that with the adjudication route closed, the parties will have to use litigation to get resolution, which will cost more and carry the risk of costs orders. That could be a deterrent to liquidators seeking the recovery of sums they consider due to the payee in all but the most straightforward cases of non-payment, to the detriment of creditors. If the payer has a genuine counterclaim, which equals or exceeds the payee’s claim, there is arguably no injustice. However, this could result in a windfall for obstinate non-payers who are true ‘debtors’ because their counterclaims are spurious.

In the event of a dispute with a party which is in administration, whether a jurisdictional challenge based on Bresco will succeed will depend on the progress of the administration and when “…the administrator intends to make a distribution and has delivered a notice [to creditors]”, because at that point the assessment of mutual dealings under IR 16 takes place and, according to Bresco, this deprives an adjudicator of jurisdiction. To avoid challenges like this, administrators are likely to resort to adjudication sooner after being appointed.  A payer with a genuine counterclaim must ensure it is in good order so that it may be speedily deployed in the event of an enforcement hearing, to obtain a stay of execution under CPR Part 83.7.

My next article will look at the ‘hard cases’, where the payee’s insolvency is merely suspected, so the adjudicator’s jurisdiction cannot be challenged using Bresco, and the payer has to work much harder to convince the court that it should grant a stay of execution.

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