Adequate security required for enforcement of adjudicator award in construction contracts

Out-Law Legal Update | 18 Oct 2019 | 12:24 pm | 3 min. read

Companies in liquidation can theoretically refer claims to an adjudicator under construction law, but it remains a futile exercise as the decision could not be enforced, unless the adjudication covers all claims and cross claims between the parties and the insolvent party puts up adequate security, a court in England has ruled.

The High Court ruling further clarifies the options of liquidators seeking payments from solvent companies through adjudication. Following the Court of Appeal decision in Bresco v Lonsdale earlier this year the practice of liquidators threatening or commencing low cost adjudications as a tactic to reach settlements for the benefit of creditors, even where the enforcement of an adjudicator's decision could be stayed, was deemed to be a futile exercise in most cases.

This High Court ruling confirms that an exception to the principles from Bresco v Lonsdale will only arise where the adjudication covers all claims and cross claims between the parties, and the insolvent party puts up adequate security.

The ruling will make it harder for liquidators to commence an adjudication or enforce a decision against a solvent company unless these conditions are satisfied. This is likely to mean that the creditors of the insolvent company will incur costs at the outset, with no guarantee of returns for creditors. This will be difficult for liquidators to justify as being in the best interests of creditors and will limit the power of claims agents from running such cases on behalf of a company in liquidation on a "no win, no fee" basis.

Under the UK's Insolvency Rules when a company enters into liquidation a mandatory, automatic and self-operating set-off regime kicks in to calculate, with certainty, the value of claims owing to or from the company in liquidation. Adjudication is often used as a quick process to determine interim disputes between the parties, and does not provide a definitive position on liability. Therefore, the Court has confirmed the position that adjudication by a liquidator will remain a futile exercise unless it covers all claims and cross claims between the parties in an attempt to reach the same conclusion as insolvency set-off.

Even if this is the case, adjudication remains an interim remedy. As a result, the enforcement of an adjudication decision will only be permitted in limited circumstances. This must include where the liquidators have provided adequate security to the solvent counterparty. Adequate security is likely to mean a combination of a bank guarantee, a cash deposit into Court, made up of the decision sum if already awarded, and after the event (ATE) cover. Without this, it is unlikely that enforcement would be allowed.

In this case Meadowside's liquidators had engaged Pythagoras Capital Limited as agent to seek to recover sums the liquidators claimed was due to Meadowside. Pythagoras's engagement included undisclosed terms regarding its costs for providing the services, including what percentage of realisations would be paid to Pythagoras upon a successful recovery. Pythagoras sought to recover sums from Hill Street Management (HSM) under a construction contract between the parties by way of adjudication. Despite resistance from HSM, the adjudicator heard the case and decided that £26,000 was due to Meadowside. Pythagoras then sought to enforce the decision against HSM in the Court in order to obtain a summary judgment.

Pythagoras had offered a guarantee from itself as security for any costs incurred by HSM in resisting enforcement or successfully litigating to overturn the adjudicator's decision, including any adverse costs awarded against Meadowside. The Court rejected this as valid security and confirmed that any guarantee should come from a bank or surety which is independent and regularly issues guarantees of this nature.

The Court confirmed that an ATE insurance policy should be obtained which sufficiently covered the categories of costs that could be recoverable in the circumstances. The Court also confirmed that ATE, coupled with a payment into Court of the decision sum, if a decision has already been obtained, could be adequate. The Court refused the summary judgment application.

As an aside, the Court also ruled that the terms of Pythagoras's engagement amounted to a Damages Based Agreement, to which the Damages Based Agreements Regulations (2013) applied. As the terms of engagement were not disclosed, the Court could not confirm whether the engagement was in breach of the terms of these regulations, which would be the case where Meadowside received less than 50% of the recoveries. The Court also said that there was a reasonable prospect of the engagement terms being champertous and an abuse of process, although it could not decide definitively due to the lack of disclosure by Pythagoras. However, this was a factor in the Court refusing to enforce the decision by way of summary judgment.

It is also worth noting that the decision in Bresco v Lonsdale is being appealed to the Supreme Court, so these issues are likely to be revisited once and for all, most likely in 2020.