WILLIAM HARE LTD V SHEPHERD CONSTRUCTION LTD
Technology and Construction Court
Coulson J
25 June 2009
THE FULL TEXT OF THE JUDGMENT OF COULSON J
1. INTRODUCTION
1. This claim under CPR Part 8 arises out of a type of contractual provision which has been a relatively rare sight in the construction industry for the last 15 years – the "pay when paid" clause. Such clauses were effectively outlawed by section 113(1) of the Housing Grants (Construction and Regeneration) Act 1996, unless it could be shown that the third party employer was insolvent. This provision, and the contract forms drafted to comply with it, have given rise to very few reported cases but now, as the UK construction industry faces severe economic difficulties, this part of the Act is back under the spotlight.
2. The dispute in the present case is simply summarised. The claimant sub-contractor (whom I shall call "Hare") was engaged in December 2008 by the defendant main contractor (whom I shall call "Shepherd"), to fabricate and erect steelwork at a large development at Trinity Walk in Wakefield. The employer was Trinity Walk Wakefield Limited (whom I shall call "Trinity"). There was an express term of the sub-contract, clause 32, which was in similar terms to section 113 of the 1996 Act and which defined the employer's insolvency by reference to four alternate situations: an administration order made by the court; the appointment of an administrative receiver; insolvent liquidation; and the making of a winding-up order by the court.
3. Hare have legitimate claims against Shepherd for £569,601.75 plus VAT (Valuation 5), and £427,081.60 plus VAT (Valuation 6). In respect of each valuation, however, Shepherd have issued a withholding notice relying on clause 32. The dispute which now arises stems from the fact that Trinity did not become insolvent by reference to any of the four events specifically identified in clause 32. Their administration was achieved through a different route and was made possible by the amendments to the Insolvency Act 1986 introduced by the Enterprise Act 2002. These amendments allow for what have been referred to as self-certifying administrations. Although the sub-contract was made many years after the amendments to the relevant legislation came into force, clause 32.2 made no reference to them.
4. Accordingly, on behalf of Hare, Mr. Brannigan submits that, because none of the four insolvency events identified in clause 32.2 have occurred, Trinity is not insolvent within the meaning of the clause and the withholding notices are therefore invalid. In this he was supported by Mr. Nissen, who acts for CJ Reynolds, another sub-contractor on the same project, who is allegedly in the same position as Hare. On behalf of Shepherd, Mr. Furst maintained that it would be absurd for the sub-contract to be construed as ignoring the subsequent amendments to the legislation, and that all routes to administration under the Insolvency Act 1986, as amended, were covered by the words of clause 32.2.
5. Before embarking on the detail of this Judgment, I should add a further word of explanation about the position of CJ Reynolds. At the outset of the hearing last week, following argument, I made it plain that this Judgment would be binding on Hare and Shepherd only, and that Reynolds' own claim for declarations was not being decided. This was because Reynolds' Part 8 claim was only issued shortly before the hearing, and neither Mr. Furst nor I have had sufficient time to absorb whether or not the factual circumstances surrounding the Reynolds' sub-contract were the same or similar to those surrounding the Hare sub-contract. That said, I invited Mr. Nissen to make submissions on the point of construction so as to ensure that all the relevant arguments of principle had been addressed before I reached my conclusions.
2. THE PRE 2002 LEGISLATION
6. Section 113 of the Housing Grants (Construction and Regeneration) Act 1996 was in these terms:
"(1) A provision making payment under a construction contract conditional on the payer receiving payment from a third person is ineffective, unless that third person, or any other person payment by whom is under the contract (directly or indirectly) a condition of payment by that third person, is insolvent.
(2) For the purposes of this section a company becomes insolvent —
(a) on the making of an administration order against it under Part II of the [1986 c. 45.] Insolvency Act 1986,
(b) on the appointment of an administrative receiver or a receiver or manager of its property under Chapter I of Part III of that Act, or the appointment of a receiver under Chapter II of that Part,
(c) on the passing of a resolution for voluntary winding-up without a declaration of solvency under section 89 of that Act, or
(d) on the making of a winding-up order under Part IV or V of that Act."
