Picture the scenario: your sub-contractor has walked off site and goes into liquidation during a termination dispute about who owes what to whom. The sub-contractor refers the dispute to adjudication. You are then faced with the possibility of paying out on a temporarily binding adjudicator's decision. Worse, you know that if the adjudicator gets it wrong, the chances of recovering your money in later court proceedings are non-existent.

A similar scenario faced the court in Michael J Lonsdale (Electrical) Ltd v. Bresco Electrical Services Ltd [2018] EWHC 2043 (TCC).

Lonsdale had contracted with Bresco for the carrying out of electrical installation works. A termination dispute arose and both parties claimed money from the other. Bresco went into liquidation and, shortly after, referred the dispute to adjudication.

Lonsdale invited the adjudicator to resign and Bresco to withdraw from the adjudication on the basis that the mandatory set-off provisions in the Insolvency (England and Wales) Rules 2016 (SI 2016/1024) (the Rules) had effectively extinguished the claims and the adjudicator did not have jurisdiction to adjudicate. Both Bresco and the adjudicator refused the invitation.

Lonsdale issued court proceedings to stop the adjudication – and was successful.

Court intervention in adjudication proceedings is rare

Court intervention mid-flow in an adjudication is highly unusual: jurisdiction challenges are normally dealt with at the enforcement stage. So why did Fraser J intervene here?

The answer lies in the relationship between the Construction Act* and the Rules and the effect of a party's liquidation under the Rules on the parties' rights. (Note, for these purposes, Fraser J's judgment applies to both the 1986 version of the Rules (Insolvency Rules 1986 (SI 1986/1925) at rule 4.90), and the 2016 version (at clause 14.25).)

The effect of liquidation

Under the Rules, when a company enters liquidation, its creditors are ranked "pari passu" (treated equally ) in pursuing what is owed to them. However, different rules apply where the company in liquidation also owes money to a creditor.

The Rules require "an account [to] be taken" of what the parties owe to each other. This involves an analysis of the parties' "mutual dealings" and a set-off of the different sums due in each direction to arrive at a single balance owing one way or another upon liquidation.

This "pound-for-pound", mandatory, insolvency set-off prevents the hardship of a debtor who is also a creditor being forced to pay out its debt in full, when it will only receive a dividend for the debt it is owed as a result of ranking "pari passu" with the ordinary creditors.

The money claims between Lonsdale and Bresco fell within the definition of "mutual dealings" under the Rules. Once their mutual dealings were replaced with a single debt, Bresco could not then seek to enforce any claims under the construction contract separately. Under the Rules, the taking of the account was the only remaining dispute and the adjudicator's jurisdiction under the Construction Act fell away.

The Construction Act does not and was never intended to give adjudicators the power to resolve disputes in the taking of the account required by the Rules. In effect, on liquidation, the need to keep cash flowing under the Construction Act gives way to creditors' rights.

What about the right to adjudicate?

Not surprisingly Bresco argued that an order to stop an adjudication contravened the right of parties to a construction contract to adjudicate "at any time". Dismissing this argument, Fraser J was clear that the right to adjudicate relates to disputes arising "under the contract". Upon liquidation, the only claim that can exist is the single dispute arrived at after the taking of account – and that arises in the liquidation not under the construction contract.

Where does this leave liquidators trying to sort out the account?

Lonsdale, which follows the decision in Enterprise Managed Services Ltd v Tony McFadden Utilities Ltd (2009), leads us to the following conclusions:

  • the courts can grant an injunction in an ongoing adjudication but such intervention will be rare;
  • a company in liquidation cannot refer disputes involving financial claims to adjudication. This could result in multiple adjudications and an inappropriate, "slice-by-slice approach" to the taking of account which the Rules did not envisage;
  • the judgment ends liquidators' relatively common practice of referring financial disputes to adjudication (and adjudicators' acceptance of referrals). In Fraser J's view, these practices had little bearing on the correct analysis of the relevant law by the court. Future such adjudication referrals will not, therefore, be the best use of available funds;
  • liquidators might still use adjudication to determine non-financial construction contract claims but the scope of this option is debatable and will likely be tested further in the courts; and
  • liquidators might now question the practice of assigning claims to third parties at a discount for them to handle such claims in adjudication.

*Construction Act: adjudication as defined by the Housing Grants, Construction and Regeneration Act 1996 as amended.

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