Insolvency and adjudication – a compatible mix?
Construction litigation is no stranger to insolvency, including insolvent claimants. This is also the case for adjudication, a fast and commercially driven form of dispute resolution for the construction industry. However, there has been considerable uncertainty as to theenforceability of adjudicators’ awards where a claimant is insolvent and receives a favourable decision. Recent cases have shed some light on this issue and have started to untangle the statutory difficulties when insolvency meets adjudication.
Bresco - Incompatibility of adjudication and insolvency
The Court of Appeal decision in Bresco Electrical Services Ltd (in liquidation) v Michael J Lonsdale (Electrical) Ltd (January 2019) highlighted the apparent incompatibility between adjudication and the insolvency regime. The Court gave guidance as to the extent (if at all) to which an adjudicator can decide claims made by an insolvent claimant which can then be immediately enforced.
Lonsdale entered into a subcontract for the provision of electrical works by Bresco. Bresco went into insolvent liquidation six months later. There were cross-allegations made by both parties concerning monies owed and termination of the subcontract. Three years after the liquidation, Bresco’s liquidator commenced an adjudication against Lonsdale claiming damages and payment for work completed.
Fraser J in the TCC granted an injunction (preventing the continuation of the adjudication) citing two key points:
I. a lack of jurisdiction – the adjudicator did not have the necessary jurisdiction to deal with claims advanced by an insolvent company because the dispute arises in the liquidation, rather than under the construction contract; and
II. the basic incompatibility of adjudication and the insolvency regime (the ‘utility argument’) – they are different processes, with different outcomes. Adjudication claims by contractors in insolvent liquidation, for example, are highly likely to be futile and incapable of enforcement where there is a crossclaim.
Bresco appealed to set aside the injunction and the matter came before Coulson LJ in the Court of Appeal.
Coulson LJ disagreed with the jurisdictional issue, noting that “Bresco’s right to refer a dispute to adjudication was not automatically lost when they went into liquidation”. Insolvent parties are able to pursue claims in litigation or arbitration, and adjudication should be no different. However, this was only the first step in the analysis. It was also necessary to consider the “utility” of the adjudication proceedings.
The judge agreed with the ‘utility argument’. There could be a significant risk that Bresco would be unable to repay the adjudication judgment sum should any Lonsdale cross-claims be successful. As such, there was almost no prospect of an adjudicator’s decision being enforced and therefore pursuing the adjudication, and incurring wasted costs in doing so, would be futile.
Coulson LJ did note that there may be “exceptional circumstances” in which such an adjudication would have practical utility. Step forward the case of Meadowside.
Meadowside – “Exceptional circumstances”
The recent decision in Meadowside Building Development Ltd v 12-18 Hill Street Management Company Ltd (October 2019) saw the court expand on the “exceptional circumstances” referred to in Bresco.
Meadowside was appointed by HSMC to carry out repair works under a JCT Minor Works Building Contract. Soon after completion of the works, Meadowside was placed in voluntary winding-up and a liquidator was appointed. Under the building contract, in the event of insolvency there was a requirement to prepare a final account taking into account monies owed to and from each party. This is in line with the Insolvency Rules, which require calculation of a net balance figure. Simple enough in theory. In practice, the final account was disputed with both parties claiming that they were owed money from the other.
By 2017 Meadowside’s liquidator had failed to collect monies from HSMC and appointed Pythagoras Capital Limited (Pythagoras), a third party agent, to assist. This type of appointment is common for liquidators, as was Pythagoras’s remuneration mechanism - based on a percentage of the sum recovered.
Pythagoras commenced an adjudication against HSMC and HSMC refused to participate (although it reserved its right to challenge the outcome). HSMC alleged that adjudication was fundamentally incompatible with liquidation proceedings and the adjudicator lacked jurisdiction. The adjudicator nevertheless decided that a net balance of monies was owed to Meadowside.
In seeking summary judgment to enforce this award, and no doubt appreciating the points raised in Bresco, Pythagoras took the unusual step of proposing a form of security by which Pythagoras themselves would guarantee the:
I. payment of any adverse costs order against Meadowside, in the event that the application for enforcement was unsuccessful; and
II. repayment of any sums paid and costs orders should HSMC successfully overturn the adjudication award.
Pythagoras also raised the possibility of either ‘ring-fencing’ the award or providing After the Event (ATE) insurance – though no formal proposal or policy was submitted to the court.
