The building blocks for construction insolvency and adjudication
07 October 2020
Perhaps now more than ever margins are tight in the construction industry, which makes the recovery of monies claimed to be due to an insolvent firm under a construction contract increasingly more difficult to realise. Driven by a legacy of adversarial attitude, payment under a construction contract continues to be an increasing source of frustration for many, particularly in an insolvency situation where creative and intransigent resistance is more blatant and widespread. All too often the solvent party is quick to raise new issues when insolvency arises, challenging the value of the work carried out and its quality, advocating that all problems and cost overrun on the project, no matter how remote, are the responsibility of the insolvent business.
The background to adjudication
Following a government-commissioned report by Sir Michael Latham in 1994 entitled Constructing the Team – being a ‘root and branch’ review of procurement and contractual procedures in the UK construction industry– the Housing Grants, Construction and Regeneration Act 1996 introduced the process of statutory adjudication whereby an appointed adjudicator would reach a decision on a disputed claim for money in a speedy 28-day period. The Act also provided that the decision was enforceable in court, in effect as a debt.
The courts quickly supported construction adjudication by enforcing payment and, as a result, construction adjudication took off to become the first and usually final tool for recovery of disputed money in the construction industry.
As a speedy low-cost process, construction adjudication was ideally suited for recovery of payment claimed by insolvent companies, but difficulties did arise. The courts came to take the view that insolvency law trumped adjudication law and if there was a cross claim creating a ‘balancing account’, the process of adjudication could not be followed. As a result, enforcement applications made by insolvent parties to the courts were usually denied, or at best enforced with a stay in proceedings.
Bresco reopening the door
However, the recent decision by the Supreme Court in the case of Bresco Electrical Services Ltd v. Michael J Lonsdale (Electrical) Ltd 2020], handed down in June 2020, now endorses adjudication as a cost-effective method of dispute resolution in insolvency situations. The Supreme Court said that adjudication brought by an insolvent party could go ahead and was not futile as the Court of Appeal had previously decided. The solvent party can continue to raise a cross claim as a defence, but is not entitled to a decision by the adjudicator to be paid money, as the adjudicator has no jurisdiction to order such a payment.
With the door to adjudication for insolvent parties re-opened, there are some key practicalities in doing so.
Adjudication is a ‘cost neutral’ dispute resolution process, which means that unlike arbitration and litigation both parties bear their own costs in proceedings. The parties are also jointly and severally liable for the adjudicator’s fees, albeit typically on the principle that ‘costs follow the event’ is maintained.
For insolvent companies the ability to fund an adjudication referral may at first glance seem challenging. However, financing options such as a damages-based agreement as governed by the Damages Based Agreement Regulations (DBAR 2013) provides a viable solution to this – permitting a private funding arrangement where a representatives’ fee is agreed as being contingent upon success, determined as a percentage of the compensation awarded to the client.
Enforcement of an adjudicator’s decision is another important key consideration. The decision is ‘binding’ on the parties and must be complied with until the dispute is finally determined by legal proceedings; arbitration; or agreement between the parties.
In most cases non-compliance is dealt with by the successful party issuing enforcement proceedings through the court, which typically enforces the decision providing it is valid. This is on the basis that much like arbitration, the courts are as a matter of policy reluctant to undermine the process. The court’s approach to enforcement applications by unsuccessful parties is widely reported and, other than in the plainest of circumstances, is generally considered a substantial waste of time and expense.
The subject of enforcement in the context of insolvency was considered in the case of Meadowside v. Hill Street [2019 EWHC 2651 (TCC). Here, the TCC (Technology & Construction Court) clarified the circumstances in which it would be prepared to allow enforcement of an adjudication decision for liquidators seeking payments from solvent companies. These included appropriate security comprising a combination of (i) an undertaking from the liquidator to the court to temporarily ringfence the sum enforced (ii) third party guarantee or bond; (iii) ATE (after-the-event) insurance.
It cannot be said that an adjudication decision in favour of an insolvent company will not be the subject of an enforcement application by the unsuccessful party. However, the grounds for doing so are limited, with the prospect of subsequent referral to arbitration or litigation likely reserved for high value and/or complex cases. The use of adjudication as a tool to recover outstanding payment has therefore swung the pendulum back in favour of the insolvent party.
Keep an eye on the R3 Events, Courses and Webinars page for a webinar on adjudication in the future.
Mark Lucas is a director at Quantex Consulting Limited.