7. In summary, whilst this provision outlawed pay when paid clauses, which caused so much difficulty in the late 1980s/early 1990s, there was one clear exception: when the ultimate employer had become insolvent. Insolvency was defined by reference to what were the four principal ways in which a company might become insolvent including at (a) "the making of an administration order against it under Part II of the Insolvency Act 1986".
8. Part II of the Insolvency Act 1986 was entitled "Administration Orders". Section 8 read as follows:
"(1) Subject to this section, if the court –
(a) is satisfied that a company is or is likely to become unable to pay its debts (within the meaning given to that expression by section 123 of this Act), and
(b) considers that the making of an order under this section would be likely to achieve one or more of the purposes mentioned below,
the court may make an administration order in relation to the company.
(2) An administration order is an order directing that, during the period for which the order is in force, the affairs, business and property of the company shall be managed by a person ('the administrator') appointed for the purpose by the court."
Sections 9 to 27 of Part II deal in detail with the effect of an administration order, the powers of administrators and the like. Part III of the Insolvency Act was concerned with receivership. Parts IV and V were concerned with winding-up orders.
9. The process of administration under Part II was widely perceived as being rather cumbersome and potentially expensive because of the need, amongst other things, for an independent report. The Practice Note of 17th January 1994, issued by the Chancery Division, commented as follows:
"Administration Orders under Part II of the Insolvency Act 1986 are intended primarily to facilitate the rescue and rehabilitation of insolvent but potentially viable businesses. It is of the greatest importance that this aim should not be frustrated by expense and that the costs of obtaining an administration order should not operate as a disincentive or put the process out of the reach of smaller companies.
Rule 2.2 of the Insolvency Rules provides that an application for an administration order may be supported by a report by an independent person to the effect that the appointment of an administrator for the company is expedient. It is the experience of the court that the contents of the Rule 2.2 Report are sometimes unnecessarily elaborate and detailed. Because a report of this character is thought to be necessary, a preliminary investigation will often have been unduly protracted and extensive and, hence, expensive."
It was this prevailing view that led to the significant amendments to Part II introduced by the Enterprise Act 2002.
3. THE ENTERPRISE ACT 2002
10. The explanatory notes to the Act gave details of how and why the changes had come about:
"640.Changes to the existing corporate insolvency regime focus on restricting the use of administrative receivership and streamlining administration. The White Paper 'Productivity and Enterprise: Insolvency - A Second Chance' recognised that the administration procedure introduced by the Insolvency Act 1986 was seen as an important tool in providing companies in financial difficulties with a breathing space in which to put a rescue plan to creditors. However, it also recognised that the procedure could be improved …
641. The existing provisions contained in Part II of the Insolvency Act 1986 allow the court to make an administration order in respect of a company that is in financial difficulties. Broadly speaking, the effect of such an order is to afford the company protection from its creditors whilst attempts are made to save the company or achieve a better result for creditors than would be achieved in a winding-up. However, in practice, in many cases where a company gets into financial difficulties, this will lead to the appointment of an administrative receiver by those providing financial support for the company (typically the company's bank), since they usually will have taken a floating charge over all the company's assets. …
643.The sections will alter the above provisions in the following way. First, the appointment of administrative receivers will be restricted to certain exceptions … and the Act seeks to provide that administrators will in future be appointed in situations that would have been dealt with through administrative receivership. Second, the procedure has been amended to streamline the process both in the provisions of the Act and the Rules made under section 411 Insolvency Act 1986 that seek to give effect to the provisions of the Act. … "
11. Section 248 of the 2002 Act was in these terms:
"248. Replacement of Part II of Insolvency Act 1986
(1) The following shall be substituted for Part II of the Insolvency Act 1986 …
'Part II
ADMINISTRATION
8 Administration
Schedule B1 to this Act (which makes provision about the administration of companies) shall have effect.'
