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Insolvency is a perennial topic in the construction industry. One of the questions that can arise is how far a paying party can go in withholding payment from contractors in financial difficulties. And if the paying party strays over the line, what are the consequences? 

Judge Fraser鈥檚 judgment considered these issues in Imperial Chemical Industries Ltd vs Merit Merrell Technology Ltd [2018] EWHC 157.

ICI engaged MMT to manufacture and install steelwork and pipework for a new paint factory. Part way through the contract in October 2014, ICI ceased paying and issued an instruction to cease all welding work, alleging MMT鈥檚 welding was of poor quality. ICI failed to make an interim payment due in November 2014 and MMT commenced adjudication proceedings in respect of that payment.

The adjudicator awarded MMT 拢7m, but ICI did not pay and MMT took steps to enforce the decision through court proceedings 鈥� this resulted in ICI paying, but not until March 2015. Welding had recommenced in January 2015 but the next month ICI purported to terminate the contract for repudiatory breach by MMT on account of quality issues. MMT strenuously disputed ICI鈥檚 allegations and challenged the validity of ICI鈥檚 termination, claiming in turn that ICI had repudiated the contract.

鈥淚CI鈥檚 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鈥檚 counterclaim鈥�

ICI commenced proceedings against MMT to recover the sums paid pursuant to the adjudicator鈥檚 decision. MMT counterclaimed for repudiation and sought to recover a wide range of losses flowing from the deterioration of its financial position. At the trial on liability issues, the court found that background cost pressures had led to ICI devising a strategy to force MMT off site and into insolvency (or close to it). ICI鈥檚 allegations of very poor welding were largely made up and designed to provide an excuse for ICI to stop payment and terminate the contract. 

Quantum was dealt with separately and is the subject of this judment by Judge Fraser. The court awarded a number of traditional heads of loss to MMT. However, ICI鈥檚 strategy of forcing MMT into insolvency had, so MMT said, caused it to suffer broader categories of loss. ICI鈥檚 failure to pay the November 2014 interim payment led to MMT鈥檚 bank losing confidence in it and withdrawing its lending facilities.

MMT was able to arrange alternative facilities 鈥� but on far worse terms. MMT then sought professional advice from lawyers and insolvency practitioners and proposed a CVA to its creditors 鈥� and while, ultimately, the CVA was not put in place this was a move that inevitably damaged its commercial reputation.

MMT was owed substantial sums from clients on other projects and, so it said, as a direct result of its financial problems it was forced to settle its claims for 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 拢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.

The judge broadly agreed with MMT. The court was hugely critical of ICI鈥檚 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鈥檚 knowledge that its conduct was likely to push MMT into insolvency was specifically noted by the court in its assessment of the quantum of MMT鈥檚 counterclaim. 

A couple of claimed losses (the costs of the liquidation and a reduced settlement in an arbitration in respect of works in India) were not awarded on the basis they were too remote/not caused by ICI鈥檚 breaches. However, the judge allowed recovery of wasted management time, costs incurred for professional advice in relation to the proposed CVA, additional banking costs (including bank adviser fees) and a VAT loan that was necessary for cash flow reasons 鈥� all of which had been plainly caused by ICI鈥檚 repudiation.

By far the largest sum awarded was 拢1.3m in respect of the reduced final account settlement from Murphy. The judge accepted that the financial difficulties faced by MMT would have made it very difficult for it to enforce any adjudication decision against third parties so it was justified in accepting the reduced offer, and could recover the difference from ICI.

The court鈥檚 ruling in relation to the Murphy settlement is noteworthy for two reasons. First, the documentation before the court showed Murphy did not dispute its liability to MMT but was simply attempting to take advantage of the serious financial difficulties caused to MMT by ICI鈥檚 strategy.

Second, the court specifically noted that the 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 erroneous but genuinely believed grounds. 

Overall this decision shows the large and unexpected liabilities that may fall to a company withholding payment on incorrect grounds.  

While the cash flow pressure that such conduct can exert can lead to a commercial settlement, it may also lead to a substantial counterclaim if the right to withhold is not upheld.