Cornerstone – Insolvent adjudications following Bresco – what should you actually do?

The much anticipated Supreme Court ruling in Bresco Electrical Services Ltd (In Liquidations) v. Michael J Lonsdale (Electrical) Ltd has finally landed and has been met by an immediate barrage of detailed legal analysis and commentary.

While fascinating, this article doesn’t seek to add to those commentaries – rather, it considers what in practice it means for a contractor who may find itself with one its subcontractors going into insolvency. What can it do to better protect is position?

What did Bresco say?

This article is about practical steps rather than a detailed analysis of Bresco. The decision of the Supreme Court in Bresco was in a nutshell that an insolvent party has a right to commence an adjudication. The position on the enforceability of any adjudication decision remains unclear – no doubt there will be more cases on that in the near future – but the bottom line is an insolvent company can adjudicate. So what can you as the other (solvent) contracting party do to best protect your position if this happens to you?

When a member of the supply chain goes into insolvency it is a pain in the proverbial for the contractor. Depending on the discipline involved, it can cause serious disruption to the main contract works – a mechanical and electrical sub-contractor for example is key to progress on almost any site. So what are the issues and what should a contractor make sure it does?

Practical steps

How much work had the sub-contractor completed?

Any party about to enter into insolvency will look for quick gains (it’s human nature), so a sub-contractor on the brink of insolvency is likely to inflate progress to date. If the last valuation from the contractor suggested 75% of the work was completed, the contractor is going to find it difficult to row back from this later. So a simple and obvious measure, but particularly important for any sub-contractor where there is a risk of insolvency, is that the valuations of any applications should be precise – you might say hard but fair. No cutting corners. You may want to rely on this at a later date.

Defective work?

Defective works are often more common with sub-contractors who are struggling financially. This can be, for instance, due to a discontented or depleted workforce, or the subcontractor trying to cut corners to save on costs or rush to complete. If there are defects, a replacement contractor will be required to carry these out at extra cost to the main contractor. How well are those costs being captured? Are they wrapped up as part of the tender so it is difficult to evidence such costs? It is important to be able to identify the defect and the value attributable to the cost of fixing it so this can be charged back to theoriginal sub-contractor later.

Delays?

This is perhaps the biggest issue and often the most expensive. Delay caused through an insolvent sub-contractor can affect other trades, cause delay to the overall main works, and lead to the potential for liquidated damages to be deducted by the client.

• Claims from other trades – if there is a claim for cost and delay by another subcontractor this is often wrapped up in a final account deal. Ensure that any final deal sets out the true cost of the delays caused by the insolvent sub-contractor – this will allow this figure to be taken into account in relation to any set-off of any sums that may remain due to the insolvent sub-contractor.
• Cost to the main contractor – as well as impacting on other trades, insolvency of a key sub-contractor will lead to additional time being spent by the contractor’s management team as well as additional time on site for site based staff. Contractors are notoriously bad at recording management time – this needs to change. Such time is recoverable and is therefore deductible from any sum due to the insolvent subcontractor but needs to be evidenced. Similarly, any additional time on site caused by the insolvent sub-contractor needs to carefully documented. This bit is tricky. A contractor will want to give the impression to the client that any delay is caused by client events, not by supply chain insolvency. The correct approach needs to be thought through, but what you cannot do six months later is evidence the costs if you don’t keep decent records at the time.
• Liquidated damages – the client may choose to deduct liquidated damages for a delay to the completion date. These costs would otherwise not have been deductible but for the sub-contractor’s insolvency. Well, that is the argument. However, is the delay clearly as a result of the insolvency of the sub-contractor? Be careful how any settlement is structured with the client – it must reflect the agreed position – but if there is an agreement that certain delays are caused as a result of the insolvency of the subcontractor make sure it says so.

The message is: think what evidence you may need to prove the losses you suffer and make sure you have it. When a contractor becomes party to an adjudication with an insolvent subcontractor, the best solution is to beat them at the first post by defeating their claim evidentially. For this reason, where a sub-contract has already been formed, contractors need to be aware of the above issues and place themselves in the best possible position to deal with any adjudication they may have to answer.

Legal steps

Following Bresco, there remains no clear position on whether adjudication decisions will be enforced by the Courts, but what is clear is an insolvent company can bring an adjudication. The Supreme Court essentially dodged this question and said enforcement would have to be dealt with on a case-by-case basis. The TCC’s (and the Court of Appeal’s) earlier decisions in the Bresco case were based at least in part on a pragmatic acceptance that enforcement would be difficult if not impossible for insolvent parties to achieve, which may be where we end back in a few months’ time anyway (after a lot of uncertainty and cost for all involved).

Nevertheless, the practical steps above will apply whatever the TCC decides on regarding enforcement and certainly for contracts already in place there is no easy fix. But might be there for future contracts?

What is to stop any sub-contact terms having a clause excluding any right for the subcontractor to be entitled to any further payment whatsoever in the event of its insolvency? Something akin to: “Notwithstanding any other terms of this Sub-Contract, in the event of the Insolvency of the Sub-Contractor, the Sub-Contractor shall have no further entitlement to any sums (including without limitation retention), whether such sums were due prior to any Insolvency or not”.

Is such a clause permissible – why not? The parties are free to agree whatever arrangement they may choose. So going forward is this a quick solution to the insolvent sub-contractor and adjudication conundrum? Will this be a common amendment to sub-contracts?

Summary

The principle in Bresco, that insolvent companies can bring adjudications, signals a significant change. However, whether this will result in a radical material outlook for contractors is not entirely certain.

Regardless of this uncertainty, the Bresco ruling serves as a reminder that contractors should be aware of the implications of their sub-contractors becoming insolvent. For existing contracts, the practical steps above of evidence gathering should be followed in order to be best prepared for any adjudications which arise, and for future contracts it is worth adding clauses similar to the above.

This article is from the July 2020 issue of Cornerstone, our monthly newsletter for those working in the construction industry. To download the latest issue, please visit the newsletter section of our website. For further information please contact a member of Birketts’ Construction Team.