Withholding payment: the legal implications of pushing contractors into insolvency 

A recent TCC decision highlights the dangers of withholding payment against contractors with a view to pushing them into insolvency. The court allowed the recovery of insolvency professional fees as well as a substantial sum reflecting a reduced settlement reached with a third party on a separate project. The court’s decision has ramifications for any party seeking to withhold large payments under a construction contract against a party who is likely to suffer serious cash-flow pressure as a result.

Imperial Chemical Industries Limited v Merit Merrell Technology Limited

ICI engaged MMT to manufacture and install steelwork and pipework for a new paint manufacturing facility. Part way through the contract in October 2014, ICI ceased making payment to MMT and issued an instruction to cease all welding work. ICI alleged that MMT’s welding was of very poor quality. Welding recommenced in January 2015 but the following month ICI purported to terminate the contract for repudiatory breach by MMT on account of quality issues. MMT strenuously disputed ICI’s allegations and challenged the validity of ICI’s termination. MMT claimed that ICI had repudiated the contract and served its own notice of termination.

At a trial on liability issues, the court found that background cost pressures had led to ICI devising a strategy to force MMT into insolvency. ICI’s allegations of very poor welding were largely made up and designed to provide an excuse for ICI to stop payment and terminate the contract. MMT commenced adjudication proceedings in relation to an interim payment due in November 2014. The adjudicator awarded MMT £7m but the time taken (until March 2015) to enforce the decision through Court proceedings led to MMT’s bank losing confidence in it and withdrawing its lending facilities.

ICI’s conduct had a profound impact upon MMT’s business as a whole and MMT sought professional advice from lawyers and insolvency practitioners and proposed a CVA to its creditors, a move that inevitably damaged its commercial reputation. MMT was owed substantial sums from clients on other projects and, as a direct result of its financial problems, was forced to settle these sums for a reduced value. One of these clients, Murphy, received notice of the CVA plans and dramatically reduced its final account offer to MMT by £1.3m on the basis that any adjudication award obtained by MMT would be stayed on financial grounds. Eventually, MMT entered voluntary liquidation in early February 2017.

ICI brought TCC proceedings against MMT to recover the sums paid pursuant to the adjudicator’s decision. MMT counterclaimed for repudiation and sought to recover a wide range of losses flowing from the deterioration of its financial position. As noted above, in a separate liability trial the TCC found ICI’s claims to be groundless and held it to have repudiated the contract. In awarding indemnity costs against ICI for the liability trial, the court noted that ICI was aware that it did not have grounds to assert a repudiatory breach at the time it sought to terminate and that the evidence at trial was “extraordinarily thin, verging on factually non-existent”.

Decision

In its judgement on quantum, the court awarded a number of heads of loss to MMT including loss of profit on the remaining work under the contract. With regard to the deterioration in its financial position, MMT recovered:

• £1.3 million in respect of the reduced final account settlement accepted from Murphy.
• Wasted management time of £266,472.
• £239,369 incurred for professional advice in relation to the proposed CVA.
• Additional banking costs of £168,599 (including bank advisor fees).
• A VAT loan for £58,994 which was necessary for cash flow reasons.

In relation to the reduced settlement sum, the court accepted that the financial difficulties faced by MMT would have made it very difficult for it to enforce any adjudication decision against third parties because of the principles governing stays of execution upon adjudication enforcement (set out in Wimbledon v Vago). Murphy’s conduct in using this fact to negotiate a lower settlement (described by the judge as “purely opportunistic”) was not too remote. MMT was justified in accepting the reduced offer (given its financial position) and could recover the difference from ICI.

Conclusion and implications

This decision provides a rare illustration of the dangers of adopting an insolvency-based strategy for the resolution of construction disputes. The court was hugely critical of ICI’s ultimately successful attempts to push MMT into insolvency by withholding payment and seeking to terminate the contract when it knew it had no grounds to do so. ICI’s knowledge that its conduct was likely to push MMT into insolvency was specifically noted by the court in connection with its assessment of the quantum of MMT’s counterclaim.

The court’s ruling in relation to the Murphy settlement is particularly notable. The documentation before the court showed that Murphy did not dispute its liability to MMT but was simply attempting to take advantage of the grave financial difficulties caused to MMT by ICI’s repudiation. As the large award under this heading shows, claims of this nature represent a very significant exposure for companies considering aggressive disputes strategies with a view to putting their opponents under cashflow pressure.

The court’s decision in relation to the Murphy settlement also has potential ramifications for genuine payment disputes. The court specifically noted that such a loss was within the contemplation of the parties at the time of contracting, which was long before ICI had formulated a strategy to push MMT into insolvency. Such a finding may readily apply to other construction contracts and lead to similar findings where payment is withheld on more genuine grounds.

Overall, the effect of this decision is to show the large and potentially unexpected liabilities which may fall to a company withholding payment on incorrect grounds. Employers and main contractors withholding large sums from their downstream counterparties would be well advised to consider their potential exposure in this regard. Whilst the cashflow pressure which such conduct can exert may be productive of a commercial settlement, it may also give rise to a considerable counterclaim if the right to withholding is not made out.

References

Wimbledon Construction Company 2000 Ltd. v Vago [2005] EWHC 1086 (TCC).

Imperial Chemical Industries Limited v Merit Merrell Technology Limited [2018] EWHC 1577 (TCC).