This article looks at whether, and to what extent, parties can make binding agreements in advance about how legal costs are to be allocated by a tribunal, and considers whether such agreements might have a (small) part to play in addressing some inefficiencies which affect the construction sector.
My conclusion is that what is presently an under-exploited loophole in section 60 of the Arbitration Act 1996 might offer employers a means of discouraging inflated, speculative adjudication and arbitration claims by contractors.
Costs in English court litigation
Section 51(3) of the Senior Courts Act 1981 says that: “[t]he court shall have full power to determine by whom and to what extent the costs are to be paid,” these being the “costs of and incidental to proceedings in [the court].”
CPR 44.2 says that “[t]he court has discretion as to … whether costs are payable by one party to another; … the amount of those costs; and … when they are to be paid.” “If the court decides to make an order about costs the general rule is that the unsuccessful party will be ordered to pay the costs of the successful party … but the court may make a different order.” And “[i]n deciding what order (if any) to make about costs, the court will have regard to all the circumstances …”.
A court may order that costs be paid either on the “standard basis” or the “indemnity basis.” In both cases, the court will disallow costs which were “unreasonably incurred or unreasonable in amount.” When costs are to be assessed on the “standard basis” the court will only allow costs which are “proportionate to the matters in issue,” and costs which it was “reasonable to incur.”
In the Courts and Legal Services Act 1990 (as amended) section 58A(6) says: “[a] costs order made in proceedings may not include provision requiring the payment by one party of all or part of a success fee payable by another party under a conditional fee agreement.” Section 58C says “A costs order made in favour of a party to proceedings who has taken out a costs insurance policy may not include provision requiring the payment of an amount in respect of all or part of the premium of the policy, unless such provision is permitted by regulations under subsection (2)” (Subsection 2 provides for regulations to allow the recovery of policy premiums in clinical negligence proceedings).
Agreements about costs in English court litigation
In the pre-CPR Court of Appeal case Gomba Holdings (UK) Ltd v Minories Finance Ltd (No.2)  Ch. 171 mortgage deeds required the borrowers to pay on demand and on a full indemnity basis all costs, charges and expenses however incurred by the bank or by a receiver under the mortgage or in enforcing the security. The Court of Appeal held:
“An order for the payment of costs of proceedings by one party to another party is always a discretionary order ...”
“Where there is a contractual right to the costs, the discretion should ordinarily be exercised so as to reflect that contractual right.”
In the post-CPR Court of Appeal case Venture Finance Plc v Mead  3 Costs LR 389 the Court of Appeal concerned guarantees under which the guarantors had promised: “I agree to pay you all costs and expenses (on a full indemnity basis) arising out of or in connection with the recovery of the monies due to you hereunder.” At first instance, the guarantors had nonetheless been ordered to pay only 50% of the lender’s costs. The Court of Appeal (Chadwick LJ) held:
“When deciding by whom costs should be paid – the court is exercising a discretion under CPR 44.3 [now CPR 44.2] and s 51(3) of the Supreme Court Act 1981 [now Senior Courts Act 1981].”
“… CPR 44.3(4) requires that when deciding what order (if any) to make about costs the court must have regard to all the circumstances; and those circumstances will include the fact, if it be the case, that there is a contractual obligation to pay costs.”
“I would allow the appeal and set aside the judge’s order. In its place I would order that each of the defendants pay the whole of the claimant’s costs of the proceedings …”
In the first instance case Astrazeneca UK Limited v International Business Machines Corporation  EWHC 3373 (TCC) the parties had agreed:
“[IBM] shall indemnify AstraZeneca … on demand from and against all Defence Costs incurred by AstraZeneca in connection with any Dispute in which judgment is given in AstraZeneca's favour.”
There was a similar provision requiring AstraZeneca to indemnify IBM in respect of Defence Costs incurred by IBM in connection with any Dispute in which judgment is given in IBM’s favour. “Defence costs” was defined so as to include: “reasonable attorney's fees and disbursements (calculated on a solicitor-own client basis)” - that is the same as the indemnity basis.
The court cited Gomba and ordered that IBM should pay 75% of Astrazeneca’s costs (presumably since that was the degree to which Astrazeneca was considered to have been “successful”) and these were to be assessed on the indemnity basis, saying (paragraph 46):
“… in exercising my discretion as to costs, I consider that where the parties have agreed the basis upon which costs are to be assessed, the court should ordinarily exercise its discretion so as to reflect those contractual rights and, in this case, should award costs on an indemnity basis.”
Gomba and Venture Finance concerned asymmetric agreements to the effect that if the lender won, the borrower / guarantor was to pay the lender’s costs on the indemnity basis. The Astrazeneca case is a symmetrical agreement - whichever side lost was to pay the winner on an indemnity basis - so would seem even less objectionable. Unsurprisingly, then, in Astrazeneca the court was prepared to exercise its discretion as to costs in accordance with what the parties had agreed.
It is common for companies’ articles of association to provide that the company will indemnify its directors, officers and auditors against liability incurred by them in defending any proceedings in which judgment is given in their favour. Although the articles of association are a contract between the company and its members, the directors or auditors might argue that when the company appointed them to their office, the same provision was incorporated into their contract with the company, and so if the company sues them and loses, it must indemnify them for their costs. In John v PricewaterhouseCoopers  1 WLR. 953 certain companies owned by the musical artist Elton John had brought a claim against their auditors and lost. A claim by auditors based on such a provision in the articles of association was discussed, but dismissed on other grounds, with the question of whether the term from the articles of association was incorporated into the auditors’ contract left unresolved.
