Adjudication – beware the counterclaim

Digby Hebbard, Partner, Fladgate LLP (dhebbard@fladgate.com)

A key consideration for a party before commencing an adjudication is what the defending party might say or claim in reply, because the courts adopt a generous approach to whether a defence or counterclaim is within the scope of the dispute.

Broadly, no matter how narrowly defined a dispute referred to adjudication might be, at law the dispute is deemed to include all defences available to the responding party (Cantillon Ltd v Urvasco Ltd [2008] EWHC 282 (TCC)).  It follows that an adjudicator’s duties of natural justice include duly considering and determining the merits of any legitimate set-off and/or counterclaim.

We have noticed a trend in adjudications that claiming parties and/or the adjudicators appear to misunderstand that an adjudicator’s jurisdiction necessarily extends to such set-offs and counterclaims.  More particularly, (i) claiming parties contend that defences and counterclaims are outside the scope of the dispute and therefore the adjudicator has no jurisdiction and/or (ii) adjudicators have accepted this jurisdictional argument or failed to deal with the defences and counterclaims in their decision.

The danger of such misunderstanding is obvious.  To illustrate, a contractor might consider it has a discrete claim for unpaid sums of, say, £100,000; however, this could be met by an employer’s counterclaim for delay damages of, say, £300,000.  A perceived “slam dunk” could end up creating a substantial liability.

In summary, the relevant authorities provide:

1. Where the referring party seeks payment of a sum of money, the dispute will be deemed to encompass any set-offs or cross claims of the responding party – Cantillon Ltd v Urvasco Ltd [2008] EWHC 282 (TCC).
2. Where an adjudicator makes too restrictive an assessment of the scope of jurisdiction, with the result that a material element of the dispute is not considered on its merits, it may make the decision unenforceable because of a breach of natural justice – Pilon Ltd v Breyer Group plc [2010] EWHC 837 (TCC).

We were recently involved in an adjudication and subsequent enforcement proceedings involving these principles.

The adjudication and enforcement proceedings

A contractor referred a claim against an employer to adjudication asserting it was owed approximately £150,000 in unpaid VAT.  The employer advanced various defences, set-offs and counterclaims, including that it was due around £300,000 for delay damages and the contractor was not entitled to payment under the contract because the contract had been terminated.  The contractor contended that such matters were outside the scope of the adjudicator’s jurisdiction.

The adjudicator found for the contractor.  The written decision recorded that the adjudicator considered the employer’s defences on delay damages and termination were outside his jurisdiction.

The employer for whom we acted did not comply with the adjudicator’s decision and the contractor sought to have the decision enforced.  Mr Justice Stuart Smith in the Technology and Construction Court refused to enforce the decision.  He accepted that the employer’s set-off for liquidated damages was part of the dispute and therefore in line with Pilon v Breyer and that the adjudicator was in breach of natural justice for failing to consider and determine these material issues.

In particular, Mr Justice Stuart-Smith decided:

• Paragraph 54 of the adjudicator’s decision makes plain that he excluded substantive consideration of the defendant’s liquidated damages submissions because he considered he had no jurisdiction to decide those issues as part of the adjudication that the claimant had raised before him.
• I have come to the conclusion that the adjudicator was wrong to exclude substantive consideration of the defendant’s liquidated damages submission…[the Claimant’s submission] was that even if, as a matter of general rule, a claim for liquidated damages could operate as a partial defence by way of counterclaim or set-off, it could not do so in the context of this adjudication because the claimant’s claim was so narrowly defined by reference to the obligation to pay VAT. That submission is unsustainable.
• … [T]his is a case where the initial ambit of the adjudication was expanded by the defendant raising a potentially material defence of set-off. As I have said, the claimant did not attempt to meet that defence on its merits, for example by asserting an entitlement to an extension of time. Instead, it simply took the jurisdiction point which the adjudicator wrongly accepted.
• That being so, there has been an error going to jurisdiction and the adjudicator has failed to rule substantively on a material issue on which he should have ruled. The adjudicator’s decision therefore cannot be enforced, and I decline to do so.

Conclusion

Referring parties need to be alive to the risk of counterclaims and set-offs and frame their adjudication in the best way possible. In this case, had the adjudication been framed as seeking a declaration on the applicable rate of VAT, rather than seeking payment, no counterclaims and set-offs would have been allowed.

Adjudicators should not ignore the defences put before them or they risk their decision being subject to challenge on the grounds of an error of jurisdiction and/or breach of natural justice.