Adjudication: an effective form of dispute resolution for an insolvent company or paper tiger?

Adele Parsons discusses how useful a dispute resolution tool adjudication really is for an insolvent company as the TCC continues to mediate the uneasy relationship between the enforcement of an adjudicator’s decision and the Insolvency Rules in FTH Limited v Varis Developments Limited.1

Introduction

There is no escaping that times are tough for the construction industry. It, like the rest of the UK, is staring down the barrel of a long recession, which hardly seems surprising given the perfect storm of market challenges faced by the industry. Indeed, the jump in inflation, fallout from the pandemic and Brexit, supply chain pressures, lack of labour, rising material and fuel costs, and the current geopolitical climate caused by the war in Ukraine, must, for many in the industry, feel like a commercial nightmare from which there is little chance of yet waking up. 

At the time of writing, in the 12 months ending in the second quarter of 2022, 19% of the insolvencies in England and Wales were within the construction industry; a total of 3,665 company insolvencies.2

Adjudication and insolvency

On the face of it, adjudication should be an effective tool for insolvent companies given its purpose is to provide a referring party with a rapid and relatively inexpensive method of resolving disputes to obtain cashflow quickly. Previously, however, it was argued that adjudication did not sit well with the mandatory set-off provisions within the Insolvency Rules. These require that a liquidator set off any claims and counterclaims made against the insolvent company by a third party with which the company has had “mutual dealings”. The result of this accounting exercise is a net balance in favour of either the company or the third party. In short, the right to set off seemed to undermine the temporary binding adjudicator’s decision.

Any wrinkles between the adjudication regime and the Insolvency Rules were seemingly ironed out some two years ago when the Supreme Court3 unanimously found that the right to adjudicate was not extinguished by the Insolvency Rules nor any cross claims that a responding party may have against an insolvent referring party. Indeed, the Supreme Court reasoned that, should the existence of a cross claim deprive a company of its right to adjudicate, this would be a “triumph of technicality over substance”4.

Essentially, the position remains that an insolvent company is not only entitled to commence an adjudication but to enforce the adjudicator’s decision if necessary. The caveats?

  • The adjudicator does not have jurisdiction to award a cross claim to a responding party where that cross claim is greater than the amount sought by the referring party. The adjudicator can, however, make a declaration as to its value. 
  • Secondly, should the insolvent referring party seek to enforce the adjudicator’s decision, they will not only need to evidence that they can provide security for the amount awarded in the decision but also for the other’s party’s costs of the enforcement. 

FTH Limited v Varis Developments Limited: the facts

How the above works in practice was recently explored further in the case of FTH Limited v Varis Developments Ltd. Here, however, the question before the court was whether it should enforce two adjudicators’ decisions awarded in favour of FTH where the latter had a Company Voluntary Arrangement or “CVA” in place. 

To summarise, a CVA is a procedure that allows a company to essentially trade its way out of trouble by coming to an arrangement with its creditors over the payment of its debts. The aim is that the company settles those debts by only paying a proportion of what it owes to those creditors. Once approved, the CVA binds the company’s creditors who can then only recover their debt from the company in accordance with the terms of the agreed CVA. 

In the first adjudication, the adjudicator upheld the validity of a Pay Less Notice. In the second, it was found that Varis had not validly terminated the parties’ contract and that it had, therefore, repudiated the contract. 

Although Varis accepted that the two adjudicator’s decisions were valid, it resisted enforcement of the adjudicators’ decisions and sought a stay of execution as it had serious concerns about FTH’s financial position and had crossclaims against FTH in the sum of some £1.7m. 

Varis submitted that, although FTH had a CVA in place, it only had a 12-month life span, and only allowed FTH to recover 56p in the pound. In addition, it was apparent that the CVA’s supervisors had not considered Varis’s crossclaim. 

Considering the above, Varis argued that if its crossclaim succeeded in whole or even in significant part, the CVA would fail and FTH would go into liquidation, and that if the court enforced the adjudicator’s decisions, there was a real risk that Varis would be deprived of security for its crossclaim.

A compelling reason not to enforce 

The Court agreed with Varis and refused to enforce the adjudicator’s decisions. 

The starting point for the court’s decision was Bouygues (UK) Ltd v Dahl-Jensen5, in which the Court of Appeal held that, where a company in liquidation seeks to enforce an adjudicator’s decision but the Defendant has cross claims, there was a “compelling reason” to refuse summary judgment particularly given the provisional (i.e., temporarily binding) nature of an adjudicator’s decision.

Notwithstanding that “compelling” reason, the court in FTH was quick to note the Court of Appeal’s judgment in Bresco v Lonsdale6 in which Lord Justice Coulson stressed that courts should be wary of reaching conclusions which prevent a company in clear financial difficulties from endeavouring to use adjudication. Indeed, not all adjudication decisions were subject to enforcement. 

Specifically, the Court of Appeal commented that the general position relating to a CVA may be very different to the situation where the claimant company is in insolvent liquidation. The reason for this is that the CVA, by its very nature, is designed to allow a company to trade its way out of trouble. In those circumstances and given that the purpose of adjudication is to provide a quick and cheap method of improving cashflow, adjudication could be a very useful tool to assist the operation of the CVA. 

CVA: can you trade out of trouble?

The court did not enforce the adjudicators’ decisions as it agreed that FTH had not been trading profitably and that there remained a real risk that Varis could be deprived of adequate (or any) security in respect of its crossclaim if the court enforced the adjudicator’s decisions. The court found that FTH would be unable to repay the judgment sum and Varis’s costs if the matter went to trial and the adjudicators’ decisions were overturned. 

As the enforcement had been refused, the court did not consider it necessary to grant a stay of execution. However, it did note that, if parties such as FTH wish to avoid a stay, they must provide detailed and reliable information in respect of their financial position. FTH had not done this. In fact, the court found it had been "somewhat economical” with the financial information it had provided meaning that court would have been justified in granting a stay had it been required. 

Is adjudication effective for an insolvent company? 

Arguably, the court’s decision in FTH raises the often raised utility or “what is the point?” question, i.e., if a court is reluctant to enforce an adjudicator’s decision where on the facts the claimant is insolvent (or heading that way) and unable to provide the necessary security, is there really any point in that party pursuing an adjudication?

Despite the increasing frequency in which cases like this have been heard by the courts over the last two to three years (a number which is only likely to rise in the current economic climate), it is clear that the merits of an adjudication enforcement claim made by an insolvent party will still very much depend on the facts. 

What is clear from FTH is that the burden is on an insolvent company to not only demonstrate the effectiveness of the CVA to which it is bound but to provide transparent and detailed information of its financial position to persuade a court that it can provide security for both the claim amount and the other side’s costs. Again, we are led back to the second caveat mentioned above. 

In all, the reliance on the facts of each case and the lack of further definitive judicial guidance means that insolvent companies should be wary of how they proceed when considering adjudication. 

Although billed as a cheap and quick form of dispute resolution, adjudication costs can easily spiral depending on the substance of the dispute, the use of experts and the number of submissions served by each party. Essentially, potential referring parties should fully review the merits of their substantive arguments and not just their bank accounts when it comes to commencing an adjudication to ensure that adjudication will not deplete already stretched funds further with little or no reward further down the line.

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Adele Parsons

Tel: +44 (0)20 7421 1986
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