Post-Insolvency Adjudication and Third-Party Funding

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There has been a long-standing debate regarding the (in)compatibility of the statutory adjudication regime and the assessment of the respective liabilities of parties after one of them has entered an insolvency process. One particular aspect of the debate is the extent to which Liquidators of insolvent companies are able to pursue adjudication proceedings. Another is how such claims can be funded. This is particularly relevant in light of the proliferation of third-party funding providers entering the adjudication forum.

Some recent case law sheds some light on these issues.

Post-Insolvency Adjudication

In Bresco Electrical Services Ltd v Michael J Lonsdale (Electrical) Limited the Court of Appeal held that, as a matter of jurisdiction, a party to a construction contract did not lose the right to refer a dispute to adjudication even after entering into an insolvency process.

Therefore, an adjudicator theoretically has jurisdiction to decide a dispute referred to them. This is despite the statutory obligation under the Insolvency Rules to take an account of the parties’ respective liabilities to each other to ascertain the sums due by setting off the liabilities of one party against the other.

However, the Court recognised that there was a clear incompatibility between the adjudication regime and the Insolvency Rules in “smash and grab” adjudications which determined the sum “due” based on a technicality rather than ascertaining the “true value” of works undertaken, e.g. where the paying party has a cross-claim.

In such circumstances, the Court has the discretion to grant an injunction preventing an adjudication from proceeding or to order a stay of execution in any subsequent enforcement proceedings.

The Court also recognised that whilst a Responding Party may be able to fight enforcement proceedings or pursue litigation to finally determine the dispute, it was unlikely to recover any legitimate cross-claim or get its costs back from an insolvent company.

The Next Step

In Bresco, the Court acknowledged that there may be “exceptional circumstances” when an insolvent party may be permitted to pursue adjudication proceedings, obtain summary judgment and avoid a stay of execution.

The judgment in Meadowside Building Developments Ltd (in Liquidation) v 12-18 Hill Street Management Company Ltd expands on what those “exceptional circumstances” might be. Here, Meadowside had obtained an adjudicator’s decision in the sum of £32,629 and was seeking to enforce payment by way of a summary judgment application.

In summary, these circumstances require the preservation of the Responding Party’s security for any cross-claims and the reduction or elimination of any costs risks in any subsequent litigation to overturn the adjudicator’s decision.

What is considered adequate security is a matter of fact to be determined on a case by case basis, but could include:

  • The Liquidator agreeing to ringfence the sum awarded on enforcement so that it is not distributed to other creditors
  • A third-party providing a guarantee or bond
  • Taking out ATE insurance

In Meadowside, the adjudication concerned a claim for all sums due under the contract (a “final account”) not just a single application for payment. It was therefore as close to determining the final net position (i.e. as would be required under the Insolvency Rules) as possible. This was important as it furthered the Liquidator’s statutory duty to pursue the insolvent company’s debts, rather than a simple cash-flow exercise.

Third-Party Funding

As a recap, “Maintenance” concerns the improper support of litigation in which the supporter has no legitimate interest in the claim and “Champerty” is an extension of Maintenance where the supporting party stands to receive a share of the proceeds of the action. Both are subject to stringent rules and regulations.

In Meadowside, the Liquidator had the benefit of a third-party guarantee and funding agreement under which the funder would be entitled to a proportion of any amount recovered. It was this agreement that was offered by the Liquidator as the security required under the “exceptional circumstances” test. However, the third-party refused to disclose the full terms of the agreement.

On the facts, the Court found that the agreement fell foul of the relevant regulations and was therefore unenforceable as between the Liquidator and the third-party. The Court also found that the financial standing of the third-party to act as guarantor was inadequate.

In the circumstances, the Court decided that the “exceptional circumstances” test had not been satisfied and Meadowside’s application for summary judgment was refused.

Commentary:

Whilst the “exceptional circumstances” would have to be considered on a case by case basis, the general position appears to be that a Liquidator may be permitted to pursue and enforce an adjudication claim providing:

  • The claim concerns the final net position between the parties (i.e. it is a final account dispute); and
  • The Liquidator is able to provide adequate security in relation to (a) any cross-claims by the Responding Party, and (b) the Responding Party’s costs.

However, the Court will apply the test stringently and, in light of the security requirements, Liquidators of insolvent companies will need to consider carefully whether pursuing adjudication proceedings will be in the best interest of the creditors. Equally, Responding Parties will need to consider whether to protect their position by seeking an injunction to prevent an adjudication continuing or to fight enforcement proceedings on the basis that the “exceptional circumstances” test has not been satisfied.

This is likely to be the first in a series of decisions on this point so watch this space!