As the impact of COVID-19 continues to be felt throughout the construction sector, Gavin Hoccom, Senior Associate at Berry Smith, reviews the position of the construction company entering or facing insolvency as a consequence of non-payment by an employer.

In 2019, the Court of Appeal observed in Bresco Electrical Services Ltd. v. Michael J Lonsdale (Electrical) Ltd. that it would be “an exercise in futility” to allow an insolvent construction company to adjudicate against an employer for payment notwithstanding it may have been the employer’s non-payment which caused or contributed to the company’s insolvency in the first instance. The rationale was, in part, that if the employer had a counterclaim or the claim related to an interim valuation only, there was a high risk of injustice to the employer should it be determined in later proceedings that some net balance was in fact due to the employer.

The Court of Appeal concluded it would entirely appropriate for the court to grant injunctions to prevent insolvent construction companies from pursuing adjudications in future in circumstances where it was determined the adjudication would be of no “practical utility”.

The decision of the Court of Appeal in Bresco was disappointing given it is an all too common occurrence: a construction company enters or faces insolvency for no reason other than an employer has taken advantage of the contractual or legislative payment mechanism to withhold an interim or final payment. Following Bresco, the construction company would effectively be left with no recourse against the employer through adjudication providing the employer could make out a counterclaim or contractual right to a true valuation. This became a particular problem during the early stages of the COVID-19 pandemic, when employers sought to withhold payment to construction companies in order to maintain liquidity at an uncertain time. Regrettably, this resulted in the insolvency of construction companies which were otherwise viable.

Despite the issues that the construction sector continues to face as the pandemic persists, there is now good news for the directors and insolvency professionals of construction companies which have entered or are facing insolvency. At the height of lockdown, the decision in Bresco was appealed to the Supreme Court, which overturned the decision of the Court of Appeal in its entirety and determined that an adjudicator does have jurisdiction to deal with a dispute referred by an insolvent company. The Supreme Court rejected the suggestion that such disputes would be “an exercise in futility” and affirmed the statutory (and often contractual) right of construction companies to adjudicate against employers for payment. There is now no doubt that a construction company which has entered or is facing insolvency can adjudicate for payment in the usual way and any attempts by an employer to frustrate the onset of adjudication will be unsuccessful.

The importance of the decision of the Supreme Court in Bresco for the directors and insolvency professionals of construction companies which have entered or are facing insolvency cannot be understated. Whilst historically the debt recovery prospects for such companies were poor, the decision in Bresco provides the opportunity for directors and insolvency professionals to seek to regain control of the financial position of the company by adjudicating for payment from employers withholding payment on contractual or otherwise tenuous grounds.

As a form of dispute resolution for companies in distress, the benefits of adjudication are clear: by comparison to arbitration or court proceedings, it is inexpensive and quick; with the majority of adjudicator’s decisions being reached within the statutory period of 28 days from the date of referral. This is a boon for both those construction companies which require a prompt injection of cash to avoid the onset of formal insolvency proceedings, and for those which have entered insolvency and are seeking to maximise the return to creditors.

There does remain one issue: should an employer against whom an award is made in adjudication still refuse to make payment, it is possible the court will not enforce the adjudicator’s decision in favour of a construction company which is in or facing insolvency unless certain safeguards are met to protect the employer in the event there is a subsequent counterclaim or true value adjudication. Such safeguards could include:

• Provision by the construction company or insolvency professional of satisfactory security and/or undertakings in respect of any sum which is ordered to be paid by the employer in any subsequent adjudication and any order which is made in later litigation that the construction company pay the costs of the employer; and/or
• The “ringfencing” of any sum paid by the employer pending the outcome of any future litigation between the parties.

There are alternative options as well which in many instances mean the “safeguarding” requirements on enforcement are not likely to prove problematic for the majority of construction companies.

It goes without saying that the decision of the Supreme Court in Bresco provides a welcome opportunity for the construction company facing or having entered insolvency to seek redress from the employer which may have caused or contributed to that insolvency; particularly at a time when employers are more likely than ever to seek to withhold payment in order to maximise liquidity during the continuance of the COVID-19 pandemic. Those companies which are in or facing insolvency may, however, be reliant on the availability of innovative funding solutions to meet the legal costs involved in pursuing an adjudication in circumstances where the company will be unable to pay those fees “upfront”.

The construction team at Berry Smith LLP is experienced in representing construction companies and employers in adjudication, and able to offer funding solutions to insolvent clients in certain circumstances. If you require further information, please contact Gavin Hoccom.