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Adjudication and insolvency – guidance from the Court of Appeal

Summer 2018 will be remembered as a special time by many readers of this blog: whether it was the spectacular weather, the giddy heights hit by the England football team, or Fraser J’s decision in Michael J Lonsdale (Electrical) Ltd v Bresco Electrical Services Ltd (In Liquidation), it was a summer to remember.

To recap on the latter, Fraser J granted an injunction preventing an insolvent contractor from pursuing an adjudication. The case was the subject of a considerable amount of commentary, including from my colleague Marcus Birch. Importantly, Bresco was in liquidation, rather than some other insolvency procedure. The case was seen as the death knell for the practice of liquidators bringing adjudications.

Perhaps understandably the decision of HHJ Waksman QC in Cannon Corporate Ltd v Primus Build Ltd received considerably less attention. In that case, the judge granted summary judgment and refused a stay of execution to an insolvent contractor in a company voluntary arrangement (CVA). In other words, a company in a CVA might (depending on the facts) still be able to refer matters to adjudication.

In a conjoined appeal, the Court of Appeal has upheld both decisions, and in doing so has provided some useful guidance on whether adjudication remains an option for insolvent companies.

Jonathan Cope has considered those aspects of the judgment that provide guidance on the scope of general jurisdictional reservations routinely made by responding parties in adjudications.

Remind me what the Insolvency Rules say?

Rule 14.25 of the Insolvency (England and Wales) Rules 2016 (Insolvency Rules) provides that when a company enters liquidation, if there have been “mutual dealings” between the insolvent company and a third party, the parties’ claims and counterclaims are set-off against each other by the liquidator. If the third party is still owed money, it only has to prove the balance as a debt in the liquidation.

First instance: if in liquidation, no adjudication

At first instance, Fraser J wrestled with the thorny issue of what the Insolvency Rules meant for the contractor’s right to adjudicate. Under both the Construction Act 1996 and the Scheme for Construction Contracts 1998, a party can commence an adjudication “at any time”.

Fraser J weighed up the authorities and concluded that an adjudicator cannot have jurisdiction to decide an adjudication when one party is in liquidation because the dispute is no longer a construction contract dispute:

“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…It is a dispute arising in the liquidation.

In effect, Insolvency Rules regime supplants the parties’ right to adjudicate.

Court of Appeal: adjudication is an option – but likely to be a waste of time

On appeal, Coulson LJ (who gave the leading judgment) agreed that Fraser J was right to grant an injunction bringing the adjudication to a halt. But he disagreed with Fraser J’s reasoning.

Coulson LJ was concerned that the first instance decision drove a wedge between adjudication on the one hand, and litigation and arbitration on the other. It was settled law that a party in liquidation could pursue an arbitration (or go to court) when it was in liquidation. So why not adjudication? We are used to describing adjudication as “interim binding” but that ignores the fact that adjudication decisions can become final and binding, if the parties agree that to be the case, or if the decision is simply never challenged.

This led Coulson LJ to conclude that adjudicators do have jurisdiction to hear disputes referred by insolvent companies. In doing so, he overturned the reasoning of Fraser J at first instance and, with some humility, that of a young Coulson J (as he then was) in Enterprise Managed Services Ltd v McFadden Utilities Ltd.

So adjudication is an option for companies in liquidation after all. But, liquidators hold your horses.

Coulson LJ went on to question the practical “utility” of permitting an adjudication to continue when one party is in liquidation.

This contained some thought-provoking discussion as to how the insolvency set-off and adjudication regimes interact, which is best illustrated by way of example.

Imagine an employer has a £100,000 claim against an insolvent contractor (for defects, liquidated damages and the like) and the contractor has a counterclaim for £75,000 (for missed payments, say). Under the Insolvency Rules, the two claims are set off, and the employer only has to prove a debt for £25,000. The employer might only receive 1p in the pound for £25,000 (£250), but it has effectively received £1 for £1 in respect of £75,000 of its claim.

Now instead suppose that the contractor could recover its £75,000 claim in an adjudication. The employer could pursue its counterclaim for £100,000, but it would only receive 1p in the pound for the whole lot.

It is this disparity that sits behind the court’s long-standing policy of (nearly always) ordering a stay of execution preventing the enforcement of adjudication decisions by companies in liquidation (see Wimbledon v Vago).

Futility test

As the court will not enforce an adjudication in favour of companies in liquidation, you’d be forgiven for asking yourself, what’s the point of adjudicating in the first place? Wouldn’t it be a waste of everyone’s time? And you’d be right. Adjudication would, in the words of Coulson LJ, be a “futile exercise” and the court will grant an injunction putting things to a stop.

Which means that, while adjudication might strictly speaking, still be an option for liquidators, it is very unlikely to be one worth pursuing in practice.

That said, the court hasn’t ruled it out completely. In “exceptional” circumstances, the court will enforce a decision in favour of a company in liquidation, in which case it would still make sense for a liquidator to pursue adjudication. As to what those circumstances are: answers on the back of a postcard please.

Of greater relevance is the question of whether all this applies to adjudications brought by liquidators where:

  • The other side does not have a counterclaim at all, even if such situations may be extremely rare in practice. Coulson LJ emphasised at various points that his judgment considered the enforceability of an adjudicator’s decision in favour of a contractor in insolvent liquidation “in circumstances where there is a cross-claim”.
  • The liquidator is pursuing a purely non-monetary remedy, for example a declaration that practical completion has been achieved.

Neither of those situations were expressly dealt with by the courts, so could still be on the cards (although it would take a brave liquidator to give it a go).

CVAs: solving insolvency, via adjudication

A CVA is a different beast entirely to liquidation. It is an arrangement between a company and its creditors as to how the company plans to pay its debts, trade its way out of insolvency, and carry on as a going concern. Having said that, it is subject to the same principles of insolvency set-off as liquidation.

In Cannon v Primus the Court of Appeal held, on the facts, that the insolvent contractor was entitled to refer the dispute to adjudication, and that the decision would be enforceable. Central to this outcome was that:

  • The employer was responsible for the contractor’s financial difficulties; and
  • If the contractor succeeded with the adjudication, it would become solvent.

In that situation, the contractor’s insolvency might be better characterised as a cash-flow issue. Precisely the sort of situation adjudication is suited to, and it is reassuring that the court came to the same view.

Time will tell whether this has a wider impact on the popularity of CVAs as an alternative to liquidation for insolvent contractors (and, more pertinently, their creditors).

As to what this means for administration, we’ll have to wait and see.

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