Can a company in liquidation recover outstanding payments?

The case of Bresco Electrical Services Ltd (in liquidation) v Michael J Lonsdale (Electrical) Ltd has developed through the courts for nearly two years. The key issue to determine in this case is whether two statutory regimes, namely the adjudication of construction disputes and the operation of insolvency set off rules, are compatible with each other. The Supreme Court has decided this issue and confirmed both regimes are compatible.

This article deals with an adjudication. Find out more about adjudication in our glossary.

Background of the Bresco and Lonsdale case 

Bresco and Lonsdale are electrical work contractors. Pursuant to a sub-contract dated 21 August 2014, Bresco agreed to perform electrical installation works for Lonsdale at 6 St James’s Square, London. 

The contract included an express provision for adjudication of disputes. The works were not completed and the relationship between the parties broke down. Bresco ceased to attend the site, alleging it was entitled to payment as a result of Lonsdale having wrongfully terminated the contract. Both parties made claims against each other for breach of the contract.

In March 2015, Bresco went into creditors’ voluntary liquidation. Lonsdale claimed approximately £325,000 for the cost of instructing another contractor to complete the works after Bresco left the site. Bresco’s liquidator began an adjudication against Lonsdale, claiming payment of £219,000 for: 

1. the value of the work carried out under the contract before leaving the site; and 
2. damages for loss of profit.

In response, Lonsdale invited the adjudicator to resign on the basis that: 

1. he had no jurisdiction because Bresco was insolvent and entered into liquidation and; 
2. the claim did not amount to a construction dispute but governed under the Insolvency Rules to determine the net balance due. 

The adjudicator refused to resign. Lonsdale subsequently sought a declaration and an injunction to prevent Bresco from commencing adjudication proceedings.

Decision in the first instance by the Technology and Construction Court

A party may refer a single dispute under a contract to adjudication at any time under the Housing Grants, Construction and Regeneration Act 1996 (“the Construction Act”). 

In contrast, the Insolvency Rules (Rule 14.25) outline a process where a net balance is derived between the insolvent company and its creditors by setting off any of the creditors’ cross claims (“the set-off procedure”). This means there is a single net balance due between both parties. 

The tension between both the adjudication and insolvency regimes has arisen because the Construction Act is only able to determine a single dispute.

The Technology and Construction Court granted an injunction stopping the adjudication. This was on the basis that, where cross-claims existed between the parties under a construction contract, the adjudicator did not have jurisdiction to conduct an account dispute. 

The set-off procedure would replace the former cross-claims with a single claim for the net balance. This would mean there is no longer a claim under the construction contract. The consequences of this decision meant when parties asserted a cross-claim against an insolvent company (Bresco), the dispute would be governed by the Insolvency Rules. A dispute did not arise under the Construction Act.

Appeal to the Court of Appeal

Bresco appealed the TCC decision and argued that the dispute did fall within the adjudicator's jurisdiction. Therefore, the injunction should not be upheld.

The Court of Appeal overturned the TCC’s finding that the adjudicator lacked jurisdiction. Coulson LJ held the adjudicator did have jurisdiction to consider the claim. However, he upheld the TCC decision. This was on the basis that although a company in liquidation could commence an adjudication, to do this would be an “exercise of futility and a waste of time and money”. 

It would only be in exceptional circumstances that an insolvent company in liquidation, which is facing a cross-claim, could succeed in an adjudication and apply to the court to enforce the award. An adjudication would therefore be pointless if the adjudicator was unable to determine the mutual account.

If, for the sake of argument, the award was enforced, the responding party (such as Lonsdale) was entitled to commence litigation to overturn the adjudication award. However, it would be almost impossible to recover its legal costs because the paying party, such as Bresco, was in liquidation. This Court of Appeal declared the Construction Act adjudication regime was incompatible with the Insolvency Rules.

The Court of Appeal allowed the injunction to continue on the basis that the adjudicator’s decision could not be enforced. It would be a waste of the liquidator’s time and money. 

The key issues determined by the Supreme Court

Bresco appealed to the Supreme Court against the extension of the injunction preventing the adjudication to continue. Lonsdale cross-appealed and requested to restore the decision by the TCC which ruled the adjudicator lacked jurisdiction.

The Supreme Court had to determine: 

i) whether an adjudicator had jurisdiction to hear a dispute referred by a party in liquidation to adjudication under a contract / pursuant to Section 108 of the Construction Act (jurisdiction argument); and 

ii) whether the likely absence of enforcement of the majority of adjudications brought by liquidators was “an exercise in futility” (futility argument). In other words, whether adjudication should continue to be restrained by an injunction.

The decision 

i)             Jurisdiction

The Supreme Court complimented the adjudication process. It agreed with Bresco that an adjudicator has jurisdiction to determine a dispute if it arises under the construction contract, or, as a statutory right under the Construction Act. Also, this has to be referred to the adjudicator by one of the parties to the contract, including a party in liquidation.
The cross appeal by Lonsdale on jurisdiction was dismissed.

