Recovering adjudication costs

KEY POINTS

• The accepted position is that parties to adjudication bear their own costs
• This means that even successful parties can be left severely out of pocket
• Is there any way a party might recover its costs?
• Possible options include a claim for damages against third parties; a claim under the Late Payment of Commercial Debts (Interest) Act 1998 and recovery in future litigation or arbitration proceedings

Substantial costs are incurred by parties in adjudication and perceived wisdom is that these costs (distinct from the adjudicator’s fees) cannot be recovered, even by a successful party.  This can make pursuing claims in adjudication unattractive, especially for substantial or complex matters, or leave respondents severely out of pocket after successfully defending unmeritorious claims.

However, whilst largely untested, there are methods by which parties might seek to recover these costs.  This article discusses three: (i) claim for damages against a third party ; (ii) the Late Payment of Commercial Debts (Interest) Act 1998 (the Late Payment Act); and (iii) recovery in future litigation/arbitration proceedings.

General position on recovery

Whilst not entirely clear, it is widely accepted that s 108A of the Housing Grants, Construction and Regeneration Act 1996 (the  HGCRA 1996 ) prohibits contractual provisions allowing the recovery of parties’ costs of adjudication unless the provision has been agreed in writing after notice of intention to refer the dispute to adjudication has been served.  This means that parties are unable to pre-agree in their construction contract who is to bear the parties’ adjudication costs or to grant the power to the adjudicator to allocate such costs. The courts also decided reasonably early in the life of adjudication that one party’s costs could not be recovered as damages from the opposing party.

In Total M&E Services v ABB Building Technologies [2002] EWHC 248 (TCC) it was held that allowing recovery of costs as damages would subvert the statutory scheme under the HGCRA 1996, given that the HGCRA 1996 did not provide for recovery of costs.

The starting point, therefore, is that each party to an adjudication must bear its own costs, unless the parties agree otherwise in writing following service of the adjudication notice.

Claim for damages against a third party

Whilst a party cannot claim its adjudication costs as damages against the counterparty to the adjudication, there may be scope for claiming those costs as damages from a third party – on the basis that a third party’s breach of contract/duty caused the adjudication, so the costs of the adjudication form part of the losses flowing from that breach.  This argument has had some success – namely in National Museums and Galleries on Merseyside v AEW Architects and Designers Ltd [2013] EWHC 2403 (TCC). As part of its claim against the architect, the employer in that case claimed its costs of an adjudication brought by the contractor – the employer’s argument being that if the architect had properly designed the works and/or coordinated the design, there would have been no dispute between the contractor and the employer.

The judge allowed recovery of the employer’s costs of (unsuccessfully) defending the contractor’s adjudication claim, holding that the architect’s breach had led to the claim by the contractor and, given that ’adjudication is a fact of life now in construction contracts’, the adjudication costs were a reasonably foreseeable consequence of that breach.  The only way that the link in causation would have been broken was if the employer had acted unreasonably in defending the contractor’s claim or if its lawyers had negligently advised the employer that it had an arguable defence.  That was not the position.

This case would seem to confirm that it is possible to recover adjudication costs as damages from third parties in the right circumstances.

It has been suggested that the case might be restricted to its facts, but there seems no reason in principle why such a claim might not be made in similar situations in other cases – for example, in relation to:

• breaches of design obligations like design defects or poor design coordination – this was the situation in National Museums;
• contentious contract administration decisions (concerning eg extensions of time, valuations and certifying practical completion) which lead to claims by the contractor; or
• breaches by a sub-contractor of its sub-contract which cause claims by other sub-contractors against the main contractor.

In addition, although in National Museums it was the legal costs incurred by the losing party in the adjudication which were recovered, there seems to be no reason in principle why the winning party in an adjudication should not recover its costs from a third party if the third party’s breach has led to the adjudication. It will be interesting to see whether this principle is ever successful in any other case.  It will obviously be important to carefully assess causation before bringing such a claim.

The Late Payment Act

The second possible method of recovery is to rely on the Late Payment Act to ‘trump’ the prohibition on recovery of adjudication costs under the HGCRA 1996.

The Late Payment Act provides for a statutory rate of interest to apply for late payment of debts under certain qualifying contracts.  The current rate is set at 8% above the Bank of England base rate. However, the Late Payment Act was amended in 2013 by the Late Payment of Commercial Debts Regulations 2013, SI 2013/395 (the Regulations) to also allow the unpaid party to recover its ‘reasonable costs’ of recovering the debt (previously only a fixed sum could be claimed for costs).  The EU Directive which the Regulations implemented makes it clear that the recoverable expenses should include the costs of instructing a lawyer or a debt collection agency.

So an unpaid party might argue that its ’reasonable costs’ of recovery include the costs it incurs in any adjudication commenced to claim payment of the debt.  Anecdotally, it appears that this argument has been successfully raised in a number of adjudications (in particular, to recover the costs of claims consultants).

