Set off in adjudication

Excuses to not pay take many forms. I recently encountered one as follows: “In view of this extension of time award, part of the liquidated damages already deducted will be repaid and this will be reflected in the next payment cycle.” This raised the question of when payments (other than interim payments) under a contract should be made. Such non-payment may also take the following form: “In view of the adjudication award, a sum of ￡X is due. However, as the Employer is entitled to a deduction of ￡Y for liquidated damages, a payment of ￡(X-Y) will be made.”

The general rule

In UK construction adjudication, a party generally cannot set off the amount of a future claim against a sum awarded by an adjudicator.

?“Future” is viewed from the time at the end of the adjudication:

Where the parties to a construction contract engage in successive adjudications, each focused upon the parties’ current rights and remedies, in my view the correct approach is as follows.? At the end of each adjudication, absent special circumstances, the losing party must comply with the adjudicator’s decision.? He cannot withhold payment on the ground of his anticipated recovery in a future adjudication based upon different issues. (Interserve Industrial Services Ltd v Cleveland Bridge UK Ltd [2006] EWHC 741 (TCC))

In Ledwood Mechanical Engineering Ltd v Whessoe Oil and Gas Ltd and Another [2007] EWHC 2743 (TCC), Ledwood was engaged by the Whessoe Oil and Gas Limited and Volker-Stevin Construction Europe BV (“the JV”) to act as subcontractor for fabrication and erection of pipework. The contract was did not come under HGCRA 1996 as the operations were not construction operation, but contained an ad hoc adjudication clause.

Ledwood submitted interim payment Application 19 in July 2007 in the sum of just over ￡2.2m (excluding VAT). The JV deducted some ￡1.5m (excluding VAT) from the application.? The balance was paid to Ledwood.

Ledwood commenced the adjudication by a notice of referral dated 28 August 2007.? The Adjudicator issued his decision on 10 October 2007.? He held that the JV had wrongly withheld ￡1,215,067.64 from its payment against Application 19 and expressed his decision in these terms at the conclusion:-

“(7) The total sum which can properly be deducted from Application 19 (exclusive of VAT) is ￡325,390.36.? Whessoe has wrongly withheld ￡1,215,067.64 (exclusive of VAT).

(8) Interest at the rate of 1% above the Bank of England base rate shall run on the total of the wrongly deducted amount (￡1,215,067.64) for the period from 3rd August 2007 to the date of actual payment.”

Three more payment applications followed Application 19, Applications 20, 21, and 22.

Application 22 was made on 4 October 2007 and, on 11 October 2007, the JV issued a revised payment notice showing an amount of ￡267,332.73 (plus VAT) due to Ledwood.? No adjustment was made at that stage in respect of risk and reward.? When the JV received the Adjudicator’s decision, they issued a further revision to the payment notice in relation to Application 22, in which they gave effect to the Adjudicator’s findings on deductions, but assessed a deduction (based on a risk and reward scheme in the subcontract and which was another part of the same adjudication) in the sum of ￡1,817,227.? That revised payment notice, dated 19 October 2007, led to a negative sum due to Ledwood.

The JV argued that the Adjudicator did not decide that any payment was due. Therefore, it was entitled to treat his findings as applying to Application 22 and to revise the payment notice in accordance with the subcontract so that no net payment was due to Ledwood.

The court disagreed and stated the following:

“Although the Adjudicator did not say in express terms that the effect of his decision was that Ledwood should be entitled to payment, he was deciding whether the Joint Venture was entitled to make the deductions which they had made in respect of Application for payment 19.? In determining that the Joint Venture had wrongly withheld ￡1,215,067.64 (excluding VAT) and that they should pay interest on that amount to “the date of actual payment”, the Adjudicator was clearly intending, in my judgment, that the sum withheld should be paid.

