Follow up article: ‘The even more complex interaction between insolvency and adjudication enforcement’
In our November 2018 article ‘The complex interaction between insolvency and the enforcement of adjudicator's awards’, we looked at the case of Michael J Lonsdale (Electrical) Ltd v Bresco Electrical Services Ltd (In Liquidation) [2018] EWHC 2043 (TCC, 31 July 2018), which conclusively states that a liquidator cannot refer a dispute to adjudication because the adjudicator has no jurisdiction, for the reasons explained there. We also looked at the approach the courts take when the payee is in an official insolvency process such as liquidation, administration or bankruptcy (known as the ‘easy cases’). In this article, we look at the approach the courts take to the enforcement of adjudicators’ awards when the payer contends that the payee is insolvent but is not yet in an official process – the ‘hard cases’.
These are so-called because they’re more difficult for all involved, because the payee is not in a formal insolvency process; insolvency is suspected. As we know, Section 108 of the Housing Grants Construction and Regeneration Act 1996 (as amended) (‘HGCRA) allows a party to a contract to refer a dispute to adjudication ‘at any time’, and the resulting adjudicator’s award is binding until the dispute is finally determined by legal proceedings, by arbitration (if applicable) or by agreement. A court will normally uphold Parliament’s intention, order the adjudicator’s award to be paid, and allow the execution of that order (i.e. the seizure of assets to obtain payment if that is not made voluntarily). However, although the HGCRA touches on insolvency in relation to payment terms, it is silent on the relationship between insolvency and adjudication, so the judges have used a combination of the Civil Procedure Rules (‘CPR’) and judge-made law to determine when a court should exercise its discretion and allow the stay of enforcement of an adjudicator’s award in favour of a company which is demonstrably insolvent.
It is worth nothing that adjudication enforcement hearings under CPR Part 7 take place as summary judgment hearings according to CPR Part 24, with an abridged timetable. Before deploying its arguments about counterclaims and payee insolvency, the payer is likely to seek to demonstrate that on the balance of probabilities it has a more than fanciful defence to the enforcement of the adjudicator’s award, perhaps because the payment notice the payee relies on was defective, the adjudicator lacked jurisdiction, or breached natural justice in the procedure they adopted. If those defences fail (which they usually do), the payer will often attack the payee’s solvency, in the hope that the court decides that since there is a real risk the payee will soon be insolvent, it should not enforce the adjudicator’s award for the reasons explained below. If those submissions fail, the payer’s last line of defence is to seek to persuade the court to exercise its discretion to stay the execution of its own order to pay the award. To succeed here, the payer must establish a ‘serious risk’ of prejudice under CPR Part 83.7. In short, the court will have a lot to contend with in what is meant to be a 3 hour hearing!
To even get ‘in the ball park’ in the ‘hard cases’, the payer must leap a number of hurdles, all of which reinforce the ‘hard cases’ moniker; the payer has to do a lot of case preparation, and the court will have difficult judgments to make on the evidence.
Firstly, the payer must demonstrate that the sum which was the subject of the award, or some other counter-claim that equals or exceeds the award, will be the subject of subsequent proceedings that will result in the return of money to the payer. A classic example would be liquidated damages owed to the payer because the payee completed late. Those payers who have ‘put their money where their mouth is’ by issuing proceedings, or are prosecuting an arbitration, will see their claims taken more seriously than those who have not. Those payers whose counterclaims did not feature in the adjudication and are therefore obliged to comply with the Pre-action Protocol on Construction and Engineering Disputes before issuing proceedings, should at least send the payee a Protocol compliant Letter of Claim, supported by expert evidence if necessary. In Michael John Construction v Golledge [2006] EWHC 71, Coulson J was not convinced that the payer had a counterclaim which equalled the adjudicator’s award, or that the payer intended to prosecute that counterclaim, so he refused to stay execution of the order to pay. In lower value cases, this requires a delicate commercial judgment; is there a risk that the payer will incur the further costs of resolution of the substantive dispute without being able to recover it from the payee? Unless the adjudicator’s award significantly exceeds those costs, or the payee is likely to go into a formal insolvency process soon - bringing the litigation or arbitration to an end due to the moratoria - then the amount of irrecoverable cost means it is often questionable how much ‘heavy lifting’ is justified to deploy the payer’s claims and get within ‘shouting distance’ of a stay.