However, there are a number of limitations to this argument:

• First, recovery could only ever be available where the Late Payment Act (as amended) applies.  This means that it would only apply: (i) for contracts made between businesses on or after 16 March 2013; (ii) to ‘qualifying debts’ – namely debts created by the obligation to pay the whole or part of the contract price; and (iii) to claims by suppliers – ie for claims flowing up the contractual chain.
• Second, the right to recover costs only applies if the statutory rate of interest also applies – this will not be the case if the contract already provides for a ‘substantial remedy’ for late payment which will ‘oust’ the statutory rate.  In the construction context, case law has suggested that an interest rate of 5% above base rate amounts to a ‘substantial remedy’, but an interest rate of 0.5% above base does not.  Most construction contracts will already provide for such a ‘substantial remedy’ for late payment and so the right to recover adjudication costs will not be available.
• Following the enactment of the Regulations, there is an argument that a ‘substantial remedy’ must also provide for the payment of the ’reasonable costs’ of recovering the debt.  However, it is likely that the correct interpretation of theLate Payment Act is that this is not required.
• Finally, the Late Payment Act takes effect by implying a term into the contract – the right to recover costs forms part of this implied term.  However, this implied term would appear to conflict with s 108A of the HGCRA 1996, as it is a contractual provision which purports to allocate payment of the parties’ costs of the adjudication.  Given this conflict, which statute takes priority?

This point remains to be tested in the courts.  One view is that the Regulations are secondary legislation (which amend the Late Payment Act) and they cannot override the HGCRA 1996, being primary legislation. On that basis, the Regulations would be inapplicable in the face of any conflict – in other words adjudication costs would not be recoverable.

The contrary argument relies on the fact that the Regulations implement EU legislation – some commentators have suggested that for this reason the Regulations must be given primacy.  However, this may be an overly simplistic analysis.  In light of the clear prohibition in s 108A of the HGCRA 1996, the Regulations are only likely to be given primacy to the extent that the underlying EU legislation has ‘direct effect’ in the UK.  Given that the relevant EU legislation which the Late Payment Act and the Regulations seek to implement are EU Directives, they are only directly effective (ie enforceable directly) against the UK state, public bodies and organisations which amount to ‘emanations of the state’.  Therefore, it is only in claims against these bodies that the Regulations could ‘trump’ the HGCRA 1996 and allow recovery of adjudication costs.

Given the above, the right to recover debt enforcement costs (including adjudication costs) by way of the Late Payment Act might only be available under qualifying contracts with public bodies where there is no existing ‘substantial remedy’ for late payment.

Subsequent proceedings

The third potential method of recovery is to seek to recover adjudication costs as legal costs within subsequent litigation or arbitration proceedings.

In both litigation and arbitration, there is scope for parties to recover costs ’incidental to’ the proceedings (pursuant to s 51, Senior Courts Act 1981 and s 59,Arbitration Act 1996 respectively).  There is case law which confirms that costs incidental to the proceedings can include pre-action preparation costs.  It is arguable that the work involved in preparing the case for adjudication is work which otherwise would have been required for later litigation or arbitration proceedings, and so should be recoverable in those proceedings.  This might cover, for example, the investigation of the factual and legal position, and preparation of witness statements or expert reports.

Having said this, the principle may not extend to pre-action ADR – in Lobster Group Ltd v Heidelberg Graphic Equipment Ltd [2008] EWHC 413 (TCC), it was held that the costs of a pre-action mediation could not be recovered as part of the costs of the litigation.  One of the main points that the judge relied upon was that the parties had agreed that they would each bear their own costs of the mediation, which tended against allowing the party to recover those costs in later proceedings.  In a similar way, the fact that the HGCRA 1996 arguably now prohibits any pre-agreement as to the allocation of the parties’ legal costs could be taken as equivalent to an agreement that the parties’ costs of adjudication should lie where they fall.

However, a method to strengthen the claim for recovery of costs would be to take a step in the litigation or arbitration proceedings before commencing adjudication – for example, to issue a Pre-Action Protocol letter of claim.  The costs of preparing the claimant’s case could then legitimately be argued to relate to the Pre-Action Protocol process, rather than to the adjudication.  It is reasonably settled law that the parties’ costs of complying with the Pre-Action Protocol are capable of being recovered as part of the costs of any subsequent litigation – McGlinn v Waltham Contractors Ltd [2007] EWHC 149 (TCC). Even if this argument were successful, however, it would not cover costs relating solely to the adjudication – for example, work in preparing adjudication submissions and in relation to jurisdictional challenges.

Conclusion

Adjudication costs are a significant issue and form a disincentive for parties to engage in the procedure, especially for substantial or complex cases.  Whilst largely untested in Court, the methods discussed above may provide a potential route for recovery of those costs and so mitigate the concerns to a limited degree.  Parties and lawyers are eternally creative and no doubt further arguments will arise in the future.

This article was first published in the August/September 2015 edition of Construction Law.