In Renewable Power & Light Ltd v McCarthy Tetrault & Ors  EWHC 3848 (Ch) auditors relied successfully on an express clause in their terms of appointment which required their audit client to indemnify them:
“From and against … any and all … costs … (collectively “Losses”) of whatever nature … which are suffered or incurred by [auditor] … and which relate to or arise from directly or indirectly [auditor’s] engagement hereunder … and [company] shall reimburse [auditor] … for all costs, charges and expenses (including legal fees) as they are incurred by [auditor] … in connection with investigating, dealing with or defending any claims (whether actual, pending, threatened or potential) which so relate or arise.”
“Provided that the company will not be responsible for any Claims or Losses to the extent that they are found in final judgement by a court of competent jurisdiction to have resulted from a criminal or fraudulent act or the wilful default or negligence of [auditor] …”
The court in that case, applying Gomba, ordered the company to pay the auditor’s costs on the indemnity basis.
There is a distinct lack of case law about other “contractual rights to costs” in court litigation. For example, if the parties had agreed that each was to bear its own costs of any litigation, would the court exercise its discretion so as to “reflect that contractual right”, and made no order as to costs? Such an agreement seems unobjectionable, particularly if made between commercial parties, and such an allocation seems to have been endorsed by parliament in other dispute resolution contexts (see the discussion of adjudication below). But there does not appear to be any authority on the point.
A court would probably be much more reluctant to give effect to an agreement that the costs of both parties were always to be borne by the party making the claim. On one view, the courts should respect freedom of contract, but the mere fact of having agreed to such a one-sided clause suggests an inequality of bargaining power, with the clause having been imposed for the sole purpose of discouraging or stifling claims. The practical effect of such an agreement would tend to be to oust the jurisdiction of the court and deny access to justice, at least for smaller claims, where the combined cost of pursuing the claim, plus the costs of the other side of defending the claim might well exceed the sum in issue. Public policy would probably mean that such an agreement would not be given effect.
There is also the question of what a court would do if faced with an agreement that the unsuccessful party was to indemnify the successful party as to any success fee or costs insurance policy premium which the successful party might incur.
In the “indemnity” cases discussed above, the court had a statutory discretionary power to award the costs that were being sought. The parties could not, by agreement, exclude that discretionary power, or fetter the court in its exercise of that power. But, when exercising that power, the court would take the agreement into account.
In the case of success fees and costs insurance policy premiums, though, the default position is that the court does not have any statutory power to award those costs. An agreement that the losing party is to pay the winning party’s success fee and costs insurance policy premium is not an attempt to limit, exclude or fetter the exercise of a statutory power - it is just an agreement, which the court should presumably give effect to on its terms like any other contract.
Costs in the Arbitration Act 1996
The Arbitration Act 1996 defines “the costs of the arbitration” to mean the arbitrators’ fees and expenses, the fees and expenses of any arbitral institution and the legal or other costs of the parties. As discussed in previous articles, the phrase “other costs of the parties” is wide enough to include premiums charged by third party funders (Essar Oilfields Services Limited v Norscot Rig Management PVT Limited  EWHC 2361 (Comm)).
Section 61 of the 1996 Act says (emphasis added) “the tribunal may make an award allocating the costs of the arbitration as between the parties, subject to any agreement of the parties” and that “[u]nless the parties otherwise agree, the tribunal shall award costs on the general principle that costs should follow the event except where it appears to the tribunal that in the circumstances this is not appropriate in relation to the whole or part of the costs.”
Section 60 of the 1996 Act says (emphasis added) “an agreement which has the effect that a party is to pay the whole or part of the costs of the arbitration in any event is only valid if made after the dispute in question.”
What is section 60 of the Arbitration Act 1996 aimed at?
One of the general principles stated in section 1 of the Arbitration Act 1996 is that “parties should be free to agree how their disputes are resolved, subject only to such safeguards as are necessary in the public interest.” Parliament evidently thought that the restriction which section 60 imposes on the parties’ freedom of contract was “necessary in the public interest”, but the precise rationale is hard to pin down. The DAC reports (the reports which led to the Arbitration Act 1996, and which are used by the English courts as aids to interpreting that Act) say that: “public policy continues to dictate that such a provision should remain”, but do not say what the public policy in question is.
An agreement that “The Contractor shall pay all the costs of any arbitration in any event” or “the party serving the notice of arbitration shall pay all the costs of any arbitration in any event” is obviously invalid under section 60 because it would have the effect that a party was to pay “the whole or part of the costs of the arbitration in any event.”
Presumably, in prohibiting such agreements, section 60 is aimed, in some sense, at protecting a weaker party from having such an onerous obligation imposed upon them where there is some inequality of bargaining power:
(a) It might be that this was thought to be a particular problem in the case of arbitration because arbitration agreements often appear in international agreements where one or both parties are not dealing in their first language, and where the risks of signing up to an onerous clause without really understanding its significance is heightened.
(b) Equally, there is the fact that many arbitration agreements incorporate institutional rules by reference, and the parties might be unlikely to go and check what every line of the institutional rules says with respect to costs. Again there is a chance of “sneaking in” an onerous clause.
(c) A party which was to bring a claim, and had its claim upheld, but was nonetheless made to bear all the costs of the arbitration might well feel aggrieved, even if on one view it had only itself to blame for having been so careless as to agree to such an onerous clause in the first place. A few such experiences could put off potential users of arbitration, and affect England’s perceived attractiveness as an arbitration destination.
