REUTERS | Toby Melville

Is the winding-up route a dead letter for non-payment?

The intention behind the 1996 construction legislation was clear with regard to payment obligations: there should no longer be any room for groundless refusal to pay. The system of notices that the legislation introduced was designed to ensure that if no notice to pay less was given by the end of the prescribed period, then the time for payment had arrived. If the payment due could properly be regarded as an undisputed debt, then there seemed to be no reason why a statutory demand should not be served. If payment was still not forthcoming, then presentation of a winding-up petition was the next step.

This procedure did not find favour. Instead, we have seen adjudication and adjudication enforcement proceedings as the preferred route to getting paid.

It was with this in mind that I read with interest the Court of Appeal’s judgment in Wilson and Sharp Investments Ltd v Harbour View Developments Ltd.

Wilson and Sharp Investments Ltd v Harbour View Developments Ltd

In Wilson and Sharp v Harbour View, the contractor was owed just over £1.2 million. It issued statutory demands against two of the employer’s directors and informed the employer that a winding-up petition was about to be presented. The employer sought an injunction to stop the contractor proceeding and was eventually successful (the Court of Appeal overruled HHJ Hodge QC’s decision to refuse the injunction).

In granting the employer a permanent injunction, Gloster LJ in the Court of Appeal accepted that the contractor’s debt was disputed on substantial grounds and that the employer had serious and genuine cross claims exceeding the alleged debt.

In construction disputes, is the winding-up route a dead letter for non-payment?

I think that it may be premature to conclude that, as a result of Gloster LJ’s judgment, the statutory demand and winding-up petition route is now effectively a dead letter.

The Court of Appeal’s reasoning regarding whether the debt was disputed on substantial grounds relied on the wording of the contract, which was based on a JCT standard form (the Intermediate Building Contract with contractor’s design, 2011 Edition (ICD 2011)), and was in terms similar to that found throughout the JCT suite. The contract provided (in clause 8.7) that no further sum was payable to the contractor after it had become insolvent, even if no pay less notice had been given.

However, not all contracts have the same wording and section 111(10) of the Construction Act 1996 (as amended), which gives effect to such clauses, only applies where the contract includes an express provision of the kind that was present in Wilson and Sharp v Harbour View.

The second ground on which the court relied to restrain the winding-up petition was the serious and genuine nature of the employer’s cross-claims, which exceeded the £1.2 million the contractor alleged was outstanding. The Court of Appeal concluded that the cross-claims were “sufficiently strong to be tested in court proceedings”. It appeared to be influenced by the fact that the cross-claims had been put forward in correspondence at a relatively early stage, and they were supported by independent valuations.

However, alleged cross-claims that are of more recent provenance, and rely solely on the employer’s expression of opinion, may not be so favourably regarded.

Another feature of Wilson and Sharp v Harbour View was that the employer acted promptly once notified that the winding-up petition was to be presented. The court’s discretion might not be so readily exercised in favour of an employer who delays in making an application. At the very least, such a delay may indicate doubt as to the validity of the dispute in relation to the debt.

Responding to a winding-up petition

The case also serves as a reminder of the dangers an employer faces where a winding-up petition is threatened.

In Wilson and Sharp v Harbour View, the employer sought to prevent the petition being presented, served or advertised. If one or more of these steps is taken, it is possible that other creditors will support the petition. Under rule 4.19 of the Insolvency Rules 1986, the court can allow those creditors to be substituted for the original petitioner, even if the original debt has been paid or otherwise resolved. The employer then needs to show that the substituted creditors’ claims are disputed, possibly at short notice.

There is a further danger for employers where the petition is presented. Section 127 of the Insolvency Act 1986 makes any disposition of the company’s assets after commencement of winding-up void “unless the court otherwise orders”. Therefore, should a petition be presented or advertised, the employer’s bank will become aware of the petition and may freeze the company’s bank account, hence affecting its ability to continue trading.

In order to prevent this happening, an employer must apply for a “validation order“, demonstrating that it can pay its debts as they arise. At the application’s hearing, both the petitioning creditor and any other creditor may object to the order being made. In practice, it may prove difficult to obtain a validation order, particularly against the background of additional creditors joining the petition.

and the moral of the story?

The moral to be drawn from this story is, unsurprisingly, that a timely pay less notice should avert these issues from arising. If, for some reason, such a notice has not been issued, then a paper trail demonstrating disputes as to the debt and justifying cross-claims is likely to be necessary, if a creditor chooses to go down the statutory demand route.

Presentation of a winding-up petition brings in a whole new set of dangers for an employer. It is not unknown for marginally solvent companies to founder at this stage due to irregular cash flow (and we all know that cash flow is the lifeblood of the construction industry!).

Herbert Smith Freehills LLP Michael Mendelblat

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