…

I consider that the Adjudicator’s decision meant that, as at the date for payment of Application 19 in August 2007, a further sum should have been paid but was not paid because of the wrongful deductions made by the Joint Venture.? The essential purpose of adjudication of interim payments is to allow a party to obtain cashflow.? In general, therefore, the claiming party is entitled to receive the payment it should have received at the date of the interim payment without taking into account subsequent events or other claims for set-off: see the summary of earlier decisions in the judgment of Mr Justice Jackson in Balfour Beatty Construction v Serco [2004] EWHC 3336 at paragraph 53, cited below.

To permit the Joint Venture to use an adjustment to the payment notice for Application 22 to give effect to the Adjudicator’s decision would ignore the wrongful deduction from Application 19 and permit the Joint Venture to take account of subsequent events and other rights of set-off which it was not entitled to deduct and did not seek to deduct from the payment due on Application 19.? In my judgment, the Adjudicator’s decision should be given effect by applying that decision to Application 19 and not Application 22.”

(Underline added)

This general principle is re-stated in Squibb Group Ltd v Vertase FLR Ltd?[2012] EWHC 1958 (TCC):

“In general, an unsuccessful party to an adjudication cannot seek to avoid the result of that adjudication by relying on the right to set-off any other claims …? It has often been said that, where there are subsequent cross-claims, the right course is for the losing party to comply with the adjudicator’s decision and not withhold payment on the ground of his anticipated recovery in a further claim …”

Two exceptions

However, there are two possible exceptions to this general rule, as stated in Balfour Beatty Construction v Serco Ltd [2004] EWHC 3336 (TCC):

a.?? Where it follows logically from an adjudicator’s decision that the employer is entitled to recover a specific sum by way of liquidated and ascertained damages, then the employer may set-off that sum against monies payable to the contractor pursuant to the adjudicator’s decision, provided that the employer has given proper notice (insofar as is required).

b.?? Where the entitlement to liquidated and ascertained damages has not been determined, either expressly or impliedly, by the adjudicator’s decision, then the question whether the employer is entitled to ser-off liquated and ascertained damages against sums awarded by the adjudicator will depend upon the terms of the contract and the circumstances of the case.”

In short, the two possible exceptions depend on (Squibb Group Ltd v Vertase FLR Ltd):

(a)?? the proper construction of the terms of the contract:

“The first possible exception to the general rule turns on the proper construction of the terms of the contract.? There will be some cases, such as Parsons Plastics Ltd v Purac Ltd [2002] BLR 334, where the contractual right to set-off may trump the enforcement of an adjudicator’s decision.? However, such cases will be relatively rare and will depend upon the precise construction of the relevant set-off provision.? Clear words permitting the set-off against a sum otherwise due will usually be required. The more common analysis is that set out by the Court of Appeal in Ferson Contractors Ltd v Levolux AT Ltd [2003] BLR 118, where Mantell LJ said that the contract had to be construed so as to give effect to the intention of Parliament, rather than to defeat it, and that if the set-off provision offended the requirement for immediate enforcement of the adjudicator’s decision, it should be struck down. …”

(b)?? the proper interpretation of the adjudicator’s decision:

“The second exception has arisen out of the proper interpretation of the adjudicator’s decision.? If the adjudicator has decided that a certain sum must be paid by X to Y, often forthwith, it is difficult to see that there could be any room for an effective withholding notice from X, or an allowable set-off of X’s cross-claims against the sum found due to Y by the adjudicator.? But if the adjudicator’s decision is instead in the nature of a declaration as to the proper operation of the contractual payment machinery, and the adjudicator identifies a sum which he says should be the subject of that machinery then, if a withholding notice can legitimately be served in accordance with those contractual payment provisions, the set-off may give rise to an arguable defence.

… in R&C Electrical Engineers Ltd v Shaylor Construction Ltd [2012] EWHC 1254 (TCC), Edwards-Stuart J concluded that the adjudicator’s decision that a sum was payable expressly in accordance with a particular clause of the sub-contract permitted the unsuccessful party to rely on that clause, and other related payment provisions, so as to raise a withholding notice and a counterclaim which had not been considered on its merits by the adjudicator.”

