Construction law v insolvency law – a clash of cultures?


Author: Jeremy Whiteson


The insolvency and construction worlds have developed sophisticated systems of law. Alas, they often pull parties in opposite directions!

The construction industry operates on contracts which, while frequently based on standard forms, are often individually negotiated. There is not complete freedom of contract, however – following the Housing Grants Act 1996, disputes under written construction contracts can be referred to adjudication – a process that the courts acknowledge to be “quick and dirty” and based on the principle of “pay now, argue later”. The courts accept this because, generally, adjudicators’ decisions are not final and binding, and disputes can be finally settled by arbitration or in court.

Insolvency, however, imposes rules that restrict parties’ contractual arrangements. It has a statutory order for payment of debts which tries to enforce a universal approach in all situations and opposes attempts to contract out of this.

It’s not the taking part that matters…

A recent example of this arose in Straw Realisations v Shaftesbury House. As the judge there said: “The tension here is between… the general rules relating to bankruptcy and liquidation, and the contractual obligation created by statute to comply with decisions of an adjudicator.”

In that case, the Technology and Construction Court considered enforcement of an adjudicator’s decision in an insolvency context. Straw contracted with Shaftesbury to carry out a development in North London for £8.5 million.

The contract provided for disputes to be referred to adjudication and stated that an adjudicator’s decision would be final and binding, unless one party gave notice within three months of the decision to refer the dispute for final determination by legal proceedings. It also contained conventional provisions for insolvency of the contractor to trigger termination of the payment obligations and a balancing of payments due each way (which the judge observed are intended to mirror the general rules on bankruptcy or liquidation).

Following practical completion in April 2009, two disputes were referred to adjudication in July 2009. The first adjudication was decided in Straw’s favour for £31,000 on 31 July. On 13 August, Straw went into administration. On 13 October, Straw won the second adjudication and was awarded £475,000.

Shaftesbury did not pay, and Straw applied for summary judgment. The judge reviewed the authorities as to whether summary judgment could be granted in Straw’s favour and decided that, because Straw’s financial position was very different from when it entered into the building contract and was not caused by Shaftesbury’s failure to pay (Straw had become, in one barrister’s words, “spectacularly insolvent” with debts of £35 million), the law is that:

  • summary judgment will not be granted if the party seeking enforcement is in liquidation or is in administration and the adjudicator’s decision has not become final; and
  • if the decision has become final (because of the provisions of the contract), but the party seeking enforcement is in administration, summary judgment may be granted, but subject to a stay.

Straw was granted summary judgment for the first adjudication, because it had become final and binding (Shaftesbury had failed to issue a notice of intention to refer it to court in time), but subject to a stay. The judge refused summary judgment on the second adjudication as, for that decision, Shaftesbury had served its notice in time.

As part of the reasoning, the judge put a restrictive interpretation on the use of insolvency set off provisions in statute or where mirrored in a contract. He said: “a clause in a contract that purports to supersede the obligation to comply with an adjudicator’s decision, in this case the provision for a mutual setting off of the accounts…and an obligation only to pay the balance and the restriction on any further payments, cannot prevail over an obligation to comply with the decision of an adjudicator”.

This interpretation will leave insolvency practitioners with a far more restricted remedy in adjudication – a restraint on the quick and easy route to recovery of construction debts that they had become familiar with.

However, adjudication is not the only area where this tension arises and many unanswered questions remain.

Termination of contracts in administration

The appointment of an administrator creates a broad moratorium requiring that certain actions, amongst other things, insolvency proceedings, legal process and enforcement of security, are not carried out without leave of the court or consent of an administrator. It was established some time ago that notice of termination of a contract would not be a “legal process”. However, could it be “enforcement of security” – which is also restricted on administration? Could rights to take possession of, or even ownership of, goods and materials amount to security?Other types of rights commonly found in construction contracts could similarly be argued to be security, resulting in their implementation being restricted in administration. Would a right to take possession of goods when twinned with rights to recover debts amount to security? These questions remain unanswered by the courts.

The anti-deprivation principle

This equitable principle could be crudely paraphrased by saying that a contractual provision cannot permit a person to contract out of the statutory order of payment on insolvency. The application of this principle is complicated, with cases going back at least 130 years. Would vesting clauses which purport to transfer ownership of goods from contractor to employer, termination of payment rights or diversion of payments to subcontractors offend this principle? Its reassertion in recent cases may bring an answer to light.

The lessons to be learned

Careful drafting of contracts can protect against some of these risks. However, the uncertainty caused by the clash between insolvency and construction law is likely to provoke unexpected results for the foreseeable future.

Jeremy Whiteson, partner and head of insolvency and restructuring (jwhiteson@fladgate.com)

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