Summary
The much anticipated Supreme Court judgment in the case of Bresco Electrical Services Ltd (in Liquidation) v Michael J Lonsdale (Electrical) Ltd [2020] UKSC 25 was handed down recently. Significantly, the Court has found statutory Adjudication to be compatible with insolvency legislation, although questions persist as to its application, specifically in relation to enforcement. In practice, the judgment will be welcomed by insolvency practitioners when acting as liquidators to whom it is now open to use Adjudication as a proportionate way of determining the net balance due to or from counterparties. However, solvent creditors are still left with the prospect of an unenforceable decision as the usual swift enforcement of an adjudicator’s decision by the Courts may be trumped by the insolvency regime where there is a cross claim not dealt with by the adjudicator.
Nevertheless, the confirmation that adjudication may still be used for the relatively proportionate determination of disputes in this context is helpful. Unfortunately, the case does not provide with promotion of cash flow in the context of administration or CVAs. It remains to be seen whether this, and the enforceability issue, will be looked at by the legislature in the future, particularly in the context of the significant additional financial strains created by the COVID-19 pandemic.
Facts of the case
Legal Background
The case primarily concerns some alleged incompatibility between the Housing Grants, Construction and Regeneration Act 1996 (the Construction Act) and the Insolvency Act 1986 (the Insolvency Act), together with the Insolvency (England and Wales) Rules 2016 (the Insolvency Rules). Under the Construction Act, a party may refer a dispute, which the courts have interpreted as meaning a single dispute, under the contract to adjudication at any time. However, the Insolvency Rules (specifically Rule 14.25) provide for a process whereby a net balance is created between the company in liquidation and its creditors by setting off the creditors’ cross-claims (the set-off procedure). The alleged tension stems from the Insolvency Rules providing for an automatic set-off of cross claims between the party in liquidation and its creditors, thus producing a single net balance between the parties, whereas the Construction Act would allow only for determination of limited disputes (limited by reference to what was referred to adjudication) and therefore would not assist with the production of the net balance provided for under the Insolvency Rules.
The Dispute
The case is historic and, as a construction dispute, unremarkable. Bresco (in insolvent creditors’ voluntary liquidation at the time) commenced an Adjudication claiming the sum of £219,000 for unpaid fees and alleged lost profit. At first instance, the TCC granted an injunction halting the Adjudication on the basis that the adjudicator did not have jurisdiction to hear the dispute because it ceased to exist under the construction contract when the party entered into liquidation; rather, the dispute under the construction contract is replaced by a single automatic set-off of claims between the parties under the set-off procedure.
The Court of Appeal disagreed with the TCC’s reasoning. It held that there was ‘theoretical jurisdiction’ as the underlying construction contract claim persists, but concluded that the Adjudication was nevertheless an ‘exercise in futility’ (see futility, below), and on that basis the injunction restraining the Adjudication remained in place.
These two limbs have now been determined in the Supreme Court, as below.
Jurisdiction
The Supreme Court agreed with the Court of Appeal that an adjudicator had jurisdiction to hear a dispute referred by a party in liquidation. It found that the application of the Insolvency Rules does not mean that there is no longer a dispute under the construction contract. The claim may be dealt with by way of adjudication in the same way as it may be dealt with in litigation, or arbitration where applicable.
Futility
However, the Supreme Court overruled the Court of Appeal and determined that adjudications by insolvent parties are not an exercise in futility. In a vote of confidence in the process, the Court commented that in most cases decisions of adjudicators are not challenged in the Courts and as such Adjudication provides for a speedy, cost effective and final resolution of a dispute and therefore such decisions do have utility.
The Supreme Court concluded that the decision around enforceability of a favourable award for a party in liquidation will turn on the specific facts of the case. Material considerations will include whether the Adjudication dealt with all issues and cross claims between the parties and the position of liquidators in relation to security for costs and any proceeds of enforcement. However, the enforcement issue in itself did not render the Adjudication process futile.
On the basis of the above, the Supreme Court lifted the injunction restraining Bresco’s Adjudication and the proceedings will continue. It is safe to say that the resolution of this specific dispute will have lasted significantly longer than the 28 day period envisaged by the Construction Act.
Implications
The Supreme Court has been clear: there is no incompatibility between the Construction Act and insolvency legislation. But the full implications are not yet known. We may get further guidance if Bresco goes to enforcement. However, among the key takeaways and implications at this stage are as follows:
- This judgment is favourable to insolvency practitioners dealing with liquidations. There has long been questions surrounding whether Adjudications can proceed - that question is now firmly answered.
- The futility question had arguably been deferred to the enforcement stage rather than fully settled. Liquidators can no doubt assist in enabling the Courts to give effect to decisions by providing the relevant security but in the absence of this, there is a danger of a backlog of valid but unenforceable decisions.
- The spotlight will now likely turn to two cases that may be relevant for enforcement. The case of Meadowside Building Developments Ltd (in Liquidation) v 12-18 Hill Street Management Company Ltd is authority that enforcement of a decision may be granted where additional third party funding is in place (to protect the other side in the event the decision was overturned in subsequent litigation). Additionally, Balfour Beatty Civil Engineering Limited v Astec Projects Limited (in Liquidation) has since determined that Rule 14.25 does not require the net balance to be determined in a single Adjudication, as there were three in this specific case.
- Given the decision, we may now see more funders willing to contribute to/ fund Adjudication as a method of recovering cash into liquidation estates for the benefit of creditors generally.
- Given the current market and increased financial pressures created by Brexit and now COVID-19, we may see a spike in insolvent construction parties commencing Adjudications to seek to recover outstanding sums.
In the short term, the continued support of the Adjudication process is to be welcomed, as well as the clarity specifically around the rights of parties in liquidation. There will no doubt be further battles at enforcement stage but the principles leave this largely in the hands of insolvency practitioners when acting as liquidators. This decision also coincides with the enactment this week of the Corporate Insolvency and Governance Act which provides a shake-up of the insolvency regime, as well as temporary measures to address the difficulties businesses face as a result of the COVID-19 crisis.
Despite providing some clarity to an uncertain market, this decision does expose the construction industry’s vulnerability to fluctuations in cash flow – a vulnerability that has not been addressed and that could still leave a successful party in an Adjudication being empty handed following a decision. Perhaps the legislature can look at this as part of the on-going review of the Construction Act?
This article was written by Oli Macrae, a Solicitor in the Construction and Engineering team at Burges Salmon.