UK: UK Adjudication Review

Last Updated: 10 August 2018
Article by Akin Akinbode, Gurbinder Grewal, Kirsti Olson and Tracey Summerell

Our summer adjudication review includes the following updates:

  • Using a winding-up petition to enforce an adjudication is unwise (a review of Victory House General Partner Ltd, Re A Company [2018] EWHC 1143 (Ch) in which the court refused a winding-up petition to enforce an adjudication);
  • The court's approach to set-off claims in adjudication enforcement proceedings (a review of MI Electrical Solutions Ltd v. Elements (Europe) Ltd [2018] EWHC 1472 (TCC) in which the court refused to allow a contractor to set-off its cross-claim against an adjudication decision); and
  • A last word on the benefits of adjudication

Using a winding-up petition to enforce an adjudication is unwise

You've made it through an adjudication, got a decision in your favor – but the "losing" party is refusing to pay up. What then?

The usual way to enforce an adjudication decision is by starting enforcement proceedings under the Civil Procedure Rules (CPR) using either Part 7 or Part 8. If the debtor can't pay, issuing winding-up proceedings against the debtor company might seem attractive. Such proceedings would be based on the debtor's inability to pay its debts as they fall due and would follow the debtor's failure to pay within three weeks of receiving a statutory demand for payment.

However, winding-up petitions are a risky approach to enforcement as shown by cases such as Shaw v. MFP Foundations & Piling Ltd. The court will dismiss them if the debt is disputed in good faith on substantial grounds – for example if there is a cross-claim. In Victory House General Partner Ltd, Re A Company [2018] EWHC 1143 (Ch), Morgan J summarised the legal principle the court will consider when dealing with a petition involving a disputed debt:

"Where a debt is bona fide disputed on substantial grounds the normal response of the court is to treat the [winding-up] petition as inappropriate, as being an abuse of the process and as being one the court should dismiss, leaving the alleged creditor to pursue the alleged debt in the other ways available to it."

Victory House and other decisions make clear that winding-up proceedings are not suitable for adjudication enforcement. There are obvious downsides to winding up a debtor for a creditor. For example, the creditor will join the ranks of the debtor's unsecured creditors, there is no guarantee of recovery and any amounts recovered will inevitably be much smaller than the debt and paid late. Further, winding-up orders have an air of finality: such proceedings are out of step with the aims of the Housing Grants, Construction and Regeneration Act 1996 as amended (the Construction Act) to give a swift but reviewable decision to keep cash flowing.

In Victory House, Morgan J decided that the employer's cross-claim made it inappropriate to wind up the company because it had not paid the judgment debt. His decision should give those considering this form of enforcement action more pause for thought.

What was the background?

RGB P&C Limited (the contractor) contracted with Victory House General Partner Ltd (the employer) on a standard form JCT Design & Build Contract 2011 to carry out development and conversion works (the contract). The contract was compliant with the Construction Act. When a payment dispute arose on interim application (IA) 30, the contractor referred the dispute to adjudication (No1) and was awarded £682,802.88 (plus VAT and interest).

The employer started proceedings under CPR Part 8 arguing it was not obliged to make the payment. In turn, when the employer did not pay, the contractor started enforcement proceedings. Miss Joanna Smith QC (sitting as a deputy judge) upheld the decision in adjudication No1 and ordered the employer to pay by a certain date. She also left two of the employer's Part 8 issues – which were irrelevant to the payment issue – for future determination.

The employer did not pay the judgment debt. The contractor went on to serve IA31 which led to a second adjudication in which the contractor sought an interim payment of £11 million (including sums claimed under IA30).

However, before the second adjudication took place, the employer paid a sum in excess of £8.5 million on account. The adjudicator went on to decide that the gross value of the contractor's work was £7,087,027.59 – less than the sum paid on account by the employer – but he did not (and could not) make a payback order.

The contractor petitioned to wind up the employer for not paying the judgment debt. In response, the employer argued that were it to pay that debt, it would immediately become entitled, in the law of restitution, to recover that sum. This effectively created a cross-claim which made it inappropriate for the court to wind up the employer for its non-payment of the judgment debt.