(d) Allowing agreements like the ones set out above might also tend to exacerbate disputes, increase costs and discourage settlements. The respondent to a claim would always fight every claim to the bitter end, knowing that even if it lost it would recover its own costs and would never have to pay those of the other side.
What about other agreements about arbitration costs?
There are, however, certain other agreements which are less obviously objectionable but which are also caught by section 60. An example would be the following agreement:
“In respect of any arbitration, each Party shall pay 50% of the arbitrators’ fees and expenses, 50% of the fees and expenses of any arbitral institution and shall pay the entirety of its own legal and other costs”
This is invalid, because it is an agreement that “part of the costs of the arbitration” will be borne by a party in any event. And yet in the adjudication context (discussed below) parties have been happy to agree that the costs of their disputes be dealt with on such a basis, and the courts have been happy to enforce such agreements.
There is also a certain tension between section 60 and 61. Section 61 provides that “the tribunal may make an award allocating the costs of the arbitration as between the parties subject to any agreement of the parties”. Presumably, therefore the parties could validly agree that “the tribunal shall have no power to make any award allocating the costs of the arbitration as between the parties”. Such an agreement would have the effect, though, that (contrary to section 60) “a party is to pay part of the costs of the arbitration in any event” because - in any event - each party is always to pay its own legal costs.
The same problem seems to apply to the following agreement:
“The arbitrators shall have no power to make any award the effect of which is that one party is required to pay the other in respect of a costs insurance policy premium, success fee, contingency fee, conditional fee, interest or other such financing cost which is incurred by that other party in connection with that party’s legal and/or other costs.”
Following the Essar case, such financing costs are part of the “costs of the arbitration.” An agreement that the tribunal is to have no power to award such costs would have the effect that the party which incurred those costs was “to pay part of the costs of the arbitration in any event.” The agreement would be void.
At the same time, there are other potential agreements which would dramatically depart from the default position in section 61, but would not seem to fall foul of the restriction in section 60.
(a) “The Contractor shall pay all the costs of any arbitration save in the event that the tribunal rolls a 6 (six) on a six sided die, in which event the costs of the arbitration shall be allocated in accordance with section 61 of the Arbitration Act 1996”. Such an agreement would not be caught by section 60, because it would not have the effect that the contractor is to pay the whole of the costs of the arbitration in “any” event. Rather, it identifies one “event” (rolling a six) where that is not to happen, and so section 60 does not apply.
(b) Perhaps rather more realistically, where an employer under a construction contract was concerned to discourage unrealistic, over-inflated claims being brought by a Contractor, the employer might propose an agreement that: “In the event that the Contractor makes any claim in an arbitration the Contractor shall pay all the costs of that arbitration save in the event that the Employer is ordered to pay the Contractor an amount equal to at least 75% of the largest amount which was at any time claimed by the Contractor (excluding interest and costs) in which event the costs of the arbitration shall be allocated in accordance with section 61 of the Arbitration Act 1996.” This should not fall foul of section 60 because it identifies one event (the Contractor recovering an amount equal to at least 75% of the largest amount which it has at any time claimed) where the Contractor is not to pay all the costs.
(c) Another possibility would be to agree that “in respect of any arbitration, each Party shall pay 50% of the arbitrators’ fees and expenses, 50% of the fees and expenses of any arbitral institution and shall pay the entirety of its own legal and other costs save in the event that any Party is found to have committed fraud, wilful misconduct or gross negligence, in which event the costs of the arbitration shall be allocated in accordance with section 61 of the Arbitration Act 1996.” This echoes the mutual indemnity provisions which are often seen in petroleum industry contracts, and would create a position similar to that in US court litigation (where each party typically bears its own costs) while admitting of a limited exception in order to avoid falling foul of section 60.
There is thus something of a ‘loophole’ in section 60 of the Arbitration Act 1996, but it seems under-used. There is no case (at least which I could find) where a court has had to consider whether an agreement which the parties made about how costs were to be allocated was compatible with section 60. In practice, it seems, parties to arbitration agreements are generally content to have the default rule in section 61 apply, and rarely (if ever) try to agree anything different.
Quite why this should be the case is something of a puzzle, since in the adjudication context (discussed below) parties and institutions seem to have been very keen to try to make agreements in advance about how the costs of adjudications are to be allocated.
Costs in adjudication under HGCRA 1996
“Adjudication” is the name given to a system of provisionally binding dispute resolution used in the (UK) construction industry, whereby parties can quickly appoint adjudicators who will decide claims on a provisional basis in advance of a full court case or arbitration to make a final decision on the claims.
A statutory right to adjudication was introduced more than 20 years ago to address perceived problems with respect to cash flow in the construction industry, which is of course a major employer. In the course of a construction project, costs would arise which were (or were arguably) for the employers’ account under the terms of the contract. Developers - who employ far fewer people - would decline to pay, forcing contractors, already operating on narrow margins, to complete the project and to carry these costs until they could recover them through court proceedings or arbitrations which might take years to reach a conclusion.
The Housing Grants (Construction and Regeneration) Act 1996 (“HGCRA 1996”) provided that a party to a construction contract was to have the right at any time to refer a dispute arising under the contract for adjudication under a procedure complying with section 108 of that Act. If the parties did not provide for such a procedure in their contract a statutory scheme would apply. The effect is that in many cases where employers would previously have held the money, now contractors would do so. Contractors could use money awarded by adjudicators to keep their businesses going and (crucially) pay their employees. If it should turn out, following an arbitration or a trial that the contractor had no such entitlement, the risk of the contractor’s default would be on the developer.
