20 May 2019

Insolvency and the power to adjudicate

by Paschal Walsh, UK Regional Director - UK

Insolvency is an all too common occurrence in the construction industry, a fact that was thrust into the public eye with the collapse of Carillion in January 2018. It’s estimated that Carillion’s failure will cost the British taxpayer over £150m, but the real impact in terms of people’s livelihoods, through loss of jobs and businesses, may never be quantified.

According to Creditsafe’s 2018 Watchdog ReportA statistical analysis of the UK economy, construction industry insolvencies soared by 73 per cent in the first quarter of 2018, compared with the final quarter of 2017.

In the same report, Creditsafe indicated that things could be getting worse for our sector and it’s estimated that construction companies are being paid on average 21 days beyond their agreed payment terms. For a cash-driven industry, it’s no wonder that contractor delinquency is such a prominent issue in construction.

A year on from Carillion, insolvency is back in the press following the Court of Appeal decision in Bresco Electrical Services Ltd v Michael J Lonsdale (Electrical) Ltd [2019] EWCA Civ 27 (24 January 2019), a conjoined appeal looking at the interplay between adjudication and insolvency.

There are several different arrangements for companies who may be insolvent; each is called something slightly different and has its own procedural variances so, before looking at the Court of Appeal’s decision, it’s worth taking a quick look what is meant by insolvent liquidation.

Insolvent liquidation is distinctly different from receivership or administration. It involves selling off or liquidating a company’s assets, with the proceeds from the sale being used to repay creditors. Once dissolved, the company will be officially closed-down and struck of the register of companies.

A company will enter into insolvent liquidation following either a court order (following a creditor’s petition) or a shareholder’s voluntary arrangement. In each case, an insolvency practitioner will be appointed to assume control of the business, collect and auction off its assets, pay the unsecured creditors from the proceeds of the sale and (if any money is left) distribute the remaining cash among the shareholders in proportion to their shareholdings. The unfortunate truth for creditors of an insolvent company in liquidation is that they are only likely to receive a very small proportion of the money they are owed (say, 1p in every pound).

Okay. Back to the Court of Appeal decision and to the guidance provided by my hero from the TCC, Lord Justice Coulson (or ‘LJC’, as I like to call him). Lord Coulson very carefully dissected a number of first instance decisions (including one of his own) relating to adjudication and its perceived incompatibility with the Insolvency Act of 1986.

In the case of Michael J Lonsdale (Electrical) Ltd v Bresco Electrical Services Ltd [2018] EWHC 2043 (TCC) (31 July 2018), Mr Justice Fraser had decided that the adjudicator, Mr Tony Bingham (another of my heroes), did not have the jurisdiction to decide a dispute over a repudiatory breach of contract because of the fact that Bresco was in liquidation.

Mr Fraser reached this decision because Insolvency Rule 14.25 says that, in liquidation, the sums due from one party shall be set off against the other, and claims and cross-claims merge and are extinguished. To put it another way: any claims and cross-claims cease to be capable of separate enforcement upon or at the date of liquidation. In liquidation terms, there is only one single claim, and this is expressed as the balance of the account between the parties.

On appeal, Lord Coulson said that Mr Fraser was wrong to reach this conclusion because the process of set-off in liquidation wouldn’t completely extinguish the underlying claims. Adjudicators would, in theory, have jurisdiction to decide an underlying claim in an adjudication involving a company in liquidation.

LJC then went on to address the issue of the utility of an adjudicator’s decision when a party is in liquidation, highlighting that adjudication is a “rough and ready process” of obtaining cashflow whereas liquidation is the careful calculation of a net balance between the company and the creditor (i.e. two very different regimes).

Consider a situation where an adjudicator awards £100,000 to a company in insolvent liquidation, the sum is enforced and then paid. As is its right, the unsuccessful party subsequently challenges the decision in litigation or arbitration, where it’s found that the adjudicator was wrong to reach the decision it did and there should have been no award of any money whatsoever. In this case, the unfortunate party would be lucky to recoup any of its £100k. At best, it may receive a few pence in the pound (in this scenario, around £3,000) back from the company in liquidation. Clearly, this would be grossly unfair.

So, with adjudication being accepted as being “likely to result in injustice” [Macob Civil Engineering Ltd v Morrison Construction Ltd [1999] BLR 93], an adjudicator’s decision would not be enforced by the courts due to the potential for injustice. Because the decision would be unenforceable, it would then make the adjudication itself: as Mr Thomas Crangle, acting on behalf of Lonsdale, beautifully put it, “an exercise in futility”.

It is yet to be tested in the courts, but there may be further inferences when considering a situation where a company in liquidation wishes to seek a declaration from an adjudicator, purely on a point of principle. On the surface, it may seem like a good, low-cost solution until you consider that the declaration will only be temporarily binding (unless of course the parties have contractually agreed to make the decision binding). Although there are no sums to be carefully considered, an adjudicator’s decision will only ever provide a temporary solution to the issue at hand and, therefore, is unable to satisfy the Insolvency Rules in the production of a calculation of a net balance between the company and the creditor.

The latest ruling provides well-reasoned support for the court’s previous decisions on the subject and it would now be a very brave Insolvency Practitioner to launch an adjudication… and an even braver adjudicator to accept the nomination in the first place.

So, whilst we can now be sure that a company in insolvent liquidation cannot launch an adjudication, an Insolvency Practitioner still has many options available to it to recover monies it believes to be due, in the form of various types of legal action. For example, the ‘Supervisor’ (to use the language from the Insolvency Act) may use its powers to apply to the court for an order to recover any “undervalue” for transactions less than 3 years old. This means that, in the unfortunate event that any business with a contract with your company goes in to liquidation, there is a good chance that the Supervisor could look at any contracts from the previous 3 years in an attempt to find and recover undervalue.

What can we do to protect our businesses against supplier insolvency?

Well, first of all, make sure the required due diligence is carried out before entering into contract, even with those suppliers you regularly do business with. Whilst they’re not foolproof, companies like Dunn & Bradstreet or Creditsafe provide up-to-date financial information on a supplier’s creditworthiness and chances of delinquency.

In addition to carrying out pre-contract financial checks, you can limit your company’s exposure by ensuring you get paid what’s due, when it’s due. We’ve already said that, in construction, ‘cash is king’, so it’s surprising how many organisations will let outstanding debts slide, often until it’s too late. If you are entitled to something; get the claim in. And chase it until you receive the payment. Adjudication will not be an option if you or your debtor go into liquidation. Move on overdue debts early, certainly before the end of the project, and make sure that cash is recovered.

If the unthinkable happens, most contracts provide a termination clause in the event of insolvency of a contractor or subcontractor. For example, the NEC3 provides several reasons for Termination of the Contract, such as the supplier having a winding-up order made against it (Reason R5); having a provisional liquidator appointed to it (Reason R6); or having a receiver appointed to it (Reason R9).

If you are at this point, it would be wise to seek professional assistance immediately as terminating a contract can be complex and, commercially, very risky. It’s extremely important that the correct procedures are followed, like issuing correctly worded termination notices and ensuring that timely payment notices are issued, continue to be issued and are issued to the correct entity.

As well as providing Planning and Scheduling, Claims Management, Dispute Resolution, Expert Witness and Legal services, Systech International also provides independent, pro-active Contract Management services, across the globe. Our consultancy team has an in-depth knowledge of construction organisations and is ready to provide dedicated support, tailored to suit your needs.

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