Insolvency Set-Off and Construction Contract Adjudications in light of Bresco Electrical Services Ltd (in liquidation) v Michael J Lonsdale (electrical) Ltd; Cannon Corporate Ltd v Primus Build Ltd  EWCA Civ 27
Ever since 31 July 2018, when Fraser J handed down his judgment in Michael J Lonsdale (Electrical) Ltd v Bresco Electrical Services Ltd (in liquidation)  EWHC 2043 (TCC), many of those involved in either insolvency or construction have been in a state of confusion tinged with disbelief. The potential ramifications were quite startling and the unease was only heightened by the more or less contemporary but very different decision of HHJ Waksman QC (as he then was) in Cannon Corporate Ltd v Primus Build Ltd  EWHC 2143 (TCC). Both matters came before the Court of Appeal in November, since when the legal profession has been holding its collective breath. Now that the Court of Appeal has handed down its much-awaited judgment in these conjoined appeals the exhalation has been audible.
The increasing instances of construction firm failures, exemplified by Carillion, have only served to underline the uneasy overlap between construction law and insolvency law. Giving the lead judgment in this appeal, Coulson LJ (with whom the other, family law, members of the panel agreed) expressly set out to provide guidance in an area that “has not remained free from doubt” for the last two decades, since the decision of the Court of Appeal in Bouygues (UK) Ltd v Dahl-Jensen (UK) Ltd  BLR 522. This guidance is therefore doubly welcome.
In Lonsdale, Fraser J granted an injunction to prevent Bresco (a company in liquidation) from pursuing its reference of a dispute under a construction contract to adjudication. He did so on two grounds. The primary ground (dubbed the “jurisdiction” issue in the Court of Appeal) was that, by reason of Lonsdale’s cross-claim and the operation of what is now rule 14.25 of the Insolvency (England and Wales) Rules 2016 (“IR16”), as interpreted in light of the authorities, in particular certain dicta in the speech of Lord Hoffmann in Stein v Blake  1 AC 243, the Judge held that Breso could not refer its claim to adjudication as its claim no longer existed: it had been extinguished by operation of IR16 r 14.25 and replaced by the right to seek the balance on the taking of an account of what had, prior to the liquidation, been the claim and cross-claim. Fraser J then went on to hold that in any event, in light of various earlier authorities, an adjudication would serve no useful purpose since, by reason of the interim nature of an adjudicator’s decision, it was inconceivable that any court would enforce such a decision in favour of a company in insolvent liquidation (the “utility” issue).
Coulson LJ examined each in turn. On the jurisdiction issue, he conceded that the language of Lord Hoffmann’s speech in Stein v Blake was not without its difficulties, but held in essence that Fraser J had given too much weight to the passage where Lord Hoffmann had talked about the effect of insolvency set-off (in that case under s 323 of the Insolvency Act 1986, as the context was bankruptcy and not liquidation) upon the original chose in action being to extinguish it and replace it with the right to an account for the balance. Taken in isolation, Lord Hoffmann’s comments did appear to give some support to the conclusion reached by Fraser J; but it is important to appreciate that Stein v Blake essentially concerned the validity of an assignment of the chose in action. Coulson LJ accepted the submission made on behalf of Bresco that Lord Hoffmann was not saying, and could not have been saying, that the original claim ceased to exist for all purposes but rather was saying that the set-off rendered the chose in action unassignable; the intervention of the insolvency set-off does not therefore mean that the claim and cross-claim cannot be pursued as such in order to ascertain their respective values (and thus the resulting balance) and Lord Hoffmann himself expressly stated that they do continue to exist for that purpose.
In fact, on the appeal it was conceded on behalf of Lonsdale (and also Cannon in the conjoined appeal) that a claim of this sort does survive liquidation and its attendant set-off to the extent that a company in liquidation can bring a claim based upon it and can refer the matter to arbitration. It has to be said that this concession (which the Court of Appeal found to have been rightly made) takes much of the sting out of the more alarming wider ramifications of Fraser J’s judgment outside the arena of construction law. It was nevertheless argued that a company in the position of Bresco could not refer a matter to adjudication under s 108 of the Housing Grants, Construction and Regeneration Act 1996 due to the fact that an adjudicator’s decision would not necessarily be final: because of its very nature, in being only temporarily binding, it could not properly be said to form any part of the taking of account under r14.25 of IR16.