HGCRA 1996 does not contain any provisions analogous to sections 60 and 61 of the Arbitration Act 1996. There was no requirement that the construction contract give the adjudicator the power to award legal costs. Neither, though, was there any limitation upon what the parties could agree with respect to adjudicators’ powers to award costs. The default statutory scheme gave the adjudicator an entitlement “to payment of such reasonable amount as he may determine by way of fees and expenses reasonably incurred by him” but it does not provide for the adjudicator to have any power to award legal costs.
If the parties did not make any agreement about their costs, the costs would lie where they fall, with each party bearing its own costs. This is confirmed in the first instance case WES Futures v Allen Wilson Construction  EWHC 2863 (TCC): “… if a successful party cannot recover its costs in the adjudication itself, it cannot recover them in enforcement proceedings either.”
Various standard sets of adjudication rules were published by different industry bodies, and standard form construction contracts would provide for adjudication in accordance with one or other of those rule sets. The various rules took different approaches to costs:
(a) The most common approach seems to have been that parties were to bear their own costs (ICE Adjudication procedure, JCT Standard Form of Building Contract (1998), CIC Model Adjudication Procedure). Had the parties made such an agreement in respect of an arbitration, it would have been invalid under section 60 of the Arbitration Act 1996.
(b) In a few instances, rules would provide that adjudicators were to have the right to award costs (e.g. GC/Works/1 (1998)).
In other cases parties eschewed (or modified) these institutional rules and made their own, bespoke, agreements about how the costs of any adjudication would be allocated.
In the first instance case of Bridgeway Construction Ltd v Tolent Construction Ltd  EWHC 248 (TCC) the parties had agreed:
“The party serving the Notice to Adjudicate shall bear all of the costs and expenses incurred by both parties in relation to the adjudication, including but not limited to all legal and experts fees.”
“The party serving the Notice to Adjudicate shall be liable for the adjudicator’s fees and expenses.”
In that case a subcontractor obtained an award against a contractor. The adjudicator, applying the provisions above, deducted from the award an amount equal to the contractor’s costs. The subcontractor challenged this aspect of the award, claiming that the clause requiring it to bear the contractor’s costs was unenforceable because its effect would be to inhibit people from pursuing the rights which the HGCRA 1996 conferred. The court declined to interfere with the contract (paragraph 29 of the judgment):
“It seems to me that main contractors and subcontractors are entitled to develop contracts to implement Acts of Parliament. … The mere fact that in this particular case the claimants are disgruntled, perhaps understandably so, about their costs situation, does not entitle me to say, “Well, these clauses are a bit unfair. Let’s change them.”
Section 141 of the Local Democracy, Economic Development and Construction Act 2009 (“LDEDCA 2009”) inserted a new section 108B into the HGCRA 1996:
“108A Adjudication costs: effectiveness of provision
(1) This section applies in relation to any contractual provision made between the parties to a construction contract which concerns the allocation as between those parties of costs relating to the adjudication of a dispute arising under the construction contract.
(2) The contractual provision referred to in subsection (1) is ineffective unless—
(a) It is made in writing, is contained in the construction contract and confers power on the adjudicator to allocate his fees and expenses as between the parties, or
(b) it is made in writing after the giving of notice of intention to refer the dispute to adjudication.”
The new section 108A was introduced with effect from 1 October 2011, and so contracts entered into before that date were unaffected.
The first possible reading is that section 108A allows agreements about the allocation of costs to be enforced, provided that with respect to the adjudicator’s fees, the parties have agreed that the adjudicator shall have the power to allocate those before the parties. If that first interpretation was correct then the Clause in Tolent would be enforceable, if it were amended as follows:
“The party serving the Notice to Adjudicate shall bear all of the costs and expenses incurred by both parties in relation to the adjudication, including but not limited to all legal and experts’ fees, saving that the adjudicator shall have the power to allocate his fees and expenses between the parties.”
The second possible reading of it is to read the words in 108A(2)(a) to mean that the only (pre-referral) “contractual provision … which concerns the allocation as between [the] parties of costs relating to the adjudication …” which will be enforceable is an agreement to confer power on the adjudicator to allocate his fees and expenses as between the parties.
An agreement which conferred such a power, but also made some other provision regarding the allocation of the parties’ other costs would be invalid. Hence a Tolent type agreement that one party was to bear those costs in any event would be invalid. But an agreement that the adjudicator was to have the power to allocate those costs as between the parties would be invalid too. The effect of section 108A would be that adjudication costs lie where they fall, and that it is only adjudicators’ fees and expenses which can be allocated as between the parties.
In Pepper v Hart  UKHL 3 Lord Browne-Wilkinson (in the majority) said:
“… references in court to Parliamentary material should only be permitted where such material clearly discloses the mischief aimed at or the legislative intention lying behind the ambiguous or obscure words. In the case of statements made in Parliament, as at present advised I cannot foresee that any statement other than the statement of the Minister or other promoter of the Bill is likely to meet these criteria.”
When the relevant minister introduced the Local Democracy, Economic Development and Construction Bill for its second reading she said (emphasis added):
“Clause 137 inserts new section 108A into the 1996 Act, preventing parties to construction contracts from entering into agreements before a dispute has arisen about who should pick up the costs of an adjudication. As a consequence of this broad and simple prohibition, pre-dispute agreements between parties, to the effect that an adjudicator can allocate fees and expenses as part of his decision, will also be caught. Allowing the parties to agree in their construction contract that the adjudicator has this power is current good practice, which we would like to preserve. Amendment 22 achieves that by carving out such agreements from the general prohibition.”
