Practical Law

The Supreme Court has handed down a judgment that will fundamentally affect construction insolvencies by allowing insolvent companies the unfettered right to start adjudications.

Today’s decision in Bresco Electrical Services Ltd (in Liquidation) v Michael J Lonsdale (Electrical) Ltd allows Bresco’s appeal from last year’s Court of Appeal decision. Pythagoras Capital acts, as it has throughout, for the liquidator of Bresco.

The decision firmly redresses the balance that was previously in favour of solvent construction companies and firmly against insolvent construction companies. It is a crucial development in a recent line of case law that recognises the importance of administrators and liquidators being able to recover debts owed to insolvent companies – using any mechanisms available.

From a public policy viewpoint, the decision could not have come at a better time. Given the current economic downturn caused by COVID-19, it is an unfortunate reality that there will be many more construction insolvencies in the coming months and years. Adjudication is a critical tool that has been denied to insolvent companies for too long. No longer.

Pythagoras Capital’s view

Much has been written about Bresco in the nearly two years that have elapsed since Fraser J granted an injunction to restrain an adjudication brought by Bresco. Most of the commentary confirmed the construction market’s view that a company in liquidation lost its right to adjudicate.

From an insolvency lawyer’s perspective, however, that view was an anathema. Parliament chose to grant substantial powers to insolvency practitioners (IPs) to help them do their job of getting in the assets of the insolvent company and distributing them to creditors. The idea that an insolvent company should be deprived of a very useful process available to all solvent companies, simply had to be wrong. And as a practical matter, the loss of adjudication made it very hard for IPs to recover sums due to the insolvent company.

As a consequence, debt recoveries for insolvent construction companies has historically been very poor. The solvent company (usually a larger company than the insolvent one) could simply assert a bare cross-claim, and the IP was left with very little recourse to recover the debt owed. The result was that the innocent creditors of the insolvent company were punished, as there was no way to make the main contractor or employer pay what they owed.

Objections to adjudication for insolvent companies

From the first instance and Court of Appeal decisions in Bresco, there were several arguments raised to justify some sort of “incompatibility” between insolvency and adjudication. The main ones were that:

• The process of taking an account to determine the net balance after mandatory set-off under Rule 14.25 of the Insolvency Rules 2016 (previously Rule 4.90 of the 1986 Rules) is incompatible with adjudication.
• Lord Hoffman’s comments in Stein v Blake about liquidation extinguishing pre-existing choses in action and replacing them with a new single cause of action, which is not capable of adjudication as it is not a claim under a construction contract.
• There is “futility” in an insolvent company using adjudication, as the decision could never be enforced.

Rejection of objections by the Supreme Court

These arguments have all now been emphatically dismissed by the Supreme Court in Bresco. Taking them in turn:

• Rule 14.25 does not in any way prevent adjudication. All that Rule 14.25 does is provide mandatory set-off of claims between two parties, one of which is in liquidation. All that is payable to the insolvent company is the net balance, if any. Rule 14.25 does not set out any process for the taking of an account between the parties. It is for the IP to determine the value of all of the various claims and cross-claims using whatever tools are available to him or her. That may involve using adjudication to determine the disputes under some or all of the contracts with the insolvent company, accepting sums due on another dealings, taking court proceedings, using mediation and/or any other process that he or she considers appropriate.
• The reliance on Stein v Blake is based on an over-literal reading of the language of Lord Hoffman’s judgment. While claims and cross-claims lose their separate identity for the purposes of assignment, Lord Hoffman himself recognised in Stein v Blake that:

“The cross-claims must obviously be considered separately for the purpose of ascertaining the balance. For that purpose they are treated as if they continued to exist.”

• On the “futility” argument, the Supreme Court disagreed with the Court of Appeal and found that a construction adjudication, on the application of a liquidator, is not incompatible with the insolvency process. It is not an exercise in futility, either because of concerns about enforcement or otherwise. Indeed, the Supreme Court made clear that the mere existence of cross-claims is not a reason to resist summary enforcement. An argument about futility because an adjudicator’s decision could never be enforced is therefore entirely misplaced.

Enforcement of an adjudicator’s decision

The mechanisms of ring-fencing and similar arrangements that were approved by the court in Meadowside Building Developments Ltd (In Liquidation) v 12-18 Hill Street Management Co Ltd and Balfour Beatty Civil Engineering Ltd v Astec Projects Ltd (In Liquidation) (both of which were also run and funded by Pythagoras Capital) may still be relevant when it comes to enforcement of adjudication decisions by insolvent companies.

The Supreme Court did not consider those arrangements in detail, but firmly decided that the appropriate time for these type of arrangements to be put in place is when the insolvent company makes an application to court for summary judgment to enforce the adjudicator’s decision, not as a condition to the issue of an adjudication.

The future

The Supreme Court’s decision in Bresco is of huge assistance to IPs. No longer are companies in liquidation (or, by extension, administration) deprived of their right to issue adjudication proceedings to recover debts owed.

There may still be complex arrangements needed at the enforcement level (similar to the ones we put in place in Meadowside and Astec) but a very substantial roadblock has been lifted. The unfettered right to adjudicate granted to companies by the Construction Act 1996 is – finally – genuinely unfettered.