The issues of entitlement to payment following a company becoming insolvent and recovery of that payment are intrinsically linked and there is a growing body of case law where the courts are issuing guidance on when and where an insolvent party may or may not be entitled to recover payment (typically through adjudication).
Entitlement
In the case of a company that has already become insolvent, from an insolvency practitioner's (IP) perspective, recovery of funds will be key either to determine the ongoing prospects of the company or to provide creditors with a dividend, however, construction contracts typically have mechanisms in place to prohibit sums becoming payable to an insolvent entity in the immediate term.
Contracts such as those within the JCT / NEC suites will contain provisions that define insolvency and issue guidance on the contractual repercussions of a party to one of those contracts entering some form of insolvency and it is not uncommon for other standard forms or bespoke forms of construction contract to contain similar provisions.
The effect of insolvency on many forms of construction contract is such that upon the insolvency of a party and the termination of the contract, the other may not be entitled to any further payments (particularly in the case of insolvent contractors being owed money by their employers) until the works have been carried out by replacement contractors. As such, whilst an office holder may seek recovery of unpaid sums under the contract, the employer will invariably assert its right to withhold further sums until the works have been completed and later assert its right to deduct / set-off losses arising as a result of the contractor's insolvency from the sums which may otherwise have been due to it.
If it is the alternative scenario, and the employer has become insolvent and the contract has been terminated, the contractor shall only be entitled to further payment as an unsecured creditor in the insolvent proceedings. If the contract has not yet been terminated, the contractor might consider continuing to comply with the requirement to submit interim (or final, if the works are complete) applications for payment however, these may not be responded to as a result of the insolvency, and the usual position where the sum applied for in an application for payment that has not been responded to becomes the default sum due (therefore opening up the option to pursue a 'smash and grab' adjudication) may not be available – see below.
Recovery
Recovery options are relatively limited in the case of an insolvent employer / contractor. The usual position applies – debts in the insolvency can be claimed in the typical way, i.e. by the submission of a proof of debt. This method comes with the usual caveat that recovery will be subject to the insolvent company’s financial position and the outcome of the IP's work. To mitigate against the risks posed by this caveat, especially in larger projects, performance bonds, parent company guarantees, and retention bonds can be agreed in advance.
Otherwise, there is a relatively recent body of settled case law dealing with circumstances where an insolvent party may refer a dispute to adjudication. In 2020, the Supreme Court held in Bresco v Lonsdale1 that in principle, an adjudicator does have jurisdiction to decide a dispute referred by an insolvent party. Following the decision in Bresco v Lonsdale and perhaps an influx of adjudications brought by insolvent parties (and their office holders), John Doyle v. Erith Contractors2 was considered in the Court of Appeal with one of the key issues at hand being whether a decision in favour of an insolvent party could be enforced. The Court of Appeal ultimately held that there is limited scope for enforcement of an adjudicator's decision in favour of an insolvent party, and even where there is scope, there is a high threshold for insolvent parties to meet in order to obtain enforcement (including security). Finally, and more recently, the Technology and Construction Court considered J A Ball v St Phillips Homes3 and gave further guidance on the enforceability of a decision issued in favour of an insolvent party. On enforceability, the Court found there where an insolvent party was facing cross-claims or set-offs, generally, it will not be entitled to enforce an adjudicator's decision in its favour – this principle arises from the effect of the Insolvency Rules (unless in relation to a company in administration prior to a notice of intended distribution being issued) and the Court found that this principle is applicable to both companies in liquidation and administration in relation to adjudication enforcement. As such, unless the adjudication considered all matters in dispute, i.e. was a final account adjudication and not an interim payment adjudication, it is unlikely (but not impossible) that a Court will enforce an award in an insolvent party's favour.
What is adjudication?
Unsure of what adjudication is? Adjudication is a short form means of alternative dispute resolution applicable only to the construction industry designed to protect cash flow throughout construction projects. An adjudicator's decision is binding but not final meaning that the issues raised in the adjudication can later be decided in Court. An adjudicator's decision can also be enforced in Court without the matters in dispute having to be re-heard. Our article here explains adjudication in more detail.