The phrase “agreement … about who should pick up the costs of an adjudication” suggests that what the bill was aimed at was an agreement which allocates costs to a party which, absent that agreement, would not have borne those costs. The minister’s statement therefore supports the second interpretation - the effect of section 108A is that, except for adjudicator’s fees and expenses, costs of adjudication lie where they fall and each party bears its own costs of any adjudication.
That, of course, goes rather wider than just prohibiting a Tolent type clause, because it also has the effect of prohibiting a clause which gives the adjudicator the power to allocate costs. Quite what parliament thought objectionable about that second kind of clause is not explained. But then, if parliament had just wanted to prohibit Tolent type clauses while still permitting agreements which give the adjudicator the power to allocate costs, parliament could just have used the same wording as in section 60 of the Arbitration Act 1996.
Yuanda and Leander
The first instance case Yuanda v WW Gear  EWHC 720 (TCC) (13 April 2010) concerned an agreement that:
“regardless of the eventual decision in the adjudication or in any subsequent litigation the Trade Contractor agrees that should he make a reference to Adjudication under the terms of this contract then he will be fully responsible for meeting and paying both his own and the Employer's legal and professional costs in relation to the Adjudication”
This agreement had been made before the new section 108A came into force, and so the new s.108A did not apply. The judge nonetheless held that the clause was invalid, departing from the approach which had been taken in Tolent.
The judge held:
“I consider that clause 9A would in practice limit [the Trade Contractor’s] freedom to refer a dispute to adjudication at any time and, in some circumstances – such as in a dispute involving a relatively small amount of money – to deprive it of a remedy altogether. I must therefore respectfully disagree with the conclusion reached by HH Judge Mackay in the Tolent case, at least on the basis of the wording of clause 9A in this particular contract.”
The judge also said that the clause would have been prohibited by the new section 108A but this was only obiter, and the judge did not explain precisely how he thought section 108A is thought to render a Tolent type clause ineffective.
In another first instance case Leander Construction v Mulalley & Co Limited  EWHC 3449 the judge “note[d] in passing” that the contract (which, again, had been made before the new section 108A came into force) required the claiming party in any adjudication to “bear all of the costs and expenses incurred by both parties”. The judge said that “Now, such a clause would automatically be invalid pursuant to section 141 of the [LDEDCA 2009].” But, again, this judgment was only obiter (the enforceability of this agreement was not even in issue in the case) and the judge did not explain precisely why he thought section 108A would have rendered the agreement ineffective.
In the Scottish case Profile Projects Ltd v Elmwood (Glasgow) Ltd  CSOH 64 the court considered a clause which said:
“the referring party shall bear the whole costs of the adjudication including, but not limited to the Adjudicators’ fees and costs in their entirety and both parties’ legal expenses (on a solicitor and client basis and upon the scale of charges applicable to Court of Session business) in and incidental to the adjudication”
This clause was, again, agreed before the new section 108A came into effect, so the case is not directly concerned with the effect of section 108A. The question for the court was whether the reasoning in Yuanda was correct - did the HGCRA 1996 already prohibit Tolent-type clauses, even before the new section 108A was inserted?
The judge said:
“It is to be assumed that Parliament knew the existing law when it passed the 2009 Act … If “Tolent” clauses were ineffective under the [HGCRA 1996], Parliament was wasting its time in enacting this section of the 2009 Act.”
“[T]he Yuanda clause … was not reciprocal but one sided — if the contractor referred a dispute to adjudication he was required to pay the costs, but there was no corresponding obligation on the employer. This lack of reciprocity was considered relevant in Yuanda ... In the present contract there is reciprocity; the clause applies to both parties to the contract, and was agreed when no one knew to whose benefit it might operate. … [T]he clause in Yuanda placed no limit on the amount of expenses which the respondent might incur and for which the referring party would be liable — there was no provision for reasonableness. This was an important factor in the judge’s reasoning in the Yuanda ... By contrast, the clause in the present case provides an entitlement to refer the account of expenses to taxation on the Court of Session scale, so there is provision for reasonableness.”
“In determining whether an Act impliedly strikes down an agreement, it is necessary to ask (1) What rights have been given to parties by Parliament? (2) Are those rights inalienable? and (3) Does the agreement in question amount to the alienation of an inalienable right? That is the process which should be followed to assess if the contractual provision is struck down by the Act. This was not done in Yuanda. In that case the judge stated his opinion (without any evidence to support it) that some parties might be discouraged from exercising their right to go to adjudication, notwithstanding that the contract does not purport to take away that right; he took the view that a clause which has the practical effect of discouraging a party from availing himself of a statutory right falls to be equiparated with a clause which deprives that party of the statutory right. Counsel described that as a giant and unjustifiable leap. In the present case, the contract does not omit any of the matters which s.108 of the Act requires it to include; on the contrary, every right which s.108 requires to be conferred on the contracting parties is conferred. Neither of the parties appears to have ever entertained any apprehension that the pursuers had been deprived, either as a matter of form or of practicality, of their right to adjudication, and the pursuers exercised that right without any apparent hesitation. For these reasons, the contract terms in the present case are effective and are not inconsistent in any relevant way with the requirements of the Act.”
Conclusion (or lack thereof) on Tolent clauses
The judges in Yuanda, Leander and Profile Projects all seem to have assumed (obiter) that the effect of section 108A would be to render a Tolent type clause ineffective. Where these judgments differ is on the question of whether such clauses were already unenforceable, even absent that amendment, under section 108 HGCRA 1996.