So, the employer was not disputing the judgment debt itself in arguing that a winding-up petition was inappropriate. (The contractor could enforce the judgment debt immediately and the deputy judge's decision to leave some issues outstanding did "not in any way detract from the final and binding character of that judgment".) Rather, the employer relied on its cross-claim.

The rule applies to cross-claims too

Morgan J also reviewed the Court of Appeal's conclusion in Re Bayoil SA [1999] 1 WLR 147: that the established rule about disputed debts also applies to disputed cross-claims – where they exceed the petition debt. (See Morgan J's summary of the rule above.) The rule is essentially the same for both disputed debts and cross-claims although "there could be exceptional circumstances where it would be appropriate to allow a petition to proceed even where there was a disputed cross-claim exceeding the disputed debt".

A right to repayment would arise and amounted to a cross-claim

Morgan J's task in assessing the substance of the employer's alleged cross-claim was made easier by the decision in Grove Developments Ltd v. S&T (UK) Ltd. [2018] EWHC 123 (TCC). (See also "Restoring fairness to the process: another episode in the smash and grab adjudication saga".)

In Grove, Coulson J held that once an adjudicator had found a certain sum to be payable for works done under the contract, without having valued the works in accordance with the contract, a second adjudication referral could be made to value the works done pursuant to the contract. If the valuation of the interim payment in the second adjudication turned out to be a smaller figure than actually paid, the employer could request a repayment.

In this case, the second adjudicator had found that, following the contract valuation, the employer owed less to the contractor than it had paid on account. If it paid the judgment debt, the employer would immediately have a cause of action for a repayment. Morgan J concluded this amounted to a cross-claim which prevented the contractor from winding up the employer for non-payment of the judgment debt. It was bad enough that the employer had already paid £8.5 million when the second adjudicator had found only £7 million due. It would be worse if the employer had to pay the extra £3 million or so to avoid being wound up.

Morgan J concluded that the employer's "nascent cross-claim" (the claim in restitution) was a bona fide claim. It was made on substantial grounds and was (at that point) a claim that would succeed. Finally, there were no special circumstances to take the case outside the application of the general rule.

Practical points

The judge's decision broadens the definition of a cross-claim to include a "nascent" right to repayment based on a valuation in a subsequent adjudication. It is another indication of the court's reluctance to use a winding-up order to enforce an adjudication decision. Here, justice demanded that it would be "quite wrong" for the employer to be wound up for failing to pay a further sum given that it had already paid a substantial sum in excess of the second adjudicator's valuation.

The court's approach to set-off claims in adjudication enforcement proceedings

When an adjudicator decides a party should pay, that party must pay up straight away. The adjudicator's decision is binding and enforceable unless there is a valid jurisdictional challenge or the adjudicator is in breach of natural justice (Macob v. Morrison, (1999)). The losing party can argue about the decision's merits in later court or arbitration proceedings. This principle underpins the aims of the Construction Act to keep cash flowing on projects.

But what happens if the paying party has a cross-claim – for example, because it has found defects in the payee's work? Can the payer set off the value of its cross-claim from the amount the adjudicator has ordered it to pay?

This is what the Technology and Construction Court (TCC) had to consider in MI Electrical Solutions Ltd v. Elements (Europe) Ltd [2018] EWHC 1472 (TCC).

The defendant (the contractor) had appointed the claimant (the sub-contractor) to supply and install mechanical and electrical works in apartment modules on the "Orchard Village" project. A dispute arose and an adjudicator decided the contractor owed the sub-contractor £179,931.57. Having identified defects in the sub-contractor's works for which it had valued the remedial works at £168,453.33, the contractor deducted that sum and paid only the balance. The sub-contractor applied to the court for summary judgment on the £168,453.33.

A court may award summary judgment where: "(a) it considers that ... (ii) the defendant has no real prospect of successfully defending the claim or issue; and (b) there is no other compelling reason why the case or issue should be disposed of at a trial."

There was no issue about the adjudicator's jurisdiction or any breach of natural justice which prevented the sub-contractor from enforcing the judgment. The only issue was whether the contractor could set off its cross-claim of £168,453.33 against the adjudicator's decision. The sub-contractor argued it could not on the principal basis that the adjudicator had dealt with set-off in the adjudication. The parties had agreed (under the Scheme for Construction Contracts which applied to their sub-contract) that the adjudication decision was binding until finally determined in litigation or arbitration. The contractor could not now raise the set-off issue again in the summary judgment enforcement proceedings.