1Bresco Electrical Services Ltd (In Liquidation) V Michael J Lonsdale (Electrical) Ltd [2020] UKSC 25
2John Doyle Construction Ltd (in Liquidation) V Erith Contractors Ltd [2021] EWCA Civ 1452
3J A Ball Limited (in Administration) v. St Philips Homes (Courthaulds) Ltd (currently unreported)
Entitlement
In the case of a company that has already become insolvent, from an insolvency practitioner's (IP) perspective, recovery of funds will be key either to determine the ongoing prospects of the company or to provide creditors with a dividend, however, construction contracts typically have mechanisms in place to prohibit sums becoming payable to an insolvent entity in the immediate term.
Contracts such as those within the JCT / NEC suites will contain provisions that define insolvency and issue guidance on the contractual repercussions of a party to one of those contracts entering some form of insolvency and it is not uncommon for other standard forms or bespoke forms of construction contract to contain similar provisions.
The effect of insolvency on many forms of construction contract is such that upon the insolvency of a party and the termination of the contract, the other may not be entitled to any further payments (particularly in the case of insolvent contractors being owed money by their employers) until the works have been carried out by replacement contractors. As such, whilst an office holder may seek recovery of unpaid sums under the contract, the employer will invariably assert its right to withhold further sums until the works have been completed and later assert its right to deduct / set-off losses arising as a result of the contractor's insolvency from the sums which may otherwise have been due to it.
If it is the alternative scenario, and the employer has become insolvent and the contract has been terminated, the contractor shall only be entitled to further payment as an unsecured creditor in the insolvent proceedings. If the contract has not yet been terminated, the contractor might consider continuing to comply with the requirement to submit interim (or final, if the works are complete) applications for payment however, these may not be responded to as a result of the insolvency, and the usual position where the sum applied for in an application for payment that has not been responded to becomes the default sum due (therefore opening up the option to pursue a 'smash and grab' adjudication) may not be available – see below.
Recovery
Recovery options are relatively limited in the case of an insolvent employer / contractor. The usual position applies – debts in the insolvency can be claimed in the typical way, i.e. by the submission of a proof of debt. This method comes with the usual caveat that recovery will be subject to the insolvent company’s financial position and the outcome of the IP's work. To mitigate against the risks posed by this caveat, especially in larger projects, performance bonds, parent company guarantees, and retention bonds can be agreed in advance.
Otherwise, there is a relatively recent body of settled case law dealing with circumstances where an insolvent party may refer a dispute to adjudication. In 2020, the Supreme Court held in Bresco v Lonsdale 1 that in principle, an adjudicator does have jurisdiction to decide a dispute referred by an insolvent party. Following the decision in Bresco v Lonsdale and perhaps an influx of adjudications brought by insolvent parties (and their office holders), John Doyle v. Erith Contractors 2 was considered in the Court of Appeal with one of the key issues at hand being whether a decision in favour of an insolvent party could be enforced. The Court of Appeal ultimately held that there is limited scope for enforcement of an adjudicator's decision in favour of an insolvent party, and even where there is scope, there is a high threshold for insolvent parties to meet in order to obtain enforcement (including security). Finally, and more recently, the Technology and Construction Court considered J A Ball v St Phillips Homes 3 and gave further guidance on the enforceability of a decision issued in favour of an insolvent party. On enforceability, the Court found there where an insolvent party was facing cross-claims or set-offs, generally, it will not be entitled to enforce an adjudicator's decision in its favour – this principle arises from the effect of the Insolvency Rules (unless in relation to a company in administration prior to a notice of intended distribution being issued) and the Court found that this principle is applicable to both companies in liquidation and administration in relation to adjudication enforcement. As such, unless the adjudication considered all matters in dispute, i.e. was a final account adjudication and not an interim payment adjudication, it is unlikely (but not impossible) that a Court will enforce an award in an insolvent party's favour.
What is adjudication?
Unsure of what adjudication is? Adjudication is a short form means of alternative dispute resolution applicable only to the construction industry designed to protect cash flow throughout construction projects. An adjudicator's decision is binding but not final meaning that the issues raised in the adjudication can later be decided in Court. An adjudicator's decision can also be enforced in Court without the matters in dispute having to be re-heard. Our article here explains adjudication in more detail.
1Bresco Electrical Services Ltd (In Liquidation) V Michael J Lonsdale (Electrical) Ltd [2020] UKSC 25
2John Doyle Construction Ltd (in Liquidation) V Erith Contractors Ltd [2021] EWCA Civ 1452
3J A Ball Limited (in Administration) v. St Philips Homes (Courthaulds) Ltd (currently unreported)