(2) The Schedule B1 set out in Schedule 16 to this Act shall be inserted after Schedule A1 to the Insolvency Act 1986.
(3) Schedule 17 (minor and consequential amendments relating to administration) shall have effect.
(4) The Secretary of State may by order amend an enactment in consequence of this section.
(5) An order under subsection (4) —
(a) must be made by statutory instrument, and
(b) shall be subject to annulment in pursuance of a resolution of either House of Parliament."
12. Section 249 dealt with what were called "Special Administration Regimes" in relation to which the new section 248 was to have no effect. These included water and sewerage undertakers, protected railway companies, air traffic services, public private partnerships and building societies. Section 249(2) made plain that, in respect of these companies, the old regime under Part II, i.e. the making of an administration order, was to continue to have effect.
13. Schedule B1 contained detailed provisions concerned with administration. It identified three different routes to administration: the appointment of an administrator by the court following the making of an administration order, dealt with at paragraphs 10 to 13 of Schedule B1; the appointment of an administrator by the holder of a floating charge, dealt with at paragraphs 14 to 21; and the appointment of an administrator by a company or directors dealt with at paragraphs 22 to 34 of Schedule B1. The first of these was the route available under the original Insolvency Act. The second and third were new and were conveniently labelled during the hearing as "self-certifying options". They were the product of the new desire to streamline the administration process.
14. Accordingly, it is no longer necessary to obtain a court order in order to appoint an administrator. This can now be done by the completion and filing at court of the requisite forms which contain declarations that the conditions for administration have been satisfied. But these options are not open to everyone. They are not available, for example, to a company in liquidation or a creditor who is not a qualifying floating charge holder. In addition, paragraph 33 of Schedule B1 makes it clear that, in the event that both court and self-certifying procedures are operating in parallel (because, say, there is a dispute about the identity of the appropriate administrator), the court order takes precedence over the other options. That aside, following the appointment of the administrator there is no significant difference in the substance of the administration.
15. The Enterprise Act 2002 (Insolvency) Order 2003 (Statutory Instrument 2003/2096) made consequential changes to, amongst other things, section 113 of the Housing Grants (Construction and Regeneration) Act 1996. Section 113(2)(a) now reads:
"For the purposes of this section a company becomes insolvent —
(a) when it enters administration within the meaning of Schedule B1 to the Insolvency Act 1986 …"
In other words, under the 1996 Act (as amended) insolvency following the entering into of administration by any of the three routes identified in the Insolvency Act (as amended) is sufficient for the exclusion provision relating to pay when paid clauses to be triggered.
4. THE HARE SUBCONTRACT
4.1 Background
16. The terms of the sub-contract between Hare and Shepherd were negotiated during the period between October and December 2008. Although it is suggested that during this period Shepherd knew about Trinity's financial difficulties but did not reveal those matters to Hare, this is not a matter which, in my judgment, is directly relevant to the issues before me on the present application (although it is easy to see how it might be relevant to subsequent claims). I therefore make no finding on that issue, which would in any event require oral evidence.
17. I am, of course, obliged pursuant to Investors Compensation Scheme v. WestBromwichBuilding Society [1998] 1 WLR 886 to take into account the factual background to the agreement of the sub-contract. I am primarily concerned with the background to clause 32 because that is the principal provision of relevance. As regards that clause, it appears that:
(a) it was drafted in about 1998 by Masons (Shepherd's former solicitors);
(b) it was probably intended to comply with section 113 of the Housing Grants (Construction and Regeneration) Act 1996 (it mirrors the unamended wording of that Act);
(c) it was an amendment to the standard form of sub-contract that the parties had agreed to use, and it was an amendment that was put forward by Shepherd;
(d) it was an amendment that was wholly in Shepherd's interests, because it endeavoured to share with Hare the risk of the insolvency of Trinity, notwithstanding the fact that Hare had no contractual relationship with Trinity.
