Smash and grab adjudications: what about insolvency?

It should come as no surprise to anyone working in or involved with the building industry that the Housing Grants, Construction and Regeneration Act 1996 (the Construction Act) requires a paying party to a construction contract to serve a pay less notice on the payee if it intends to withhold money. The act lays downs a strict timescale for such notices, and the consequences of serving a notice that is defective or late can be dire: the unpaid party may suspend performance and/or commence adjudication proceedings. In most cases, the lack of a pay less notice means that the payer must pay the amount of any payment application, regardless of its merits. This approach has spawned a rash of so-called “smash and grab” adjudications. A recent example ended up before the Court of Appeal, where the court confirmed that the payer was entitled to challenge the value of an interim application in adjudication proceedings, but only after it had parted with the entirety of the notified sum.

But what happens if the party which is paid in full becomes insolvent? What is the status of any counterclaims for defective works or delays? These issues were considered by the court in Indigo Projects Ltd vs Razin, a case which demonstrated that the timing of the insolvency is crucial to the outcome, as well as the possibly that the courts may not be wholly enthusiastic about “smash and grab” adjudications if there is a chance that a final reckoning between the parties might be affected.

But what happens if the party which is paid in full becomes insolvent? What is the status of any counterclaims for defective works or delays? These issues were considered by the court in Indigo Projects Ltd vs Razin

In 2017, Indigo, the claimant, was employed by the defendants, Mr and Mrs Razin, to build a new four-storey detached house in Kingston-upon-Thames. It is worth noting that the defendants were residential occupiers and therefore the Construction Act did not apply to the dispute. However, the contract for the building works was a JCT Standard Building Contract With Quantities 2011 which contained an analogous payment procedure and allowed the parties to refer any dispute to adjudication.

In June 2018, Indigo issued an interim payment notice nearly equal to the original contract sum. The defendants claimed that there were significant delays and defective works, but they did not issue a pay less notice in accordance with the contract. In the absence of a payless notice the money became due (without any set-off) on the final date for the payment. The defendants informed Indigo that they were unable to pay in full, but they did make a payment on account of £30,000. Indigo referred the matter to a “smash and grab” adjudication and obtained an order for payment of the outstanding sum.

By January this year, the balance remained unpaid and Indigo applied to the court for enforcement of the adjudicator’s decision. In the following February, prior to the date of the hearing, Indigo entered into a company voluntary arrangement (CVA), citing late payments and cash flow difficulties.

At the hearing, the defendants pointed out that the terms of the CVA obliged the CVA supervisors to take into account the claims and counterclaims of all Indigo’s creditors and calculate the balances due to them. This turned out to be an estimated 60p in the £1, which would have left the defendants significantly out of pocket in relation to any counterclaims they might have been able to prove later on. The defendants maintained that enforcement of the adjudicator’s order (which was acquired solely on the basis of the lack of payless notice) would cut across the CVA supervisor’s exercise of taking account.

Indigo countered that on the contrary, the award should be enforced in advance of the CVA supervisors’ netting-off exercise, but the court accepted the defendants’ interpretation and refused to issue the enforcement order. The decision was mainly due to the timing of the CVA: if the debt arising under the adjudication had actually been paid before the CVA it would have become part of the netting-off exercise; but as it could now only be paid after the CVA, the balancing of the dealings between Indigo and the defendants which was required under the terms of the CVA would be “distorted” if the money became part of a general fund to be shared between all of Indigo’s creditors.

Although the purpose of the CVA was said to be the protection of jobs, completion of outstanding contracts and the resolution of cash flow issues, it is difficult not to believe that the court must have had some sympathy for the defendants, whose home was the subject of the proceedings. While the statutory consequence of a failure to provide pay less notices is intended to support contractors’ cash flow, this may not always sit comfortably with payment upfront in an insolvency situation, particularly if there is a possibility of valid counterclaims.

This case may herald a move by the courts away from the upholding of “smash and grab” adjudications where insolvency is a factor. It is also worth noting that any company contemplating a CVA (especially if it has the benefit of an unenforced adjudicator’s award), should think very carefully about timing before taking such a major step.

Stephanie Canham is national head of projects and construction at Trowers & Hamlins