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The obligation to pay a notified sum where the contractor is insolvent

The general rule created by section 111 of the Construction Act 1996 is well known: in the absence of a pay less notice, the notified sum is to be paid without set-off or deduction.

Although this is capable of causing problems for an employer in the short term, any overpayments can usually be corrected in future payment cycles (whether interim or final) or by a true value adjudication (following S&T (UK) Ltd v Grove Developments Ltd).

But what about when the contractor is or becomes insolvent? The concern for an employer here is obvious: money paid over to an insolvent contractor is liable to disappear into the general fund and be distributed at pennies in the pound, leaving the employer unable to recover the full value of any overpayment or cross-claims. There may not be any future payment cycles and, even if there are such cycles or a true value adjudication, it may be impossible to make a full recovery. Unlike the normal scenario, it will not simply come out in the wash.

What, therefore, can an employer do?

Giving a pay less notice

The first solution is the obvious one. To be scrupulous about giving pay less notices in respect of any cross-claim, or if there are any other grounds to resist payment.

However, it may not always be possible to give a timely pay less notice. For example, suppose the facts that would entitle the employer to do so do not arise until after the deadline (or arise before the deadline but do not come to the employer’s attention until afterwards).

In any case, in practical terms, it is not unheard of for an employer simply to fail to put in a pay less notice, or to miscalculate the period for doing so, through inadvertence or otherwise.

While taking care over payment notice and pay less notices is the first and most important step, it is also necessary to consider what comes next.

Section 111(10) of the Construction Act 1996

Section 111(10) of the Construction Act 1996 provides that the obligation to pay the notified sum does not apply if:

  • The contract provides that if the contractor becomes insolvent, no sum need be paid in respect of the payment; and
  • The contractor has become insolvent after the last date for giving a pay less notice.

That provision is not comprehensive. In particular:

  • It will not assist where the contractor’s insolvency precedes the last date for giving a pay less notice. The rationale appears to be that an employer in that situation can protect its position by giving a pay less notice. As suggested above, this may not always be the case.
  • It will also not assist in any scenario where the contract does not provide that if the contractor becomes insolvent, no sum need be paid in respect of the payment. This is less likely to be an issue in contracts concluded on standard forms, but may be an issue in informal contracts. No such provision will be implied by Part II of the Scheme for Construction Contracts 1998.

However, even if section 111(10) is inapplicable, that is not necessarily the end of the matter for an employer facing a notified sum claim from an insolvent contractor.

Resisting enforcement

The next option is to resist enforcement of any adjudication decision by reference to the claiming party’s insolvency and, in particular, by reliance on the doctrine of insolvency set-off.

The principle that the claiming party’s insolvency can be relied upon to resist summary judgment in adjudication enforcement proceedings, where the other party has a cross-claim amounting to an insolvency set-off, is well established. It was considered by the Court of Appeal in John Doyle Construction Ltd v Erith Contractors Ltd, in light of the Supreme Court’s decision in Bresco Electrical Services Ltd v Michael J Lonsdale (Electrical) Ltd.

In John Doyle, the adjudicator had determined the net balance in a final account dispute. The resisting party (Erith) maintained that it had a cross-claim and that, on a true valuation, the claiming party (JDC) had been overpaid. Coulson LJ concluded that, notwithstanding dicta in Bresco that might have been thought to point the other way, JDC was not entitled to summary enforcement. Approving Meadowside Building Developments Ltd v 12-18 Hill Street Management Company Ltd, he explained that the decision of the adjudicator was a provisional assessment only, and that:

“… where the decision remains provisional … ‘it is clear that the rights under the insolvency regime prevail’.”

He continued:

“I do not consider that the provisional finding of an adjudicator, even on a single final account dispute where no other significant non-contractual or other contractual claims arise, can be treated as if it were a final determination of the net balance, in circumstances where the other party maintains its set-off and cross-claim. It is not a question of security; it is a question of the insolvent company’s cause of action being for the net balance only.”

The entitlement following insolvency was to be paid the net balance and that:

“… must in law be the balance as finally determined, not as per the adjudicator’s provisional view.”

It follows that a resisting party can rely on insolvency set-off even if the cross-claim in question was rejected on the merits by the adjudicator.

Two further possibilities

There are two further possibilities that merit consideration: rely on an insolvency set-off defence during the adjudication and/or restrain any notified sum adjudication by injunction.

Rely on an insolvency set-off defence during the adjudication

The first possibility is to rely on an insolvency set-off as a defence during the adjudication itself. There are various technical rules governing the application of insolvency set-off that cannot fully be considered here, including as to the timing of the relevant claims. However, if it is in principle possible, in a suitable case it may be cheaper and more effective to do so rather than to wait until the enforcement stage.

An adjudicator can generally consider an insolvency set-off by way of defence, as part of their general jurisdiction to consider any available defence (Bresco). This includes the possibility of simply making a declaration as to the value of the main claim and leaving the value of the insolvency set-off to be determined separately.

The ordinary rule is that there is no set-off against a notified sum. Insolvency set-off is different in kind from other set-offs (Bresco), but it would nevertheless be necessary to construct an argument that it should be an exception to this rule. Such an argument might be along the lines that the obligation to pay a notified sum is of a “provisional” character (S&T v Grove), and that, just like the provisional determinations of an adjudicator (as to which, see John Doyle above), it cannot be allowed to prevail over the insolvency regime.

However, it would be necessary to confront the implications of section 111(10) for such an argument.

Restrain any notified sum adjudication by injunction

The second possibility is to seek to restrain any notified sum adjudication by injunction.

In Bresco, the Supreme Court overturned the Court of Appeal’s decision that adjudication during insolvency would generally be futile and so should be restrained by injunction. This was for essentially two reasons:

  • A party has a statutory and contractual right to bring a dispute to adjudication. The court should not interfere with that as a matter of principle.
  • The adjudicator’s speedy determination of the issues (whether on the main claim alone or any cross-claim advanced by way of set-off) may be of “real utility” even if the decision is not as such enforceable.

It is far from obvious that the latter reason would apply to a notified sum adjudication. The adjudicator does not consider the underlying facts, and so does not contribute to resolving the “real” dispute. It is at least arguable, therefore, that an adjudication on a notified sum dispute is futile unless it can be enforced.

However, if (as suggested above), it is possible for the responding party to rely on an insolvency set-off in the adjudication, it may be that the process is not futile if the adjudicator can consider the merits of that set-off, which may be of some utility to the parties on the basis explained in Bresco. In any case, futility does not dispose of the former objection, described in John Doyle as the ratio of Bresco. The fundamental point is the statutory and contractual right to make a reference at any time.

Conclusion

The best-established and safest routes to avoiding payment of a notified sum to an insolvent contractor are the service of a timely pay less notice, reliance on section 111(10) of the Construction Act 1996 where it applies (including ensuring that any contract contains an appropriate clause to engage that section), and resisting enforcement following any adjudication. These routes are not comprehensive, however, and it may be that certain claims slip through the cracks.

It is unclear whether the two more speculative routes (relying on insolvency set-off as a direct defence and seeking to restrain any adjudication by injunction) would find favour.

One thought on “The obligation to pay a notified sum where the contractor is insolvent

  1. Any payment due to an insolvent contractor is logically due to the creditors. It is unclear why an employer should be treated more favourably than any other debtor.

    Creditors have not agreed on a contract does that provides that if the contractor becomes insolvent, no sum need be paid in respect of the payment But this commentator is no lawyer”

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