In our latest update, we review the courts' recent approach to the use of insolvency proceedings in non-payment scenarios arising out of construction contracts.

In two recent decisions, the courts have reviewed insolvency proceedings issued in respect of the non-payment of amounts allegedly due under construction contracts. The general rule is that insolvency proceedings must not be used for matters of routine debt collection. The commencement of such proceedings in circumstances where the alleged debt is genuinely disputed on substantial grounds is an abuse of process. What approach are the courts taking in the context of construction?

The first case involved an employer seeking to restrain a contractor from presenting a winding-up petition against it.

COD Hyde Limited v Space Change Management Limited

Space Change's decision to serve a statutory demand was part of a wider strategy which included the suspension of performance and termination of the contract.

In overview the key facts were as follows:

  • The parties entered into a contract based on the JCT Design & Build form 2011 Edition (the Contract).
  • In relation to two of Space Change's applications for interim payment number (6 and 7), COD Hyde's payment notices were served late, no pay less notices were served and payment was not made.
  • Further disputes arose relating to Space Change's application for interim payment number 8 - neither a payment notice nor a pay less notice was served and COD Hyde said that the application had not been received.
  • Space Change left site shortly after this and COD Hyde instructed others to carry out the works.
  • The dispute and related correspondence continued and in February 2016, Space Change served a Statutory Demand for the sums claimed to be due pursuant to Applications 6, 7 & 8.

Space Change did not withdraw the Statutory Demand when requested to do so by COD Hyde and consequently, COD Hyde applied to the court for an injunction restraining the presentation of a winding up petition against COD Hyde. The application also set out a contention that COD Hyde had a counterclaim that exceeded the figure demanded by Space Change.

In summary, the court refused to grant the injunction sought and dismissed COD Hyde's application on the basis that there was no merit in COD Hyde's various claims which included arguments on liability to make the interim payments, plus the suspension and termination of the contract.

Mr Justice Warren found himself unable to accept that COD Hyde had even a "shadowy" counterclaim in any identifiable amount.

The court's reasoning included reference to the "balance" of the JCT Design and Build form (as between the interests of the employer and the contractor) and confirmed the potentially serious consequences of a payer's failure to follow the contractual payment notice regime. Mr Justice Warren stated:

"If an employer fails to observe the clear contractual procedure laid down, the contractual consequences follow and it cannot be heard to say that the interim sum is not due and is excessive. Any necessary adjustments can be effected at a later stage of the contract."

COD Hyde's assertion that there was a dispute about whether or not Space Change had diligently progressed the works did not, in the particular circumstances, affect its rights to suspend or terminate nor COD Hyde's obligation to pay in respect of Space Change's applications for payment which had not been "answered" by valid payment and pay less notices.

Ro-Bal Steel Fabrications Limited v G Jones Site Services Limited

The second recent case is Ro-Bal Steel Fabrications Limited v G Jones Site Services Limited 2016 - Ro-Bal was a sub-contractor and sub-sub-contracted certain works to G Jones.

This time, the paying party Ro-Bal managed to establish that there was a substantive dispute between the parties and so the winding up petition presented by G Jones was struck out. The substantive dispute related to whether or not the relevant provisions of the Housing Grants (Construction and Regeneration) Act 1996 as amended (the Act) applied to the contracts made between them.

The Companies Court was very clear in its decision that it was "not an appropriate court for the determination of an issue like [this]" - this was a technical issue capable of swift resolution in the Technology and Construction Court (TCC). The dispute could also have been referred to adjudication.

The commencement of insolvency proceedings proved to be an expensive exercise for Jones, particularly bearing in mind that the sum actually in dispute was around £6,500. As is the standard approach of the courts in circumstances where a winding up petition is dismissed, Jones was required to pay Ro-Bal's costs on an indemnity basis. Jones would also have had to meet its own costs and, as a result, its total costs liability exceeded the sums being claimed from Ro-bal.

A wind-up?

Proceed with caution: Ro-bal ended up out of pocket and Space Change's apparent success proved a hollow victory, as the company entered administration shortly after the judgment was handed down.

Statutory demands remain an option to recover undisputed sums, but in construction disputes, circumstances where debts are genuinely undisputed are rare. This means that insolvency proceedings are usually inappropriate, leaving the payee vulnerable to an adverse order for indemnity costs. In most cases, adjudication will remain a better, swifter option.

These decisions meanwhile highlight once again the vital importance to the paying party of serving valid, timely notices following applications for interim payment - in accordance with the terms of the contract and the Act. Effective systems of contract and payment management will help to protect you from such insolvency proceedings as well as "smash and grab" adjudications.