Last year the Technology and Construction Court (TCC) held that a company in liquidation cannot refer a dispute to adjudication in circumstances where there are claims by a company in liquidation and cross claims by the other party1.
This was said to be because following the liquidation of one of the parties, the set off provisions of the Insolvency Rules apply meaning that any pre-existing claim for payment under the Housing, Grants, Construction and Regeneration Act 1996 (as amended) (HGCRA) would be replaced by a claim for payment of the net balance owing between the parties. It followed, on the court's analysis, that the right to payment under the construction contract was subordinated by the Insolvency Rules and there was no longer a payment dispute capable of being referred for adjudication. The TCC granted an injunction to restrain the insolvent party's claims in adjudication (i.e. claims for payment said to arise under the construction contract) from continuing.
You can read our summary of that decision here.
In January, the Court of Appeal2 confirmed that the right to adjudicate is not automatically lost when a party goes into liquidation and there is, or there may be, a cross claim. However, any decision made in favour of a company in insolvent liquidation would not be enforced by a court meaning that no payment would (necessarily) pass from one party to another. As such, the injunction was upheld but on different grounds. The Court of Appeal noted that some of the arguments regarding the insolvency regime and the Insolvency Rules 2016 ("the Rules") that it heard had not been raised previously at an adjudication enforcement hearing. The reasoning of Lord Justice Coulson is worth examining in more detail given that it represents what is, at least for now, the leading judicial consideration of the issues raised in these circumstances.
The central question the Court of Appeal posed itself was why couldn't an insolvent company adjudicate a dispute that could have been litigated or arbitrated. In short, the Court of Appeal's answer was the 'basic incompatibility' between construction adjudication and the Rules. Adjudication is, broadly speaking, intended to provide a means of obtaining improved cash flow quickly and cheaply. Insolvency is a fundamentally different regime founded on special principles and governed by the Rules, including 'insolvency set-off' (Rule 14.25), which is unique to other forms of set-off. In essence, insolvency set-off is an exercise whereby a detailed account is taken of the parties' mutual dealings to calculate the net balance owing between the insolvent company and a creditor. By contrast, adjudication is a rough and ready process designed to produce a temporarily binding decision. They are therefore very different processes.
The majority of claims referred to adjudication are not claims for a net balance and will, perhaps, form only a small part of the mutual dealings between the parties. An adjudication decision could result in money changing hands temporarily or, possibly, permanently.
If that contractor is in insolvent liquidation then any sum paid over in this way (and the other party's cross-claim) might not form part of the net balance calculation. The other party would have to prove for the entirety of its cross-claim in the contractor's liquidation and would only receive a dividend out of any available assets. This sort of potential windfall, for the insolvent party, runs contrary to the insolvency regime, which is based on fairness as between creditors, whose claims in a company's liquidation rank 'pari passu' (on an equal footing). Conversely, it is a fundamental tenet of the HGCRA that in the absence of a payment or pay less notice, the employer must pay over the sum claimed – whether that party has a cross-claim against the contractor or not.
The Court dealt with the tension between the HGCRA and insolvency regime in the following way: whilst the right to adjudicate is not lost by a party entering into insolvent liquidation, in circumstances where there is a cross-claim, such a decision would be incapable of enforcement and therefore "an exercise in futility". Even though the adjudicator may technically have the necessary jurisdiction, the adjudication will not lead to a meaningful result. It is doubtful, in these circumstances, if there would ever be any practical utility in allowing an adjudication brought by a company in insolvent liquidation to continue.
The Court of Appeal confirmed the jurisdiction of the TCC to grant an injunction to restrain an adjudication reference from continuing if that reference is, or would be, a futile exercise – not on grounds of jurisdiction, but on the basis that such jurisdiction could not lead to a meaningful result.
The Court also identified wider considerations which support this view:
- A liquidator has, by definition, only limited assets available to him or her with which to pursue the claims of the insolvent company and it would ordinarily be wasteful to pursue a claim which could only be enforced in exceptional circumstances. However the Court did not explain what might amount to such exceptional circumstances
- An adjudicator's decision cannot stand as a form of assessment of the value of a claim and cross-claim. The decision is often the result of one party failing to correctly operate contractual payment procedures as opposed to the operation of the Rules. The result may be far removed from the insolvent party's overall entitlement (if any) and the result would not be any kind of estimate or assessment of the parties' mutual debts
- The responding party would be obliged to fund its own role in a futile adjudication process which would be wrong in principle.
- Even if the party in insolvent liquidation is successful in the adjudication and summary judgment is granted, the responding party would have to bring its own claim in court to overturn the result of the adjudication. That would require yet more costs to be incurred by the responding party to regularise its position and recover any sums due from the company in insolvent liquidation. This would result in further costs being incurred without any prospect of recovery or security for such costs being granted against the insolvent party
- If companies in insolvent liquidation could run adjudications all the way through to enforcement, there would be a further strain on the already overburdened resources of the TCC which may deprive other court users of access to the court.
The question remains as to whether the Court would have reached a different conclusion if there were no cross-claims and all that was at stake were sums due from the employer to the insolvent contractor. In our view it would not have. The adjudication process can, at best, only ever produce a temporarily binding decision that may not be determinative of the final net balance following the taking of the mutual account envisaged by the Rules.
Even if an insolvent company managed to successfully obtain such a decision and enforce it by summary judgment the Court would, it is submitted, be bound to stay any execution because of the probable inability of the insolvent party to repay such sums following any final determination. Again, because this would be so wasteful of costs in a process where the liquidator's duty is to maximise recoveries for the benefit of the creditors as a whole, there cannot be any utility in allowing such an adjudication to continue. It would be neither just nor convenient for an adjudication to continue that could never produce a final determination of sums due from one party to the other.
Finally, the appeal in this case was conjoined with another appeal3 which concerned the status of sums awarded in adjudication against a contractor that was subject to a Company Voluntary Arrangement (CVA). At first instance, the judge had awarded summary judgment and refused any stay of execution irrespective of the fact the contractor was in a CVA. The Court of Appeal also found that the general position relating to a CVA may, depending on the facts, be very different to an insolvent liquidation, in which the liquidators seek to realise funds to pay dividends to creditors. The purpose of a CVA, on the other hand is to try and allow the company to remain in existence and to continue to trade. The net balance procedure in Rule 14.25, for instance, does not apply in a CVA.
The Court found that the quick and cost-neutral mechanism of adjudication may be an extremely useful tool to permit the CVA to work. In such circumstances, courts should be wary of depriving a party of its statutory right to use adjudication, if appropriate, to assist it to trade out of its difficulties. That is, after all, the essential purpose of statutory adjudication: to provide a quick and cheap method of improving cash flow.