The adjudicator’s decision

In R&C Electrical Engineers Ltd v Shaylor Construction Ltd [2012] EWHC 1254 (TCC), the relevant adjudicator’s decision was expressed as follows:

“Any sum to which R&C are entitled to be paid by Shaylor shall not be paid forthwith (but only following issue of the Final Certificate under the Main Contract and then in accordance with clause 21.8 (b))."

(Emphasis in original)

Clause 21.8 (b) of that contract provided as follows:

Not later than 7 days before the final date for payment of the Final Payment the Contractor may give a notice to the Subcontractor which shall specify any amount proposed to be withheld or deducted from the amount notified under clause 21.9 (a) the ground or grounds for such withholding or deduction and the amount of the withholding or deduction attributable to each ground.”

The court found that, among other things, this Clause 21.8 (b) provided that:

Not later than 7 days before the final date for payment of the Final Payment Shaylor may give notice to R&C “which shall specify any amount proposed to be withheld or deducted from the amount notified under Clause 21.9 (a)” together with the grounds on which the amount is being withheld and the amount withheld that is attributable to each such ground.

(Emphasis in original)

Therefore, because of the existence of this provision in the contract and how the adjudicator had expressed his decision (by making a specific reference to this provision), the court found that “there is nothing to prevent Shaylor from setting off against the sum found due by the Adjudicator any sum that it would have been entitled to set off … under clause 21.8.” (There was no Clause 21.8 (a), so the reference to “clause 21.8” meant Clause 21.8 (b).)

In Thameside Construction Co Ltd v Mr & Mrs J Stevens [2013] EWHC 2071 (TCC), the court had to decide if Mr & Mrs Stevens were “entitled to set off or withhold against the sum payable pursuant to the decision provided that the withholding was done in accordance with the contract between the parties”. The court stated the following:

There can be no doubt that, to determine the issue as to whether or not the losing party in an adjudication can set off against sums said to be payable by the adjudicator’s decision, one needs to consider the terms of the decision itself. …

… the issues arising where a party seeks to set-off against or withhold from sums which an adjudicator has said are to be paid or are payable:

(a) The first exercise should be to interpret or construe what the adjudicator has decided. In that context, one can look at the dispute as it was referred to him or her. That can involve looking at the Notice of Adjudication, the Referral Notice, the Response and other "pleading" type documents. One can have regard to the underlying construction contract. Primarily, one needs to look at the decision itself.

(b) In looking at what the adjudicator decided, one can distinguish between the decisive and directive parts of the decision on the one hand and the reasoning on the other, although the decisive and directive parts need to be construed to include other findings which form an essential component of or basis for the decision (see Hyder Consulting (UK) Ltd v Carillion Construction Ltd).

(c) The general position is that adjudicators’ decisions which direct that one or other party is to pay money are to be honoured and that no set-off or withholding against payment of that amount should be permitted.

(d) There are limited exceptions. If there is a specified contractual right to set-off which does not offend against the statutory requirement for immediate enforcement of an adjudicator’s decision, that is an exception albeit that it will be a relatively rare one. Where an adjudicator is simply declaring that an overall amount is due or is due for certification, rather than directing that a balance should actually be paid, it may well be that a legitimate set-off or withholding may be justified when that amount falls due for payment or certification in the future. (See Squibb Group Ltd v Vertase FLI Ltd).

(e) Where otherwise it can be determined from the adjudicator’s decision that the adjudicator is permitting a further set-off to be made against the sum otherwise decided as payable, that may well be sufficient to allow the set-off to be made (see Balfour Beatty Construction v Serco Ltd).

?

These cases serve as a caution that, in view of the consequences of falling under this exception to the general rule on set off against an adjudication award, a party (whether referring or responding) may need to give some thought to the formulation of redress or declarations sought from the adjudicator.

AARON MAK BSc (Hons) LLB (Hons) MCIARB MICE MHKIE

ASSOCIATE DIRECTOR HANSCOMB INTERCONTINENTAL

Telephone +44 20 3287 8518