Secondly, the payer must show that the payee is, or will be, unable to repay any monies payable under the award because it is, on the balance of probabilities, insolvent, or will be insolvent when dispute is likely to be finally resolved. The payer will seek to show that the payee’s position infringes either of the insolvency tests, namely the payee cannot pay its debts as and when they fall due (‘cash-flow insolvency’), or its liabilities exceed its assets (‘balance sheet insolvency’). Because adjudication enforcement takes place in a summary judgment context under an abridged procedure, the courts have no rigorous safeguards for ensuring they can assess the payee’s solvency in any meaningful way. The burden is rightly on the payer to show that the payee is likely to go ‘pop’. However, there is no duty of disclosure on the payee to demonstrate its solvency, so it can ‘cherry pick’ the financial evidence it relies on, whereas the payer has to rely on what information it can glean from Companies House. Moreover, in the absence of an order for expert evidence there has been a tendency for accountants’ evidence to overlook the requirements of CPR Part 35 at the expense of impartiality. As Couslon J remarked in Alexander & Law v Coveside [2013] EWHC 3949, there is a tendency for accountants’ reports to be “peppered with errors and advocacy.”
Note that the payer must show the payee is insolvent in all cases except where the payee is already in a formal insolvency process (i.e. liquidation, administration and bankruptcy – the ‘easy cases’, where the payee is clearly insolvent). Where a winding up petition is presented against the payee, but it has not yet been heard, the payer must still put in the time presenting evidence of payee insolvency, so that a stay may be granted pending the outcome of the hearing of the petition (Harwood Construction v Lantrode (2000) unreported; Alexander & Law v Coveside). The fact that a payee is in a CVA is helpful to the payer’s contentions but does not put the case in the ‘easy cases’ category either; the burden remains on the payer to demonstrate payee insolvency, (see Mead General Building Ltd v Dartmoor Properties Ltd [2009] EWHC 200). The burden will therefore have to be discharged where an individual payee is in an IVA too, and also in other demi-official insolvency processes (Schemes of arrangement; Compositions with creditors).
Thirdly, the payer must show that the prejudice it complains of now is not of its own making. Therefore, the payer will not get a stay where the payee’s financial position at the time of the enforcement hearing is no worse than it was when the contract was awarded (Herschell Engineering Ltd v Breen Property Ltd (2000) Unreported). Basically, a payer is unlikely to secure a stay if it chooses to contract with an entity with no resources, such as an SPV which never had any resources of its own except the development itself (LXB RP (Crown Road) Limited v Squibb Group Limited [2016] EWHC 2669). Furthermore, if the payee’s likely inability to repay is caused by payer’s failure to honour the adjudicator’s decision itself, the payer cannot complain about the impecuniosity he has caused (Absolute Rentals Limited v Gencor Enterprises Limited (2001) 17 Const. L.J. 322). Indeed, in Mead General Building Ltd v Dartmoor Properties Ltd (above) it was held that the CVA was itself a direct consequence of Dartmoor Properties’ failure to pay the decision, and the court accepted the CVA supervisor’s view that if it were paid then Mead would survive to trade and repay if it lost any subsequent proceedings on the dispute.
