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28 July 2020

Adjudication v Insolvency Set-Off

It is an unfortunate reality that the number of insolvencies in the construction sector seems certain to rise in coming months as the economic impact of COVID-19 takes effect.  In this context, the recent Supreme Court decision in Bresco Electrical Services Ltd (In Liquidation) v Michael J Lonsdale (Electrical) Ltd [2020] UKSC 25 is particularly relevant.

This case concerned important questions regarding the compatibility of two statutory regimes:

  • the adjudication of construction disputes pursuant to section 108 of the Housing Grants, Construction and Regeneration Act 1996, (Construction Act); and
  • the operation insolvency set-off pursuant to Rule 14.24 and 14.25 of the Insolvency (England & Wales) Rules 2016 (Insolvency Rules).

While adjudication was intended to resolve disputes on an interim basis for cashflow purposes on a “pay now, argue later” basis, it has quickly become the default method of dispute resolution in the construction industry.

The Insolvency Rules provide that an account be taken of all claims and cross-claims between an insolvent company and each creditor, which has the effect of producing a “net balance” due to the either the insolvent company or the creditor.

The Court of Appeal described adjudication as “a method of obtaining cashflow quickly”, whereas the regime under the Insolvency Rules is “an abstract accounting exercise, principally designed to assist the liquidators in recovering assets in order to pay a dividend to creditors”. On a literal reading of the individual regimes, both are valid descriptions and stark in their application. In this case the Supreme Court was required to untangle them.

Background

The facts were not in themselves unusual.  In 2014, Bresco Electrical Services Ltd (Bresco) was employed to perform electrical installation works by Michael J Lonsdale (Electrical) Ltd (Lonsdale). Having ceased to attend the site in December 2014, Bresco entered creditor’s voluntary liquidation in March 2015. Bresco and Lonsdale made various claims against each other for damages.

In June 2018, Bresco served Lonsdale with notice of intention to refer a dispute to adjudication. Faced with the unappealing prospect of defending an adjudication brought by an insolvent company, Lonsdale sought an injunction from the Technology and Construction Court (TCC). 

Lonsdale argued that:

  • Bresco’s claim and Lonsdale’s cross-claim had cancelled each other out by the process of insolvency set-off. This meant there was no longer any claim, or therefore any dispute under the contract, so adjudication was unavailable (jurisdiction point).
  • The adjudication was pointless as the adjudicator’s decision would not be enforced until the liquidator calculated the net balance (futility point).

Bresco appealed to the Court of Appeal, which upheld the injunction on the basis for the futility point, but rejected the jurisdiction point.  Bresco appealed again to the Supreme Court. Lonsdale cross-appealed on the jurisdiction point.

The decision

  1. The jurisdiction point

The Supreme Court found that the adjudicator did have jurisdiction: the right to refer a dispute under the Construction Act was not extinguished by operation of the Insolvency Rules.

The Supreme Court rejected Lonsdale’s argument that claims subject to insolvency set-off lose their separate identity when amalgamated into the final net balance. When a liquidator pursues a claim, it “…remains one based upon the underlying contract, even if an undisputed set-off is acknowledged, or a disputed set-off is raised by way of defence”. It similarly made no difference as to whether the cross-claim was less (or significantly less) than the claim of the insolvent company, or whether it exceeded it. The only limitation on the adjudicator’s jurisdiction was that, in the event the cross-claim was greater, the balance could not be awarded to the creditor by the adjudicator, although a declaration could be made as to its value.

  1. The futility point

The Court of Appeal had decided that adjudications brought by insolvent companies would be a waste of time and money for all parties, as the awards could not be enforced other than in “exceptional circumstances” (see Meadowside Building Developments Ltd v 12-18 Hill Street Management Company Ltd [2019] EWHC 2651 (TCC)).

The Supreme Court rejected this view: it would be inappropriate for the court to enforce injunctive relief over a party’s attempt to “enforce a contractual right, still less a statutory right”.

In any event, adjudication, as a mainstream form of alternative dispute resolution, is a tool that can (and should) be utilised in its own right “…even where summary enforcement may be inappropriate or for some reason unavailable”. The Supreme Court therefore considered that there may be a practical utility in allowing insolvent companies to adjudicate, despite the potential enforceability enforcement challenges, which could be dealt with on a case by case basis.

As doubtless many companies face the squeeze of the upcoming recession, the ability to adjudicate could potentially become a key tool for insolvency practitioners seeking to efficiently determine claims and cross-claims. Their next challenge will be to overcome the requirement to provide adequate security to the solvent defendant – it is likely that the courts will be asked to consider some creative solutions to this funding challenge in the coming months. 

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