Insolvency Set-Off and Contract Adjudications – Supreme Court Settles the Debate

Adjudication has since 1996 helped to preserve project cashflows by providing a cost-effective and swift means of resolving building contract disputes – but its interaction with the insolvency regime, in particular the principle of insolvency set-off, has long been a subject of debate. An important Supreme Court ruling has, however, finally put such disagreements to bed.

Under the principle known as ‘pay now, argue later’, adjudicators’ rulings are treated as final and binding unless and until they are overturned by a court. Insolvency set-off, however, means that, when a company enters liquidation and there are mutual debts between it and one of its creditors, the debts in each direction automatically cancel each other out. That enables liquidators to calculate the net balance and to decide how much the company owes or is owed overall.

The case under consideration concerned an electrical contractor (the supplier) which had been engaged to carry out works by another (the employer). After the supplier entered insolvent liquidation, both parties claimed that they were owed money by the other. The employer said that the supplier’s premature abandonment of the project had cost it £325,000. The supplier, however, asserted that it was owed £219,000 by the employer in unpaid fees, plus damages for lost profits.

After the supplier sought to refer its claim to an adjudicator, the employer objected to the procedure. The supplier’s claim, if any, and the employer’s cross-claim were said to have cancelled each other out by the process of insolvency set-off. The employer argued that there was thus no longer any claim or contract dispute to be resolved and that, on that basis, the adjudicator lacked jurisdiction.

The employer also claimed that the proposed adjudication would be a futile waste of resources in that no judge would enforce the adjudicator’s ruling until the supplier’s liquidators had calculated the net balance. Any such enforcement would interfere with the insolvency process and undermine the ‘pay now, argue later’ principle. The employer argued successfully before the High Court and the Court of Appeal that the adjudication should be blocked.

In upholding the supplier’s appeal against that outcome, the Supreme Court concluded that the adjudicator did have jurisdiction to consider the matter. The insolvency set-off did not mean that there was no longer a dispute under the contract or that the supplier’s claim had simply melted away. The supplier could have brought court proceedings to determine the value of its claim, or exercised its contractual right to take the matter to arbitration. It was therefore also entitled to refer its claim to adjudication.

Turning to the futility issue, the Court could detect no basic incompatibility between adjudication and insolvency set-off.  It would ordinarily be inappropriate for the courts to interfere with the supplier’s statutory and contractual right to an adjudication and such a process would be a simple, proportionate method of enabling the supplier’s liquidators to determine the net balance. Even if the courts proved reluctant to direct enforcement of the adjudicator’s award due to the insolvency process, that did not deprive the adjudication of its potential usefulness to the liquidators. The Court’s ruling opened the way for the adjudication to proceed.