18. The parties were also agreed that section 113 of the 1996 Act and the subsequent changes to it brought about by the Enterprise Act 2002 were also a relevant part of the background to the sub-contract. They are agreed that they should be taken to have known about the prohibition on pay when paid clauses, the exception at clause 32, and the changes to the administration regime identified in the amendments to section 113; that is to say, the fact that administration can now be achieved by three different routes rather than one.
4.2 The Relevant Clauses
19. Clause 32.2 was in these terms:
"For the purposes of clause 32.1 a company becomes insolvent
32.2.1 on the making of an administration order against it under Part II of the Insolvency Act 1986;
32.2.2 on the appointment of an administrative receiver or a receiver or manager of its property under Chapter 1 of Part III of that Act or the appointment of a receiver under Chapter 2 of that Part;
32.2.3 on the passing of a resolution for voluntary winding up without a declaration of solvency under section 89 of that Act; or
32.2.4 on the making of a winding-up order under Part IV or V of that Act."
20. Clause 29.3 is also of some relevance because it dealt with the potential consequences of Hare's insolvency. It provided:
"… if the sub-contractor makes a composition or arrangement with his creditors or becomes bankrupt or being a company … under the Insolvency Act 1986 or any amendment or re-enactment thereof has an administrator or an administrative receiver appointed then … the contractor may, by notice to the sub-contractor, determine the employment of the sub-contractor under this sub-contract and such determination shall take effect on the date of receipt of such notice."
21. Therefore, as Mr. Brannigan rightly notes, the words "under the Insolvency Act 1986 or any amendment or re-enactment thereof" in clause 29.3 was sufficient to cover, amongst other things, the different methods of appointing an administrator now set out in Schedule B1 to the Insolvency Act as amended. He contrasts that with clause 32, which does not contain similar words.
5. THE FACTS
22. On 2nd March 2009, Hare issued Application 5 in the gross sum of £5.8 million-odd plus VAT. On 8th April Shepherd valued this application in the net sum of £569,601.75 plus VAT. However, they withheld that sum because of what they referred to as Trinity's insolvency.
23. The evidence as to Trinity's financial position was this. At a meeting on 11th March 2009, following the withdrawal of their bank's support, the Board of Directors of Trinity resolved to place Trinity into administration with immediate effect. Shepherd were present at that meeting as observers and they were formally told about the decision later that same day when Trinity also filed at court Form 2.8B (Notice of Intention to Appoint an Administrator).
24. On 19th March Trinity filed two more documents at court: Form 2.9B (Notice of Appointment of an Administrator by a Company and Directors) and two Forms 2.2B (Statement of Proposed Administrator). Further to Schedule B1 this meant that administrators were appointed upon and by the filing of the notices on 19th March, without any separate order of the court.
25. On 25th March 2009 Hare issued Application 6 in the gross sum of £9.3 million-odd plus VAT. On 8th May Shepherd valued this application in the net sum of £427,081.60 plus VAT but again withheld the sum on the basis of Trinity's insolvency.
26. On 27th May 2009 Hare issued these proceedings. In particulars of claim served the same day the relief they sought was identified in the following terms:
"1. The following declarations and each of them:
(a) No administrative order has been made against Trinity under Part II of the Insolvency Act 1986;
(b) No administrative receiver or manager has been appointed in relation to Trinity's property under Chapter I and Part III of that Act nor has a receiver been appointed under Chapter 2 of that Part;
(c) No resolution has been passed by Trinity for voluntary winding-up without a declaration of solvency under section 89 of that Act;
(d) No winding-up order under Part IV or V of that Act has been made in respect of Trinity;
(e) Accordingly, Trinity was not insolvent for the purposes of and is defined at clause 32.2 of the sub-contract as at 8th April 2009 or 8th May 2009, the dates of its withholding notices; and
(f) As a result, William Hare is entitled to recover the certified sums of £569,601.75 plus VAT in relation to Valuation 5 and £427,081.60 plus VAT in relation to Valuation 6.