Insolvency Rules…OK?

Posted by Natalie Powers, 26th February 2019
We examine the implications for liquidators in the Court of Appeal decision in Bresco  Electrical Services Ltd v Michael J Lonsdale (Electrical) Ltd [2019] EWCA CIV 27.

Under the Housing Grants Construction and Regeneration Act 1996 (widely known as the ‘Construction Act’), a party to a construction contract has a statutory right to refer a dispute to adjudication “at any time”. The Act itself does not impose any limitations on insolvent parties from referring a dispute to adjudication and historically, right from the outset with Macob –v Morrison, the courts have emphasised the primacy of the right to adjudicate. However once a company goes into liquidation, the Insolvency Rules state that any mutual claims between the parties become one single amount owed to one party or the other, with only the balance of the account capable of being ‘proved’ as a debt in liquidation. Such an extensive accounting exercise is highly likely to be far beyond the remit of an adjudicator and therefore the relationship between the Insolvency Rules and the adjudication process is a multifaceted, complex one.

Whenever the insolvency of one of the parties is a factor the quick-fire, ‘rough and ready’ form of justice that adjudication allows can become a very real headache for all parties involved, not least for a paying party which might have ‘cross claims’ against the insolvent party.  The issue of whether an adjudicator has jurisdiction to decide an insolvent referring party’s claim has been subject to extensive case law, starting with the decision in Bouygues v Dahl-Jensen which established that an adjudicator’s decision would not be enforced if the claimant was in insolvent liquidation and the respondent had an arguable counterclaim. This decision was followed in subsequent rulings (for example Wimbledon v Vago) with the courts looking at the potentially unfair outcomes that adjudication enforcement, without restriction, might bring. This would allow the parties (even if insolvent) to commence adjudication but there remained some tension, not to say uncertainty, about how the Construction Act and the Insolvency Rules interplayed.

Occasionally this tension received judicial consideration, for example in the Scottish case of Melville Dundas v George Wimpey in which the court ruled that terms dealing with the termination of the contract and insolvency took precedence over the ‘payment-friendly’ provisions of the Construction Act.

However, the situation concerning the right to adjudicate (enshrined in the Construction Act) required some clarification which the Court of Appeal has now provided in its recent decision in Michael J Lonsdale (Electrical) v Bresco Electrical Services.

The claimant (Lonsdale), brought (pre-emptive) proceedings against Bresco under Part 8 of the Civil Procedure Rules. Under the (sub)contract entered into between the parties, Bresco was engaged to carry out electrical installation works.  However, Bresco left site prior to completion of the works, with each party alleging wrongful termination on the part of the other. Lonsdale engaged another sub-contractor to complete the unfinished works. Bresco subsequently became insolvent and went into voluntary liquidation. Two years later, Lonsdale pursued a claim against Bresco for wrongful repudiation of the contract.  Bresco (acting via its liquidators), remained resolute that Lonsdale had been at fault and had wrongfully terminated the contract and issued adjudication proceedings of its own. Bresco maintained that Lonsdale owed money for works completed under the sub-contract and damages for loss of profit.

An adjudicator was appointed in June 2018 but Lonsdale contended that the adjudicator had no jurisdiction to deal with the claim, owing to the fact that Bresco was insolvent and citing the relevance of the mutual set-off provisions under the Insolvency Rules. The adjudicator rejected this argument, stating that he had the necessary jurisdiction and issued a timetable for his decision.  Lonsdale immediately commenced a ‘Part 8’ claim seeking a declaration and injunction to prevent Bresco continuing with the adjudication or bringing any further claims in connection with sums allegedly owed to Bresco under the sub-contract. By agreement between the parties, the adjudication was stayed awaiting the Technology & Construction Court (TCC)’s decision over Lonsdale’s Part 8 claim.

The TCC held that, as Bresco was in liquidation, Rule 14.25 of the Insolvency Rules 2016 (Winding Up: mutual dealings and set-off) meant that all claims and cross-claims between the parties were no longer capable of separate enforcement. The rules required the “mutual dealings” (i.e. sums claimed) to be taken into account to arrive at a net balance due to, or from, Bresco, under the 2016 Insolvency Rules and not under the construction contract. The dispute referred to both money claims and cross-claims, and an analysis of how much was owed to Bresco, so the adjudicator lacked jurisdiction. The declarations sought by Lonsdale were granted and the adjudication discontinued.

That ‘first instance’ decision was delivered during the summer of 2018 and the construction legal world held its breath awaiting the outcome of the appeal that was to follow.

At the end of January, the Court of Appeal gave its ruling on the initial decision (as well as, at the same time, ruling on the case of Cannon Corporate v Primus Build which, interestingly, concerned a refusal to allow a stay of execution where the receiving party was in a ‘voluntary arrangement’ as opposed to liquidation).  The decision of the TCC was upheld by the Court of Appeal, although on slightly different grounds. Lord Justice Coulson held that the adjudicator could have jurisdiction to deal with the adjudication – he found that there was some difficulty in preventing an adjudicator having jurisdiction when it would still be possible, in theory, for the insolvent company to bring litigation or arbitration proceedings.  Interestingly, this meant that he was not just overturning the first instance TCC decision in this case but he was also distinguishing one of his own judgments from some years ago (as a TCC judge himself) in Enterprise Managed Services v McFadden Utilities. 

Instead, Coulson LJ granted the injunction on the grounds of “practical utility”.  In doing so, he highlighted the fundamental incompatibility of the adjudication and insolvency regimes stating that, whilst the right to refer a dispute to adjudication is not automatically lost on liquidation, any attempt by a liquidator to refer a claim to an adjudicator in order to recover sums owed to an insolvent company would be an “exercise in futility” where there is a genuine cross-claim, because only in exceptional circumstances will the courts uphold the adjudicator’s decision.

The decision is likely to have far-reaching implications on liquidators who were, naturally attracted to the idea of referring disputes to (quick and relatively inexpensive) adjudication as a means of determining monies owed to the insolvent company. Whether this applies in circumstances where there is no counterclaim, or where a liquidator is pursuing a non-monetary remedy is yet to be seen. However, if one thing is clear, it is that the right to adjudicate “at any time” in order to maintain the cash-flow of a project, is secondary to the accounting exercise required to be undertaken under the Insolvency Rules.

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