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FTH v Varis Developments – adjudication and insolvency meet head on again

In its decision in Bresco v Lonsdale, the Supreme Court confirmed that insolvent companies have the statutory and contractual right to adjudicate construction disputes, even if that claim is affected by insolvency set-off.

While Lord Briggs found overarching compatibility between the adjudication and insolvency regimes, that wasn’t to dismiss the difficulties arising between them, particularly those raised by insolvency set off. It is now settled law that these difficulties are not matters of jurisdiction: rather, they are factors for the courts to consider if the adjudication reaches enforcement stage on a case-by-case basis.

FTH Ltd v Varis Developments Ltd is the latest in a series of decisions (both before and after Bresco) that illustrates how the courts are grappling with insolvent parties’ applications for summary judgment to enforce adjudication decisions in their favour, this time in the context of a company voluntary administration (CVA).

Bresco and “real risk”

The intersection between the insolvency and adjudication regimes has generated some helpful case law over the past while. It features in FTH in the context of summary enforcement of adjudicators’ decisions, so it’s worth briefly recapping where we’ve got to.

In Bouygues v Dahl-Jensen (a liquidation case), the Court of Appeal held that where a party seeking to enforce an adjudication decision is in liquidation and there are latent claims and cross claims between the parties:

“there is a compelling reason to refuse summary judgment on a claim arising out of an adjudication which is, necessarily, provisional.”

The rationale for this, in basic terms, is that if the decision is enforced in favour of the party in liquidation, the paying party’s cash will form part of the fund to be distributed amongst the enforcing party’s creditors. This deprives the paying party of the security that it would ordinarily be entitled to set-off, pound-for-pound, against the decision under the insolvency rules.

In Bresco, specifically the Cannon appeal, the Court of Appeal distinguished between enforcing parties that were subject to a CVA, rather than liquidation. Coulson LJ noted that a key difference is that a party subject to a CVA may, depending on the facts, “trade its way out of trouble”, and therefore that:

“…courts should be wary of reaching any conclusions which prevent the company from endeavouring to use adjudication to trade out of its difficulties.”

It may be that if the CVA is allowed to run its course, the enforcing party will avoid liquidation altogether.

When Bresco reached the Supreme Court, this issue was addressed in obiter. Lord Briggs confirmed that the difficulties between adjudication and insolvency set off were matters to be addressed at enforcement stage, citing the ratio in Bouygues with approval, noting that:

“… where there remains a real risk that the summary enforcement of an adjudication decision will deprive the respondent of its right to have recourse to the company’s claim as security (pro tanto) for its cross-claim, then the court will be astute to refuse summary judgment.”

In John Doyle v Erith (another liquidation case), at first instance Mr Justice Fraser cited the “real risk” test as one of the five applicable principles when considering an application for summary judgment on an adjudication decision in favour of a company in liquidation. The Court of Appeal upheld this judgment.

This brings us back to FTH (a CVA case), in which the court adopted the same approach as Doyle: the test was whether the enforcement posed a real risk to the paying party’s security over its cross claim. Let’s look at how that worked.

The FTH case

Varis engaged FTH under a design and build contract in August 2018. Matters evidently deteriorated between the parties, and in October 2019, payment was being withheld pursuant to a pay less notice and Varis had purported to terminate the contract. There was then a series of adjudications:

  1. Adjudication decision 1: relating to the validity of a pre-termination pay less notice (it was valid);
  2. Adjudication decision 2: as to whether Varis’ termination was invalid and Varis had repudiated the contract (it was, and Varis had); and
  3. Adjudication decision 3: relating to FTH’s claim for payment based on a pre-termination valuation. FTH was entitled to payment of £757,000 odd.

Importantly, FTH entered a CVA after decision 2, but before decision 3. Varis did not pay the amount awarded in decision 3, and said that it would resist enforcement, referring to a cross claim of £1.7m flowing from the termination that was issued to the CVA supervisors after the adjudication.

The enforcement proceedings

FTH sought to enforce adjudication decisions 2 and 3, although the main question for the TCC was whether FTH was entitled to enforce the payment due under decision 3. If FTH was entitled to summary judgment, there was then the question of whether a stay of execution would be appropriate in the circumstances.

On the question of whether summary judgment should be granted, as above, the court concluded that the approach was the real risk test. That question turns on the facts of each case.

Here, on the evidence before the court, FTH failed to show that Varis would not be deprived of its security. Under the CVA, the best-case scenario was a return of 56p in the pound for creditors. The assumptions underlying that projection were flawed: it assumed 85% recovery for two claims after costs (including the claim against Varis). It became evident that there would be no recovery from the second claim, nor was there any certainty of what costs would erode any recovery in any case. Among the other reasons, the CVA did not take Varis’ cross-claim of £1.7m into account.

On these facts, the court concluded that the enforcing party’s financial situation was more akin to a liquidation than a CVA, and therefore, there was a real risk that summary enforcement would deprive Varis of security for its cross-claim. Summary judgment was refused.

As for the stay, the court has discretion to order a stay of execution if there are “special reasons which render it inexpedient to enforce” (CPR r 83.7(4)). This was not in issue here, given that summary judgment was refused. However, to put the matter beyond doubt, the court observed that FTH’s inability to repay the judgment sum at the end of a substantive trial qualified as special reasons.

Thoughts

Post-Bresco, it is clear that adjudication is open to insolvent parties as a way of maximising recovery. That line of cases focus on the key features of the insolvency and adjudication regimes, and where the lower courts found incompatibility, the Supreme Court found compatibility. Unfortunately, it is likely that the courts will see this issue come up again: the UK is facing uncertain economic times, and as Coulson LJ put it in the Doyle appeal, adjudication is “for most construction disputes … the only game in town”.

For adjudication to be an enforceable tool for insolvent parties facing cross-claims, this requires some thought to ensure that a court will provide that relief. How might that be achieved? We have some guidance from recent cases.

  • There may be a sufficient guarantee or “ringfencing” of the proceeds of the adjudication, such that they are not distributed amongst the creditors on enforcement (see Bresco).
  • In some rare cases, the adjudication will determine all mutual dealings between the two parties, removing the need for security over the cross-claims.

On the other hand, FTH joins a series of cases in which summary enforcement was refused (see, for example Doyle, Indigo, Westshield). As the judge noted in FTH, the question of whether summary enforcement was appropriate in the circumstances depended on the facts, and so these cases are of limited utility as a matter of precedent. However, they illustrate the potential mischief that insolvency set off causes for adjudication decisions in insolvent parties’ favour.

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