The editors of Keating on Construction Contracts 10th Ed. (2016) write:
“The wording of [section 108A] is unfortunate because it appears to allow the parties to agree on the allocation of the parties’ costs provided that the provision also, rather than only, confers power on the adjudicator to allocate its fees and expenses as between the parties. The former meaning would deprive the section of any real effect and it is thought that the courts are unlikely to adopt that interpretation.”
Coulson J writing in a non-judicial capacity as the author of Construction Adjudication 3rd Ed. (2015) described the wording of section 108A as “inept” and likewise thought it arguable that section 108A allows parties to allocate their fees by agreement before any adjudication commences provided they also agree that the adjudicator may allocate his fees and expenses.
As yet, there do not seem to be any cases where the effect of section 108A has been tested and conclusively determined - i.e. there is no case where a court has had to decide whether a Tolent type clause which gave the adjudicator the power to allocate costs between the parties was rendered unenforceable by section 108A. But it seems likely (given the parliamentary record) that section 108A requires that, absent a post-referral agreement, the costs of an adjudication lie where they fall, saving only that the parties may agree to confer power on the adjudicator to allocate his own fees and expenses as between the parties.
Institutional rules post-LDEDC 2009
Some examples of provisions with respect to the parties’ legal costs in adjudication rules published since the new section 108A was introduced are:
(a) The ICE Adjudication Procedure 2012 include a provision for the adjudicator to be allowed to allocate his fees and expenses between the parties. With respect to the parties’ other costs Rule 6.5 says: “The Parties shall bear their own costs and expenses incurred in the adjudication …”. This just reproduces the default position at law.
(b) The TecSA Adjudication Rules v3.2.1 include a provision for the adjudicator to be allowed to allocate his fees and expenses between the parties (Rule 23). With respect to the parties’ other costs Rule 25 says: “If the Parties so agree in writing after any Party has given a Notice in accordance with Rule 3, the Adjudicator shall have jurisdiction to award the parties’ legal and expert costs in relation to the adjudication as he sees fit.” Such an agreement would be valid by virtue of section 108A(2)(b).
(c) The TECBAR Adjudication Rules 2012 (Rule 8) provide for liability for the adjudicator’s fees and expenses to be regulated by paragraph 25 of the statutory scheme, which provides for the adjudicator to be allowed to allocate his fees and expenses between the parties. With respect to the parties’ other costs Rule 8 says: “Unless otherwise agreed, the adjudicator has no power to order one party to pay the costs incurred by the other party.” It is not specified that the agreement should be made after the giving of notice of intention to refer the dispute to adjudication, leaving open the possibility of a pre-referral agreement.
(d) The CEDR Rules for Construction Adjudication 2016 include a provision for the adjudicator to be allowed to allocate his fees and expenses between the parties. With respect to the parties other costs: “Each party shall bear its own costs. The Adjudicator may not decide the parties’ legal and other costs arising out of or in connection with the adjudication unless the parties otherwise agree.” It is not specified that the agreement should be made after the giving of notice of intention to refer the dispute to adjudication.
Late Payment of Commercial Debts
The Late Payment of Commercial Debts (Interest) Act 1998 (“Late Payment Act”) “applies to a contract for the supply of goods or services where the purchaser and the supplier are each acting in the course of a business, other than an excepted contract …[the “excepted contracts” are consumer credit agreements and contracts intended to operate by way of mortgage, pledge, charge or other security]. Hence the Late Payment Act applies to construction contracts.
Briefly, the effect of section 1(1) of the Act is to imply into such a contract a term providing for the payment of simple interest at a statutorily pre-determined rate on debts created by virtue of the obligations in the contract.
Directive 2011/7/EU says:
Compensation for recovery costs
1. Member States shall ensure that, where interest for late payment becomes payable in commercial transactions in accordance with Article 3 or 4, the creditor is entitled to obtain from the debtor, as a minimum, a fixed sum of EUR 40.
2. Member States shall ensure that the fixed sum referred to in paragraph 1 is payable without the necessity of a reminder and as compensation for the creditor’s own recovery costs.
3. The creditor shall, in addition to the fixed sum referred to in paragraph 1, be entitled to obtain reasonable compensation from the debtor for any recovery costs exceeding that fixed sum and incurred due to the debtor’s late payment. This could include expenses incurred, inter alia, in instructing a lawyer or employing a debt collection agency.”
Pursuant to this Directive, parliament inserted a new Section 5A into the Late Payment Act:
“5A Compensation arising out of late payment
(1) Once statutory interest begins to run in relation to a qualifying debt, the supplier shall be entitled to a fixed sum (in addition to the statutory interest on the debt).
(2) That sum shall be–
(a) for a debt less than £1000, the sum of £40;
(b) for a debt of £1000 or more, but less than £10,000, the sum of £70;
(c) for a debt of £10,000 or more, the sum of £100.
(2A) If the reasonable costs of the supplier in recovering the debt are not met by the fixed sum, the supplier shall also be entitled to a sum equivalent to the difference between the fixed sum and those costs.]
(3) The obligation to pay under this section in respect of a qualifying debt shall be treated as part of the term implied by section 1(1) in the contract creating the debt.”
A question therefore arises whether a “supplier” which pursues an adjudication is entitled to recover his reasonable costs of the adjudication under these provisions. If so, is there not a conflict between the term which is implied by section 5A of the Late Payment Act and section 108A of the HGCRA?
Lulu Construction Limited v Mulalley & Co Limited  EWHC 1852 (TCC) concerned an unusual situation were a subcontractor (“Lulu”) asserted a claim against a contractor (“Mulalley”) in correspondence, and Mulalley referred to adjudication the question of how much it was properly liable to pay Lulu.