The judge reviewed the adjudicator's decision and agreed with the sub-contractor: the adjudicator had indeed dealt with set-off in the adjudication. The contractor should have deducted the cost of repairing the defective works from the payment applied for in the pay less notice. It had not done so and could not now raise the cross-claim in defence to the summary judgment application.

The contractor could have started CPR Part 8 proceedings to introduce substantive law issues on the merits for the judge's determination at the summary judgment hearing –or sought to establish the criteria in Hutton Construction v. Wilson Properties. (Hutton provides that when deciding whether a contractor can raise issues in defence of an enforcement hearing, the court's starting point is whether there is a jurisdictional challenge or a breach of natural justice (see Macob). The contractor must then show the issue raised in defence of an enforcement application is suitable for the CPR Part 8 process. The issue must be short and self-contained; must already have been raised in the adjudication; or require no oral evidence or elaboration that would extend the enforcement hearing unreasonably. The defendant must also show that it would be unconscionable for the court not to hear the point. The judge in Hutton made clear that scenarios where substantive points can be raised will be rare.)

In MI Electrical, the contractor also raised alternative arguments that it could set off its cross-claim under two set-off clauses in the contract. In dismissing these arguments, the judge made a passing ("obiter") comment after reviewing the relevant precedents. To be effective, the contractual terms allowing set-off must either be consistent with the policy of the Construction Act or be struck down as inconsistent with its policy. (There are exceptions where set-off was granted such as in Parsons Plastics (Research & Development) Ltd v. Purac Ltd [2002] EWCA Civ 459 – but Parsons was an unusual case.)

The judge dismissed the contractor's contractual set-off arguments. He interpreted the Scheme for Construction Contracts to mean that the adjudication decision was binding irrespective of the terms of the contract. Alternatively, he interpreted the two set-off clauses relied on by the contractor as not applying to the adjudicator's decision – as that was the only way in which they could be consistent with the Construction Act (and therefore effective). Other interpretations would stop payment and thwart the underlying policies of the Construction Act to keep cash moving.

The contractor was left with no right of set-off. Its defence to the summary judgment application failed. The case was suitable for summary judgment and the judge enforced the adjudication decision and awarded judgment to the sub-contractor.

Practical points

  • Include any cross-claims that arise during the works in the relevant pay less notice, clearly explaining the deduction/set-off.
  • When considering making a defence to enforcement proceedings, remember that the Construction Act was introduced to improve payment procedures and cash flow. Most adjudication decisions will be enforced.
  • If you defend an enforcement action and intend to raise substantive issues in response to an adjudication decision, ensure you come within the ambit of Hutton and make an early CPR Part 8 application. Failure to do so could leave you with a failed defence, a large costs bill and an outstanding duty to pay the sum due under the adjudication decision.

Last word on the benefits of adjudication

MI Electrical Solutions shows the downside – the so-called rough justice – inherent in the adjudication process for those who have to pay up while their own claims are outstanding. The overall benefits, however, should be kept in mind. Twenty years ago, the usual option to recover payment was full-blown litigation. Lengthy, costly proceedings in the TCC are now both unthinkable and unaffordable for most. As The Honourable Mr Justice Fraser commented in his recent judgment in Imperial Chemical Industries Ltd v. Merit Merrell Technology Ltd [2018] EWHC 1577 (TCC) ("a long-running and bitter dispute"): "[This] litigation also stands as something of an advertisement for adjudication". Adjudication remains a swift process for resolving payment disputes while maintaining a party's right to seek a final resolution in the courts or arbitration.

Dentons is the world's first polycentric global law firm. A top 20 firm on the Acritas 2015 Global Elite Brand Index, the Firm is committed to challenging the status quo in delivering consistent and uncompromising quality and value in new and inventive ways. Driven to provide clients a competitive edge, and connected to the communities where its clients want to do business, Dentons knows that understanding local cultures is crucial to successfully completing a deal, resolving a dispute or solving a business challenge. Now the world's largest law firm, Dentons' global team builds agile, tailored solutions to meet the local, national and global needs of private and public clients of any size in more than 125 locations serving 50-plus countries.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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