TCC Bars Adjudication Proceedings for Companies in Liquidation

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A recent TCC decision has ruled that adjudication proceedings cannot be brought by companies in liquidation in relation to financial claims under a construction contract. The decision will have considerable ramifications for the practical management of liquidations for companies with exposure to construction contracts. The decision would appear to run contrary to current liquidator practice, both as to the use of adjudication proceedings in liquidations and as to the assignment of claims to third parties, but essentially only confirms the mandatory nature of insolvency set-off.

Insolvency set-off: an overview

Under the Insolvency (England and Wales) Rules 2016 (the “Insolvency Rules”), a mandatory set-off takes effect upon a company’s entry into liquidation. The set-off applies where there have been mutual dealings between the company and a creditor. The effect of the rule is to net-off those dealings so that only the balance is provable in the liquidation.

The rule is an exception to the pari passu principle (i.e. equal treatment) as the set-off provides the creditor with a full recovery of part of its claim. Without the rule, the creditor would be obliged to make full payment of any amounts owed to the company, whilst only being able prove in the liquidation for its own claims. If the dividend from the liquidation is small, the creditor could well be required to pay more into the liquidation than it would receive in return despite the fact that its claims against the company exceed the company’s claims against it.

Insolvency set-off takes place automatically upon liquidation and overrides all other set-offs or contract terms to the contrary. In addition, the parties cannot contract out of insolvency set-off nor waive its operation.

Michael J Lonsdale (Electrical) Limited v Bresco Electrical Services Limited (in liq)

In August 2014 Lonsdale entered into a sub-contract for the provision of electrical installation works by Bresco. Bresco ceased work in December 2014, with each party alleging wrongful termination against the other. Bresco entered into liquidation in March 2015. Lonsdale subsequently claimed for the costs of completing the works. In response, Bresco maintained Lonsdale had wrongfully terminated the sub-contract and was liable to pay damages to Bresco.

In June 2018, Bresco issued a notice of adjudication seeking a number of decisions including: (i) whether Lonsdale was in repudiatory breach of the sub-contract in December 2014, (ii) whether Bresco was entitled to be paid for the works it had completed prior to that breach, and (iii) whether Bresco was entitled to damages for loss of profit in respect of work not completed and/or whether Lonsdale was entitled to deduct completion costs from sums due to Bresco. The notice also sought determinations as to the quantum of any sums due between the parties.

Lonsdale objected to the adjudicator’s jurisdiction on the basis that the financial relationship between the parties was now governed by the set-off provisions of the Insolvency Rules. Part 8 proceedings were commenced for an injunction restraining the adjudication proceedings.

Claims no longer enforceable

The court agreed with Londsdale and restrained the continuation of the adjudication. Following a detailed analysis of the relevant authorities, in summary the court held that:

  • once a contractor goes into liquidation all financial claims under a construction contract cease to be capable of separate enforcement and are replaced with a single claim for the net balance to be ascertained after taking into account of the mutual dealing of the parties under the Insolvency Rules;
  • an adjudicator has no jurisdiction to determine the net balance under the Insolvency Rules or any of the claims which make up that balance;
  • this conclusion applies regardless of whether the parties mutual dealings are confined to the construction contract before the adjudicator or whether they span multiple contracts.

In doing so, the court rejected an argument that its conclusion would run contrary to the practice of liquidators who regularly refer construction disputes to adjudication as part of the process of determining the net balance under the Insolvency Rules or to as a means of resolving complex disputes with creditors. Liquidator practice could not affect the proper legal analysis of such proceedings and override the statutory force of the Insolvency Rules.

Conclusions and implications

This is a significant judgment which puts the spotlight squarely on the legal position of the interface of insolvency and construction law. Given the current stress in the construction sector the judgement is likely to have wider ramifications including upsetting current practice of liquidators in relation to construction insolvencies in at least two ways:

  • Liquidators will now have much less scope to start an adjudication (or threaten one) as a practical means of resolving disputed accounts with creditors. It appears that this had been a developing practice in the construction sector offering a helpful low-cost route for a liquidator to determine the complex issues which inevitably arise when a contractor enters liquidation (even though any award would be liable to be stayed on the grounds of insolvency).
  • Liquidators may also now have less opportunity to assign claims to third parties as a means of quickly raising funds for the liquidation. These third parties would typically purchase such claims at a discount on the premise that they could be pursued through adjudication at a reasonable level of cost. Of course to the extent the company in liquidation is owed a net sum, the liquidator could assign that claim.

The court’s findings would appear to include situations where only a single claim exists (for defects, for example), but may leave open the prospect of non-financial claims being referred to adjudication. For example, it is unclear whether an adjudication confined to the question of repudiation could have been pursued by the liquidator in this case. On one hand, such claims would not determine sums due between the parties, but on the other they may be a “stop along the way” to determining the net balance under the Insolvency Rules. Further court decisions are likely to be needed to identify the precise limits of the present rule.

References: Michael J Lonsdale (Electrical) Ltd v Bresco Electrical Services Ltd [2018] EWHC 2043 (TCC).