The adjudicator ordered that Mulalley make a substantial payment to Lulu. This included £47,666.27 for what were described as “debt recovery costs” said to be due under section 5A of the Late Payment Act. These were Lulu’s costs of running the adjudication. Mulalley paid the rest of the sum awarded, but declined to pay these “debt recovery costs”. Lulu applied for summary judgment in respect of that part of the award.
Mulalley argued that the adjudicator had no jurisdiction to make that part of the award, because Lulu’s claim in respect of “debt recovery costs” had not been referred to the adjudicator (it was not referred to in Mulalley’s Notice of Adjudication or Referral Notice, nor in Lulu’s response. It was pleaded, for the first time, in Lulu’s rejoinder.
The court referred to an earlier judgment in Allied P& L Limited and Paradigm Housing Group Limited  EWHC 2890 (TCC) where it was said that:
“The ambit of the reference to arbitration or adjudication may unavoidably be widened by the nature of the defence or defences put forward by the defending party in adjudication or arbitration … In my view, one should look at the essential claim which has been made and the fact it has been challenged as opposed to the precise grounds upon which it had been rejected or not accepted. Thus, it is open to any defendant to raise any defence to the claim when it’s referred to adjudication …”
“It follows from the above that if the basic claim, assertion or position has been put forward by one party and the other disputes it, the dispute referred to adjudication will or may include claims for relief which are consequential upon and incidental to it and which enable the dispute, effectively, to be resolved. Thus, even if the claim did not as such seek a declaration or discretionary interest or costs, it is so connected with and ancillary to the referred dispute as properly to be considered as part of it. There must be limits to this which can be determined by analysing what the essential dispute referred is.”
The judge in Lulu held that the “debt recovery costs”:
“… are clearly connected with and ancillary to the referred dispute and must properly be considered part of it. It follows, in my view, that the adjudicator was correct to say that he had jurisdiction to decide this element of the dispute: although it was not within the scope of the referral, it was something which was connected with and ancillary to that referred dispute. So, therefore, in my judgment, there is no answer to the application for summary judgment in relation to that sum.”
It is important to note that what the court was asked to decide in Lulu was whether Lulu’s claim for “debt recovery costs” had been referred to the adjudicator. Provided it had been referred to the adjudicator, he had jurisdiction to decide it, and his decision would be (provisionally) enforceable, irrespective of whether it was right or wrong as a matter of law (following Bouygues (UK) Ltd v Dahl-Jensen UK Ltd  EWCA Civ 507).
Lulu does not resolve the question of whether, as a matter of law, a “supplier” can recover its adjudication costs under section 5A of the Late Payment Act.
Enviroflow Management Ltd v Redhill Work (Nottingham) Ltd is a first instance decision given on 16 August 2017 by O’Farrell J. Enforcement was sought of an adjudication award which had included an order that the unsuccessful respondent pay £14,900 in respect of the reasonable costs of recovering the debt. At the time of publication we have been unable to obtain a transcript of the judgment - it is still being transcribed by the shorthand writers and has yet to be approved by the judge. But the summary on Lawtel says:
“The Late Payment of Commercial Debts (Interest) Act 1998 s.5A provided for an implied term in a contract that a successful party was entitled to its costs of recovering a debt. The Housing Grants, Construction and Regeneration Act 1996 s.108A as amended provided that where a construction contract had been referred to adjudication, the costs of an adjudication could only be awarded where such a provision had been made in writing. Accordingly, by reason of the 1998 Act, the claimant was entitled to seek its reasonable costs by reason of an implied term. However, such an implied term was caught by s.108A of the 1996 Act and was ineffective unless an agreement had been made in writing. It was common ground that no agreement had been made in writing. Therefore the adjudicator had had no jurisdiction to make a costs award. The claimant was awarded judgment minus the sum awarded in the reasonable recovery of its costs.”
It will be recalled that, to be effective, a contractual provision which concerns the allocation of costs relating to adjudication must be: “made in writing, … contained in the construction contract and confer … power on the adjudicator to allocate his fees and expenses as between the parties.”
From the description on Lawtel the reason why the term which is implied into a contract by section 5A of the Late Payments Act is not effective is simply because it is not “made in writing.”
It is difficult to comment without having seen the judgment, but this does give rise to some questions. It is not clear whether the parties had, by their agreement, given the adjudicator a power to allocate his fees and expenses. Nor whether the court thought that other agreements as to the allocation of costs are effective provided the adjudicator is also given such a power. It is not clear what the position would be if the parties had instead set out in their written contract the term which is implied by section 5A of the Late Payments Act.
An alternative approach would have been to say that the effect of section 5A of the Late Payments Act is to deem the parties to have “made” an agreement in the terms which are set out (by parliament) “in writing” in section 5A “(“if the reasonable costs of the supplier in recovering the debt are not met by the fixed sum, the supplier shall also be entitled to a sum equivalent to the difference between the fixed sum and those costs”).” That being the case, there is an “agreement in writing” for the purposes of section 108A of the HGCRA 1996 Otherwise, parliament has acted in vain, by implying a term into contracts by the Late Payments Act, and then invalidating that same term by section 108A.
It also needs to be borne in mind that parliament enacted section 5A of the Late Payments Act in order to comply with its obligation, imposed by the EU Directive, to “ensure that” “[t]he creditor shall, in addition to the fixed sum … be entitled to obtain reasonable compensation from the debtor for any recovery costs exceeding that fixed sum and incurred due to the debtor’s late payment” and that “[t]his could include expenses incurred … in instructing a lawyer …”. The interpretation suggested above would avoid a breach of the directive.