Coulson LJ rejected even this more limited jurisdiction argument: there was no good reason why a reference to adjudication was materially different to a reference to arbitration. The fact that the result of an adjudication may not be permanently biding could not in itself deprive the adjudicator of jurisdiction. The dicta of Chadwick LJ in Bouygues had been misunderstood, doubtless in part due to the unsatisfactory nature of the way in which the case had presented itself, but there was nothing in that decision to suggest that an adjudication was precluded as a matter of jurisdiction. Coulson LJ conceded that he himself had been wrong in Enterprise Managed Services Ltd v Tony McFadden Utilities Ltd [2009 EWHC 3222 (TCC);  BLR 89 (another case essentially concerned with assignment) to the extent that anything he had said there suggested otherwise. In this respect, Fraser J had been wrong and HHJ Purle in Philpott & Anor v Lycee Francais Charles de Gaulle School  EWHC 1065 (Ch) had been right. The jurisdiction issue was therefore decided in favour of Bresco: the lid was slammed back down on Pandora’s Box. However, that was not enough to determine the appeal, because the mere fact that the adjudicator had jurisdiction was quite different to the question of whether, as a matter of utility, there was any purpose in allowing such an adjudication to proceed.
On the utility issue, Coulson LJ found that a fundamental incompatibility between insolvency and the adjudication process nevertheless remained. In Philpott, HHJ Purle had suggested that it was inconceivable that an adjudicator’s decision in favour of a company in insolvent liquidation would ever be enforced. To do so would (as Chadwick LJ had pointed out in Bouygues) make a nonsense of the set-off rules where they applied. Coulson LJ agreed essentially with the reasoning of both (though accepting that “inconceivable” was perhaps setting the bar a little high). There were other considerations that pointed to the essential incompatibility of the two regimes: the liquidator, by definition, would be likely to have limited resources; an adjudicator’s decision would be unlikely to be of real assistance to a liquidator in considering proofs; there was no good reason why a respondent should have to incur the costs of an adjudication and, if the adjudication was in the insolvent company’s favour, might have to incur yet more costs in pursuing its own claim to overturn the result of the adjudication; and the enforcement procedures that would follow an adjudication would be a waste of the court’s resources. In these circumstances, therefore, a reference to adjudication, though permissible as a matter of pure jurisdiction, was an exercise in futility.
For those reasons Coulson LJ rejected the appeal in Lonsdale on the basis that the Judge, though wrong on the jurisdiction point, had nevertheless been entirely correct to grant an injunction to prevent the adjudication from continuing.
The position on the Cannon appeal was more complex and in fact, in the interval between the hearing of the appeal in later November and the handing down of judgment in late January, the case had settled. The Court of Appeal decided that the issues in the appeal were of sufficient interest that it was worthwhile to hand down their judgment anyway and so they did. The context of the appeal was very different, because in this case the company was in CVA rather than liquidation and the decision of Judge Waksman had been delivered against a backdrop of a succession of repeatedly made and then withdrawn concessions. In principle the Court of Appeal held that, if there had been anything in the jurisdiction argument, already rejected in the Lonsdale appeal, it would not in any event have been open to Cannon to take the jurisdiction point having not done so at the appropriate time. The court had been entirely right on the particular facts in this case to enter summary judgment on the basis of the adjudicator’s decision and therefore it followed that Primus were entitled to enforce and Cannon would have been refused their stay. The matter having already concluded following the settlement there was no need to make any further order on the appeal.
The decision of the Court of Appeal is commendable both in its (much-needed) clarity and in its common sense. The potentially dangerous wider implications of the first instance decision in Lonsdale have been safely returned to their box and we are left with a clear reasoning on why it will rarely be appropriate for a company in liquidation to be allowed to press ahead with a reference to adjudication; conversely, where the matter lies outside that context, there may be more room for accommodation between the barely compatible spheres of insolvency and adjudication, as exemplified in the case of Cannon v Primus.