The Supreme Court also differed with the Court of Appeal. It did not regard “construction adjudication as in any way incompatible with the operation of the insolvency code in general, or with insolvency set-off in particular.” There is no provision in the Insolvency Rules or the Construction Act which prevents a liquidator referring a dispute to an adjudication.

The mere existence of a cross-claim operating by way of insolvency set-off rules does not mean the dispute under the construction contract will “simply melt away so as to render them incapable of adjudication.” The liquidator could commence an adjudication in the same way as it may pursue a contractual claim by litigation or arbitration. This means a claim pursued by a liquidator is within an adjudicator’s jurisdiction, irrespective of any cross-claims or the Insolvency Rules.

ii)            Futility

The Supreme Court overruled the decision of the Court of Appeal. It concluded that adjudications by liquidators are not an exercise in futility i.e. are not a pointless exercise. Lord Briggs emphasised the importance of cash flow and advocated that adjudication is a mechanism that supports cash flow. 

Adjudication has become a mainstream method of ADR. It leads to the speedy, cost effective and final resolution of most of the disputes that are referred to adjudication.

Adjudication is a useful tool for liquidators. They will be able to determine what monies are owed by a debtor and monies owed to creditors. Adjudication is not conflicting with the insolvency process - the adjudicator will be better placed than most liquidators to resolve construction disputes.

Although adjudication is temporarily binding, the award would usually be accepted by both parties and rarely enforced in the courts. Even if an adjudication award could not be enforced in the courts because of the insolvency set-off rules, the adjudication mechanism could not be rendered as an exercise in futility.

Following this, the Supreme Court considered it was entirely unsuitable for the court to interfere with the exercise of a statutory and contractual right to refer a dispute to adjudication. There was no need for an injunction. Going forward, parties will need to pass a “very steep hurdle” to obtain an injunction to restrain an insolvent company for exercising its contractual or statutory right to refer a dispute to adjudication.

The significance

This is a significant decision in the construction industry. There has been a long period of uncertainty as to whether companies in liquidation and administration can refer a dispute to adjudication. The Supreme Court has now clarified that adjudication of construction disputes and the operation of insolvency set off are compatible with each other. 

Insolvency practitioners dealing with liquidations of construction companies will certainly welcome this decision. They will be able to add adjudication (notwithstanding arbitration or litigation) as a quick and useful weapon in their arsenal. Insolvency practitioners will still need to prove their claim. It is, therefore, fundamental they obtain all factual evidence to prove their entitlement to recover monies into liquidation estates before commencing an adjudication.

Construction experts in adjudication proceedings will be better equipped than insolvency practitioners to resolve construction related disputes.

Given the current economic conditions caused by:

• Covid-19
• the shake-up of the insolvency laws caused by the Corporate Insolvency and Governance Act 2020, and;
• the uncertainty of Brexit

I suspect there will now be a sharp rise in the number of insolvency practitioners bringing adjudication proceedings against employers and contractors by insolvent contractors and subcontractors to release funds for creditors.

Adjudication is now considered not only as a temporary binding, but a “mainstream dispute resolution mechanism in its own right”. Lord Briggs outlined 7 key features to adjudication as follows:

1. Parties are not required to adjudicate every dispute.
   Each party is given a statutory and contractual right to require an adjudication of any dispute which may arise under a construction contract at any time. Even after the contract has been fully performed or come to an end.
2. The right to refer a dispute to adjudication is conferred upon every legal person/company, who or which is, or was, a party to a construction contract. This includes a company in liquidation.
3. An adjudicator’s jurisdiction extends to every dispute which arises under a qualifying construction contract.
4. Adjudication is a speedy process because of the tight time limits imposed on parties and the adjudicator.
5. The adjudication process is almost bound to be cheaper than arbitration or litigation. This is because lawyers and clients will know the costs and time involved in a dispute.
6. The adjudicator will be independent and equipped with the requisite knowledge and expertise.
7. An adjudicator’s decision cannot be appealed. The TCC will summarily enforce the adjudicator’s decision provided that the adjudicator acted independently and within their jurisdiction. A dissatisfied party can have the dispute determined in court, even though the adjudicator’s decision will continue to bind in the interim.

Insolvency practitioners must be mindful of the fact that an award does not mean companies in liquidation will always be successful. If a responding party fails to pay an adjudication award, a company in liquidation will have to enforce the award in the TCC. A liquidator would be expected to provide relevant security such as appropriate undertakings to ring-fence any enforcement proceeds.

Ultimately, in the current economic climate, insolvency practitioners should welcome this decision. It clears the path for a company in liquidation to refer a dispute to adjudication.

If you have any questions about the adjudication process, or require advice to recover an outstanding payment, please do not hesitate to contact our specialist construction solicitors. I am based in our Chelmsford office and can be contacted on 01245 453804 or you can email me at [email protected]