Can an insolvent entity refer a dispute to adjudication?

The Supreme Court judgment in Bresco Electrical Services Ltd v Michael J Lonsdale (Electrical) Ltd has clarified the interplay between adjudication and the process of insolvency set-off.  

25 June 2020

The Supreme Court judgment in Bresco Electrical Services Ltd v Michael J Lonsdale (Electrical) Ltd has clarified the interplay between adjudication and the process of insolvency set-off. 

The issues

When a company enters insolvency, sums due between it and any entity with which it had dealings are set off against each other. This process – insolvency set-off – is mandatory and automatic. The intention and effect of insolvency set-off is to simplify cross-claims and to ensure that the creditor is not unfairly disadvantaged.

The Housing Grants, Construction and Regeneration Act 1996 (the “1996 Act”) confers a right to a party under a construction contract to refer a dispute arising from that construction contract to adjudication at any time.

Two main issues arise when sums, which are subject to insolvency set-off, are claimed in an adjudication:

  1. If insolvency set-off has automatically operated to replace the dispute under the construction contract with a claim in the insolvency, then it is not immediately clear that an adjudication can be brought within the provisions of the 1996 Act: is the claim still a dispute under a construction contract? If it is not, then the adjudicator seemingly cannot have jurisdiction to decide the claim.
  2. If an adjudication were to proceed and a decision were to be granted in favour of an insolvent entity, where there was a cross-claim, it is unclear that decision could be enforceable by the courts. The reason for this is that the other entity cannot be held liable to make payment of debts it owes, but only be permitted to claim a dividend in the insolvency in respect of debts it is owed. It is entitled to set off the two figures. This would not permit enforcement of an adjudicator’s decision, so adjudication in these circumstances may be thought to be futile and a waste of resources.

These apparent conflicts between the processes of adjudication and insolvency set-off have previously been thought to limit the scope for adjudication to take place between entities where one is insolvent. Both points have now been addressed by the Supreme Court in the context of an attempted injunction to restrain an adjudication from proceeding.

Background to the case

Michael J Lonsdale (Electrical) Ltd (“Lonsdale”) engaged Bresco Electrical Services Ltd (“Bresco”) to carry out electrical installation works at St James’s Square, London. The works were undertaken in 2014. Bresco went into creditors’ voluntary liquidation in 2015.

Each party considered that the other was in breach of contract. In 2017, various contractual claims were intimated between them.

In 2018, Bresco’s liquidators referred a dispute to adjudication seeking £219,000 in respect of Lonsdale’s alleged wrongful termination of contract. Lonsdale had a £300,000 cross-claim in respect of Bresco’s alleged breach of contract, and it objected to the adjudication taking place. Amongst Lonsdale’s arguments were the two main issues noted above – jurisdiction and futility.

Following consideration of the matter in the Technology and Construction Court and the Court of Appeal, the Supreme Court has now decided these arguments. 

The Supreme Court’s decision

The Court held that neither the jurisdiction argument nor the futility argument preclude a claim in these circumstances from being referred to adjudication.

In finding that the jurisdiction point was misconceived, the Court noted:

  • If insolvency set-off meant that the underlying contractual claims disappeared, such that an adjudication could not proceed, this would be the outcome even if the sum to be set off was vastly lower than the principal sum claimed. This would be “a triumph of technicality over substance.”
  • When insolvency set-off operates, claims and cross-claims do not lose their separate identity for all purposes.
  • The existence of insolvency set-off does not deprive the owner of the original claim of ancillary rights under the contract which created it – for example, a secured debt may remain secured even after it is reduced by insolvency set-off.
  • A liquidator is entitled to pursue a company's claims by arbitration; the same must apply to the right to refer disputes to adjudication.

On the futility point the Court considered that even where enforcement of an adjudicator’s decision may not be possible (due to insolvency set-off or for other reasons), adjudication still has purpose.  The court stated, “it is no answer to the utility (rather than futility) of construction adjudication in the context of insolvency set-off to say that the adjudicator's decision is unlikely to be summarily enforceable.” The points that were relevant include:

  • For the Courts to allow an injunction to prevent a party from having a dispute decided by an adjudicator is to prevent that party from asserting a statutory right. This is a “very steep hurdle” to overcome and is not surmounted by the operation of insolvency set-off.
  • Although adjudication is often used as a tool to protect cash flow within a construction project, this is not its only purpose. Dispute resolution is “an end in its own right, even where summary enforcement may be inappropriate or for some reason unavailable.”
  • Disputed cross-claims often need to be resolved to conclude a final account in an insolvency. Construction disputes arising during insolvency may be more amenable to resolution by a professional construction expert than by the liquidator.

Accordingly, it is now clear that adjudication is available under the 1996 Act notwithstanding that a party to the adjudication is insolvent and notwithstanding that difficulties may still arise in having the decision summarily enforced in the usual way.

Points to take away

  • Adjudication generally offers a cost-effective and efficient method of dispute resolution; whereas the costs of litigation or arbitration may seem unpalatable and disproportionate to a liquidator tasked with concluding a final account, so adjudication may seem more practicable.
  • The decision of the Supreme Court is therefore likely to increase the probability of a construction dispute being referred to adjudication in circumstances where a party has become insolvent.
  • This is the case even although the decision arising from such an adjudication may not be summarily enforceable in the usual way.