2020-06-19
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Insolvent liquidation - an adjudication threat from beyond the grave?

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Posted by Paul Slinger on 19 June 2020

Paul Slinger - Construction and Building Solicitor
Paul Slinger Partner

The Supreme Court has, in June 2020, given judgment on a landmark case which sets out the current state of the law relating to the availability or otherwise of adjudication as a means of dispute resolution when one of the parties is in insolvent liquidation. This has been a hard-fought area for a number of years.

The tale of the case between Michael J Lonsdale (Electrical) Ltd v Bresco Electrical Services Ltd from its 2018 first instance decision in the Technology and Construction Court, through 2019's Court of Appeal decision and finally to 2020's Supreme Court decision, and the arguments and rationale adopted by each court shows the difficulties that have to be grappled with when the insolvency regime meets the adjudication regime.

Adjudication is a process that applies to most types of construction contract and gives swift decisions, specifically within 28 days of the dispute being referred, subject to any agreement to extend the process.  Adjudication is also a regime that is supported by a procedure for the rapid enforcement of the adjudicator's decision in the Technology and Construction Court.   The speed of the process leads to a relative lack of deep forensic analysis compared with arbitration or court proceedings, so it does often mean that adjudicator's decisions need to be revisited.  The process is therefore deemed to be of ‘temporarily binding effect’, which means that the same dispute can be overturned by any subsequent court or arbitration proceedings.   Such proceedings can lead to an order to repay some or all of the sums paid pursuant to the adjudicator's decision.

But where a successful party in an adjudication is in insolvent liquidation, there can be conceptual and practical difficulties with achieving finality between the parties.  The insolvency regime is one that seeks to achieve finality of the position between  an insolvent company and its creditors and debtors by reducing all matters between them to a single  net balance due one way or the other.  So can adjudication be used for that process, or as part of that process?

In the first instance decision, the Technology and Construction Court held that this requirement to achieve a single net balance under the Insolvency Rules meant that claims for payment that would otherwise be capable of being referred to adjudication would be replaced by a claim for payment of the net balance in the liquidation, such that the Insolvency Rules effectively trumped the right to payment granted by the adjudication regime.  Without an appropriate claim, there would therefore be no right to commence an adjudication .  The result was that the court granted the injunction sought by the solvent party which prevented the adjudication from continuing.

When the case went to the Court of Appeal, the position was rowed back.  The Court of Appeal said that the right to adjudicate did not in fact disappear in the event of an insolvent liquidation.  As such there is still a right to commence an adjudication and to see it through to a decision being reached.  However, given the difficulties that the Court of Appeal foresaw in going ahead and enforcing the decision, it still upheld the injunction.  It stated that there was a "basic incompatibility" between the insolvency and adjudication regimes.  The 'quick and dirty' nature of adjudication was said to be at odds with the insolvency regime, particularly those relating to insolvency set-off.  Insolvency set-off is the detailed accounting process used to arrive at the net balance said to be due between two parties where one of them is in insolvent liquidation.  The Court of Appeal therefore went on to find that if there was a cross-claim between two parties, one of whom was in insolvent liquidation yet had an adjudication decision in its favour, attempting to enforce such a decision would be "an exercise in futility" and should therefore fail.  The courts would not allow enforcement of a payment out, which might prove not to be final/correct, with little practical hope of the wronged paying party ever getting any of the money back.  The enforcement process would be a waste of court time and parties’ money.  So the injunction was still upheld on these different grounds.

The Supreme Court  rowed the position back even further.  It agreed that the right to adjudicate is not lost when a party enters into insolvency litigation.  So adjudicators DO have jurisdiction to decide disputes involving parties in insolvent liquidation.  But crucially it also went on to say that there is no fundamental incompatibility between the insolvency and adjudication regimes either, so the arguments about futility set up by the Court of Appeal were also swept aside.

The Supreme Court saw merit in using adjudication where appropriate to help in determining some or all of the net balance position between the parties:

The liquidator may, if it appears economical and proportionate to do so, untangle a complex web of disputed issues arising from mutual dealings between the company and a third party by picking some as suitable for adjudication, others for arbitration and others for disposal by an application to the court for directions, or by ordinary action.”

It acknowledged that securing cashflow is a vital role of adjudication but, also stated that adjudication is a mainstream type of Alternative Dispute Resolution in its own right

The door is therefore fully open for adjudications involving insolvent parties to commence, to continue and to reach enforcement.

There is considerable doubt that such decisions will now be enforced as a matter of course however, because the risk of repayment if and when the matter is finally determined in court or arbitration proceedings could still be a factor in many cases.  The Supreme Court itself acknowledged this but did confirm that some cases will be able to proceed to be enforced.

It is of note that between the Court of Appeal and the Supreme Court decisions, there have been a number of cases where companies in insolvent liquidation have tried to enforce adjudicator's decisions with insurance-backed guarantees and indemnities to offer to keep funds available to pay back and compensate for any perceived wrongs if the decision is successfully challenged in subsequent proceedings.  This movement, with specialists effectively funding and therefore taking on the risk of pursuing sums in anticipation of financial gain, has gained traction and support.  The Supreme Court decision will certainly add further wind to their sails.

As such, if you are involved in a project where part of the supply chain becomes insolvent, which is a heightened immediate risk in this post-pandemic world, do not drop your guard and assume that they are dead and buried and no longer a threat.  If you know that they considered they were still owed money and/or you have a potential cross-claim against them, make sure you keep good, full records (including for example costs to complete or remedy their work) because you might still have to prove you are right to avoid a nasty surprise down the line.

About the author

Paul helps clients get their construction and engineering projects delivered within the right timescale, for the right amount of money, and to the correct quality.

Paul Slinger

Paul helps clients get their construction and engineering projects delivered within the right timescale, for the right amount of money, and to the correct quality.

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