The discussion above concerns “construction contracts” which are, by section 108 of HGCRA 1996, required to provide for adjudication. “Construction contracts” means (in summary) a contract for the carrying out of “construction operations” in England, Wales, Scotland or Northern Ireland.
A contract for the carrying out of “construction operations” in another country, even if it were subject to English law and English court jurisdiction (or English seated arbitration) is not required to provide for adjudication.
Many other operations are excluded from the definition of “construction operations.” For example, drilling for and extraction of oil and natural gas, extraction of minerals, and certain construction works associated with nuclear processing, power generation, water treatment, effluent treatment, production, transmission, processing or bulk storage of chemicals, pharmaceuticals, oil, gas, steel or food and drink.
Yet these kind of operations are at least closely analogous to “construction operations”, and give rise to the same kind of disputes and cash flow problems which were thought to have justified imposing the statutory right to adjudication. There is nothing to prevent parties to those kinds of contracts, or foreign construction contracts, including an adjudication clause.
In those kinds of contract, though, the right to adjudication is not mandated by statute, but is entirely a creature of contract, created and defined by the parties - a right which is additional to those which the parties enjoy at law. The parties can define the scope of that right however they wish, and agree whatever they like with respect to who is to bear the costs of any adjudication.
There are, of course, other contractual dispute resolution methods in respect of which parties might make agreements in advance about who is to bear the costs.
One example is mediation. Sometimes (albeit rarely) contracts will provide for a ‘tiered’ system of dispute resolution which includes compulsory mediation before arbitration or court proceedings are commenced. There is no reason why a contract which included such a provision could not specify who was to bear the costs of such a mediation. Indeed, where such clauses are used, they generally make it clear that each party is to bear its own costs in any event.
Expert determination is another example of a dispute resolution methodology. The parties agree that some dispute (usually a dispute on a very specific, technical question) is to be determined by an expert, and the expert’s decision is to be final and binding and determinative of the parties’ rights under their contract. For example, it is common in contracts for the sale and purchase of companies to provide for “completion accounts” to be prepared and agreed between buyer and seller which describe what was the company’s financial position on the completion date. The final price which is payable for the company is to be calculated by reference to the values stated in the completion accounts.
Where the parties cannot agree on completion accounts, there is often a provision for the seller to be allowed to refer a dispute about the completion accounts to be decided by an expert accountant. Such contracts may provide for how the costs of any such expert determination are to be allocated - typically each party is to bear its own costs, with the referring party to pay the expert’s fees.
Construction is complicated, slow, expensive and risky. Developers and the consultants they pay must contend with the frustrations of the planning system and extensive regulation. Developers must make provision for contingencies and claims by the contractors, and pay lawyers and experts. It may not be until long after completion that the final cost of a project is known and resources are freed up to be redeployed more productively.
Statutory adjudication potentially exacerbates this risk and uncertainty. Employers face the prospect of having to contest in a short time frame claims which contractors have prepared at their leisure These claims will be determined in a relatively summary way (it is not fair to say that adjudication is always “quick and dirty” or approximative, but there is a grain of truth in such characterisations). And an employer who is unsatisfied with an adjudicator’s decision must pursue court proceedings or an arbitration to reverse it. In the interim, the contractor holds the money and the employer has no security.
Of course, none of this is a problem if contractors are making well-founded claims which reflect their contractual entitlements. An employer can hardly complain about having to pay a contractor what is due. A perception persists, though, because claims cannot be subject to the same scrutiny as in arbitration or court proceedings, adjudication encourages contractors to take a chance on inflated, speculative claims. Employers have sought to address this by making agreements about how costs are to be allocated. But even innocuous agreements to the effect that the adjudicator is to have the power to award costs have been outlawed. Since each party must bear its own costs, and so contractors cannot be penalised there is little disincentive to bringing a speculative claim.
Inflated claims create inefficiencies, because both developers and contractors must pay lawyers, experts and tribunals, and must spend management time on these matters and set aside resources which could be used elsewhere. And routinely inflated claims are not just a problem in adjudication - they arise in arbitration and court too.
An agreement in advance about how the costs of an arbitration will be allocated might do something to discourage inflated claims. Above, I suggested that section 60 of the Arbitration Act 1996 would not prohibit an agreement that the Contractor was to pay the costs of an arbitration unless it is recovering an amount equal to at least (say) 75% of the largest amount which it had at any time claimed. Where statutory adjudication applied, this wording would need to be re-worked, because the contractor might not be claiming anything in the arbitration - the employer might be making a claim to reverse the effect of an adjudication award. For that kind of contract, adding a further clause along the following lines might work:
“In the event that: (i) the Contractor brings any claim by way of adjudication; and (ii) any adjudication award is made in the Contractor’s favour in respect of that claim; and (iii) the Employer seeks a final determination of that claim in arbitration proceedings then the Contractor shall pay all the costs of the arbitration save in the event that the tribunal determines that the Employer’s proper liability to the Contractor in respect of that claim is equal to at least 75% of the largest amount which was at any time claimed by the Contractor (excluding interest and costs) in which event the costs of the arbitration shall be allocated in accordance with section 61 of the Arbitration Act 1996.”
There is scope for argument, of course, about whether this would strike the right balance, such as to dissuade speculative inflated claims without stifling well-founded ones. And the precise terms would be a matter for negotiation in each case. My point, though, is that similar clauses might offer employers a means of discouraging inflated, speculative adjudication and arbitration claims, which seems a legitimate use of the underused ‘loophole’ (such as it is) in section 60 of the Arbitration Act 1996.