PLC Construction recently received an enquiry about an employer’s ability to deduct liquidated and ascertained damages (LADs) for delay under a demand issued after the contractor had gone into administration. Could the employer set-off its demand for LADs under the Insolvency Rules?
The High Court considered the operation of insolvency set-off during administration in the recent case of In the matter of Kaupthing, Singer and Friedlander Limited (in administration)  EWHC 2308 (Ch). That case highlighted two key points:
- Insolvency set-off in administration does not operate unless and until the administrator gives notice of his intention to distribute assets to unsecured creditors.
- So long as the insolvent company is under the obligation that gives rise to the payment liability before it goes into administration, the fact that the payment liability itself does not fall due until after the administration (and that the amount of the liability is not quantified until after the administration) does not stop the payment liability being set-off.
If the administrator has not declared an intention to distribute assets, then the general principles of set-off apply. (The employer might also be able to raise a counterclaim to any action brought by the insolvent contractor.)
The importance of the building contract
Assuming that the building contract contains LADs provisions, the Kaupthing case apparently relieves the employer from having to establish precisely when liability to pay LADs arises. This is helpful, because many standard forms of contract are rather vague in this regard. For example, Option X7 of the NEC3 Engineering and Construction Contract simply states that “The Contracor pays delay damages at the rate stated in the Contract Data from the Completion Date…”.
Despite this, the employer should still consider the precise wording of the building contract, as it may clarify other important issues, such as whether the contract:
- Imposes any conditions precedent to the recovery of LADs, as the employer’s entitlement to LADs may not crystallise until any preconditions have been properly satisfied. (See for example, the three conditions precedent in clause 2.32 of the JCT Standard Building Contract, 2005 edition, Revision 2 2009.)
- Expressly allows the employer to recover LADs as a debt from the contractor, or only permits deductions from sums otherwise due to the contractor under the contract.
- Payment. (For example, does the employer actually have to pay the contractor? Did the employer serve a withholding notice, if required?)
- Insolvency. (For example, what is the definition of insolvency under the building contract? Double check the nature of the contractor’s “insolvency”: make sure it is administration and not insolvent liquidation.)
- Termination. (For example, does the contractor’s employment terminate immediately and automatically on the contractor’s insolvency? If not, can the employer give notice to terminate and should the employer do so, tactically? What are the parties’ contractual rights on termination?)