For your convenience, the relevant tests were summarised by Coulson J in Wimbledon Construction Co 2000 Limited v Derek Vago [2005] EWHC 1086, the leading case with ‘go to’ guidelines for when a stay of enforcement on the grounds of insolvency will be forthcoming; see paragraph 26 (a) – (f). Where a winding up or bankruptcy order is made against the payee in an insolvency court before an enforcement hearing in the TCC, what is a ‘hard case’ will become an ‘easy case’. In those circumstances the court is unlikely to enforce the adjudicator’s award by summary judgment at all, let alone stay enforcement of the order to pay (see Hart Investments Ltd v Fidler [2006] EWHC 2857 where, at paras 71 – 75, Coulson J qualified paragraph 26(e) of his own judgment in Wimbledon v Vago). This is because if the court were to order that the adjudicator’s decision ought to be enforced, this would fetter the liquidator or administrator with a judgment in the payee’s favour that only supports a temporarily binding decision (i.e. the adjudicator’s decision) when an insolvency officer’s role is to make a judgment about the parties’ underlying substantive dispute, as he is obliged to do under the Insolvency Act 1986. The rationale for the refusal to enforce is the same which led to Fraser J’s judgment in Lonsdale v Bresco, as explained here.
A further dimension exists to the above tests; I call these the ‘alleged foul play’ cases, where the payer seeks to avoid enforcement by claiming the payee’s conduct has been so questionable as to taint the adjudicator’s award or the enforcement of it. The payee’s financial position is commonly called into question in cases like this too, and a recent case where alleged foul play featured illustrates the clear difference between the court enforcing an adjudicator’s decision by saying it was payable on the one hand, but staying enforcement of that order on the other.
Generally, in such cases, a distinction can be made between matters where the allegations were or should have been ‘live’ in the adjudication, and those where the alleged wrongdoing is independent of the dispute before the adjudicator, or could only have come to light subsequently. In the former case the court will usually enforce the adjudicator’s decision in the usual way rather than allow the payer to reopen the decision, since to do otherwise might frustrate the HGCRA’s intention of arriving at a temporarily binding and quickly enforceable decision In the latter scenario, the court will not enforce the adjudicator’s decision if the payer can, by reference to clear and unambiguous evidence not available at the time of the adjudication, impugn the decision because it directly concerns a fraudulent claim (SG South Ltd v King's Head Cirencester LLP [2009] EWHC 2645; Speymill Contracts Ltd v Baskind [2010] EWCA Civ 120).
In the recent and stark case of Gosvenor London Ltd v Aygun Aluminium UK Ltd [2018] EWHC 227, Gosvenor was Aygun’s cladding sub-subcontractor, and had obtained an adjudicator’s award for £553,958.47 plus VAT against Aygun, mostly concerning Gosvenor’s site labour. Aygun’s defence to the enforcement proceedings and accompanying witness statements stated that "…a substantial proportion of the Claimant's award is based on sums fraudulently invoiced to the Defendant by the Claimant in the period between 15 May 2017 and the end of October 2017." Aygun’s defence, pleaded by counsel, cited a figure of £300,000 and contended that "…the allegations of fraudulent invoicing set out below were not and could not reasonably have been raised during the adjudication process as much of the relevant information was not available to the Defendant at the time and/or could not have been obtained in the highly restricted timetable imposed on statutory adjudication under the 1996 Act." The witness statement of Aygun’s Site Supervisor and Health and Safety Officer also referred to site labour records going missing, and intimidation of Aygun’s employees after the adjudicator’s decision had been received. Grosvenor did not file any evidence to counter these allegations until after the enforcement hearing, and only sought to do so just before the judgment was finalised. On that point, Fraser J said: “I do not consider that it is to reverse the burden of proof by making the obvious point that where complaints are made of a plan hatched in advance to engage in fraudulent over-charging, collusion with the Aygun Project Manager, theft of the site laptop, attempted bribery, threats and intimidation, one could at least expect some sort of denial in a witness statement.” However, Fraser J said none of this was relevant to whether the adjudicator’s decision should be enforced, because the facts pleaded to support the fraud allegation could and should have been argued by Aygun in the adjudication but were not. Therefore, Gosvenor succeeded in its summary judgment application; the adjudicator’s award stood and was payable.