The Court's decision
While conceding that the adjudication process and the insolvency regime are “fundamentally incompatible”, liquidators have a statutory obligation to collect debts and adjudication should not be excluded as an option to achieve this. The Court expanded on the “exceptional circumstances” raised in Bresco - a case is likely to be an exception to the ordinary position where the following factors are satisfied:
I. The adjudication determines the final net position between the parties;
II. Satisfactory security is provided in respect of both (a) any sum awarded in the adjudication (in case it needs to be repaid if the award is overturned); and (b) any adverse costs order made against the insolvent company in any enforcement or other future proceedings;
III. What constitutes such “satisfactory security” is a question of fact in each case. It may mean that the liquidator must agree not to disburse the adjudication sum, or that security such as a third party bond or guarantee or ATE insurance is put in place; and
IV. Any funding agreement or security put in place is not an abuse of process.
On the facts in this case, the Court found that the final “abuse of process” ground had not been satisfied. The funding agreement between the liquidator and Pythagoras was found not to comply with the Damages-Based Agreement Regulations 2013. Notably and despite numerous requests, Pythagoras repeatedly failed to disclose the specific terms of the funding agreement. Accordingly, the abuse of process point could not be satisfied.
The Court was also concerned about the sufficiency of security provided by Pythagoras. ’Ring-fencing’ the adjudication award or purchasing sufficient ATE insurance cover were acknowledged to be satisfactory security options, as was a guarantee or bond provided by a reputable “bank or equivalent” that could provide a “high degree of certainty that the guarantee will be called successfully”. However, having assessed Pythagoras’s accounts, the Court considered that the financial position of Pythagoras did not provide the Court with sufficient certainty that should the guarantee be called 12 or 18 months down the line, Pythagoras would be in a position to cover an adverse order for costs.
The Court refused to give summary judgment to enforce the adjudicator’s award.
Granada – Insolvent from the outset
The decision in Granada Architectural Glazing v RGB P&C Ltd (November 2019) provides further hope for insolvent claimants.
Granada, who were employed by RGB to design, supply and install curtain walling, commenced adjudication proceedings against RGB despite being balance sheet insolvent.
Having been awarded £102,089 by the adjudicator, Granada applied for summary judgment to enforce the award. RGB responded by applying for a stay of execution and unsurprisingly pointed directly to Granada’s insolvency.
The Court’s decision
Granada’s debts clearly exceeded their liabilities. However, this financial status was commonplace for Granada who relied on intra-group loans from its parent company to assist with the repaying of debts. This arrangement had allowed Granada to pay its debts as they fell due and trade successfully. Notably, RGB were aware of this situation when they entered into the contract with Granada.
The judge referred to previous cases which have established that where a claimant’s position “is the same or similar to its financial position at the time the relevant contract was made” it is unlikely that a stay of execution of the adjudicator’s award will be granted, even if it is probable that the claimant would be unable to repay the judgment sum. Here, Granada’s current financial status was “materially similar” to its position when the contract was entered into.
Although the judge envisioned a “reasonable likelihood” that Granada would not be able to repay sums should the decision be overturned, they were deemed more likely to do so than not. The stay of execution was refused.
Importantly, RGB’s alternative application for the sum due to be paid into the court was also dismissed on the basis that this “halfway house”/ pseudo-escrow solution undermined a key purpose of adjudication, which was to mitigate cash flow difficulties.
So where does this case law leave us?
Following Bresco and Meadowside it is clear that a liquidator’s obligations to take all steps to recover outstanding debts will often be at odds with the adjudication procedure. Yet the judgment in Meadowside provides some welcome clarity in understanding when an insolvent company may be able to both bring an adjudication claim and successfully enforce a favourable award. There are specified exceptional circumstances which must be met.
The court recognises that, though funding agreements are market standard and acceptable, they must be regulation compliant. They should also be drafted with the expectation that they will be disclosed to, and scrutinised by, the court. Ensuring that this is the case will help prevent claims falling foul of the ‘abuse of process’ exception.
In terms of security, ‘certainty’ is the name of the game. Insolvent claimants should aim to provide a guarantor that the court will have full confidence in, both at the time of the award and in the future. Reputable banks are preferable, but the courts have left the door open for other third party guarantors if they can provide the necessary comfort in respect of their financials. If security is to be offered via insurance, such insurance should be in place prior to the award and any relevant policies disclosable, on-demand, to the court.
Despite the conflict with insolvency and liquidation, Granada demonstrates the court’s commitment to adjudication and its fundamental purpose: a fast, commercial form of dispute resolution. It shows a desire to take a factual approach to each individual case and on that basis make a judgement as to whether adjudication awards are enforceable.
This article was written by James Scott and Eveline Strecker and appears in the Spring edition of our construction, engineering and projects publication, Construct.Law. For more information, please contact James or Eveline on +44 (0)20 7438 2272 or at firstname.lastname@example.org or email@example.com.