However, on the question of a stay of the enforcement of that order, the fraud allegations were a ‘special circumstance’ relevant to CPR 87.4, and in addition, evidence showed that there was a real risk that Grosvenor was organising its financial affairs with the purpose of dissipating the sum payable in the adjudicator’s award so that it could never be repaid. Gosvenor’s director had verbally threatened as much, there was a £600,000 discrepancy in Gosvenor’s accounts for 2016 due to the sum due to creditors having been inflated, and it had recently been threatened with strike-off by the Companies Registrar. Aygun’s cross-application for a stay of execution was successful. Fraser J said at paragraph 39 of his judgment that the Wimbledon v Vago guidelines should be supplemented by this rule: “(g) If the evidence demonstrates that there is a real risk that any judgment would go unsatisfied by reason of the claimant organising its financial affairs with the purpose of dissipating or disposing of the adjudication sum so that it would not be available to be repaid, then this would also justify the grant of a stay.” At paragraph 40, Fraser J emphasised that cases which fall into category (g) will be rare. Fraser J’s approach was endorsed by the Court of Appeal (see [2018] EWCA Civ 2695), with Coulson LJ giving the lead judgment.
It can therefore be seen why the ‘hard cases’ are so named. In addition to showing that the payee is or will become insolvent, to obtain a stay of execution, the payer must show that it faces real prejudice in relation to the resolution of the substantive dispute, and that the payee’s financial situation is worse than when the parties contracted, and that this is not due to the payer’s failure to honour the adjudicator’s award. On the question of alleged foul play, matters which could and should have been argued at the time of the adjudication will not impugn the adjudicator’s award. However, these may be relevant to whether there should be a stay of enforcement, and evidence that the payee intends to dissipate the money due under the adjudicator’s award will also justify the imposition of a stay.
What should you do in this situation?
What do the ‘hard cases’ mean for payers who think that a payee which has the benefit of an adjudicator’s award is insolvent? Commercial judgment is paramount; how does the cost-benefit analysis of resisting payment pan out? Is there a short cut available, by means of subsequent valuations in the payment cycle in which the payer can use a Pay Less Notice?
If enforcement is to be resisted, I recommend exhausting more fundamental grounds of challenge which may dissuade the court from enforcing the adjudicator’s award. Firstly, did the adjudicator lack jurisdiction, and were appropriate reservations of rights in relation to that made at the start of the adjudication? If not, it may well be too late to complain now that the award has been made. Secondly, are there any factors, arising perhaps from the payee’s payment notice, or unfairness in the procedure the adjudicator has adopted, that impugn his decision, whether in whole or in part?
What are the merits of the substantive dispute, and is there a credible defence or genuine counterclaim ready to be speedily deployed in the event of an enforcement hearing, and what are the likely future costs of resolving it? Is it worth getting additional expert evidence to support the substantive claim? Note that the payer must not seek to re-fight the adjudication at the enforcement hearing (a pointless exercise) but must show that it will fight the underlying substantive dispute and may win. This is the foundation of a ‘serious risk’ of prejudice; if the entitlement to be repaid is weak, there is no prejudice.
Next, the payer should build its position on prejudice by showing the payee is unlikely to re-pay. Is the payee’s financial situation worse than when the contract was entered into; what does the balance sheet show, what are other creditors saying? Do checks of public records show there any insolvency processes afoot? If the picture is bleak, and the payer is confident it is not the cause of that, obtain an expert accountant’s analysis of the payee’s financial situation; this report will have more credibility if it is compliant with CPR Part 35. If no recent accounts are publicly available, then challenge the payee to disclose management accounts in open correspondence, warning them that any failure to co-operate will be drawn to the attention of the court. Do not take it for granted that because the payee is the subject of a petition, is in a CVA, an IVA or has compromised with its creditors, the court will necessarily agree that it is insolvent.
Crucially, consider whether it is likely that any winding up or bankruptcy petition will be heard before an enforcement hearing; if so, and the insolvency court makes the order, what is a ‘hard case’ will become an ‘easy case’. In those circumstances the court is unlikely to enforce the adjudicator’s award by summary judgment at all, let alone stay enforcement of the order to pay.
In relation to any alleged foul play, argue this in the adjudication where the evidence that supports that is available. Otherwise, deploy that evidence in order to secure a stay.
These notes have been prepared for the purpose of articles only. They should not be regarded as a substitute for taking legal advice