Richard Swan discusses a dilemma which is frequently faced by Responding Parties in UK adjudication proceedings. The dilemma is whether or not a Responding Party is able to raise issues in his Response to a Referral which may or may not be directly related to the dispute as defined by the Referring Party, and whether the Adjudicator has the jurisdiction to consider them. This article considers what may or may not be examined by the Adjudicator and gives guidance on how to approach a Response to a Referral, where the Responding Party wishes to raise issues of set-off and/or counterclaim in its Response.

The Issue

A Sub-Contractor issues a Referral under the Scheme for Construction Contracts to a Main Contractor in respect of the value of an interim payment. It is well known by the Sub-Contractor that there are a number of issues and events which he considers may be a good case in defence by the Main Contractor, and he has deliberately drafted the Referral to exclude any reference to those issues and events. Indeed the Sub-Contractor has expressly placed a limitation on the Adjudicator’s jurisdiction by stating that his jurisdiction extends no further than making an appropriate valuation against a single interim payment. In effect, the Sub-Contractor is attempting to exclude the Adjudicator’s jurisdiction in respect of the Main Contractor’s set-off/counterclaim.

The Main Contractor is also well aware of the issues and events which it contends fall within the liability of the Sub-Contractor and claims that the Sub-Contractor is liable for defects. He wishes to include these issues as set-off and counterclaim in his defence to the adjudication.

Therefore the question is: What can the Responding Party do in order to have its set-off/counterclaim considered in the adjudication and how may the Adjudicator react?

Commentary

These tactics employed by the Referring Party are not uncommon. He is clearly keen to limit his exposure to issues which may threaten to reduce the value of any award that the Adjudicator may make in the Referring Party’s favour. Indeed, it is not uncommon for a Referring Party who is not financially secure to go to great lengths to prevent any set-off or counterclaim issues from being heard because a finding for the Responding Party in these issues may be sufficient to create Referring Party impecuniosity, and therefore the Responding Party may have a case for not paying out any sums found in the Referring Party’s favour. This is allowable in law as it places the Responding Party in a position where it would not be able to recover the monies paid in subsequent proceedings to arbitration and/or litigation due to the insolvency of the Referring Party.

It would be unusual for a Referring Party to draft the Notice of Adjudication widely enough to allow the Responding Party to include any set-off or counterclaim. The Responding Party, meanwhile, is naturally keen to have the Adjudicator consider everything that it is confident in winning without having to go to the additional expense and further delay of a separate adjudication.

An Adjudicator’s jurisdiction is derived from the Notice of Adjudication and not from the subsequent Referral. A tactic by the Responding Party may be that if the Referral does not directly copy the issues raised in the Notice of Adjudication, he cries “foul” and contends that the Referring Party has submitted the ‘wrong’ Referral, which creates a jurisdictional issue. With experience of the Construction Act, it appears that Adjudicators are now not concerned with this, as long as the basis of the nature of the dispute is the same; Adjudicators appear to decide that they will continue if the detail is different, but the basis remains unchanged, taking their jurisdiction from the Referral.

It is important to distinguish the difference between set-off and counterclaim, as this has direct relevance to what is admissible in adjudication (and indeed arbitration) proceedings. The English distinction between set-off and counterclaim is whether or not the claim by the Responding Party is an integral part of the dispute between the parties. Setoff is a cross-claim which is directly linked to the original claim (a true defence), whilst a counterclaim is a cross-claim which is not necessarily linked to the original claim. Set-off therefore has a narrower meaning. Of significance, in litigation, the English courts can consider both, but in arbitration (and adjudication), arbitrators (and adjudicators) have not been given the same power. An Adjudicator’s jurisdiction is limited by the true nature of the dispute raised in the Referring Party’s claim, and therefore only set-off would fall within the jurisdiction of the Adjudicator, unless the parties agree to widen the scope of jurisdiction to include counterclaims.

Admissibility of issues is therefore complicated further by language, and Responding Parties would be well advised to avoid the use of the term “counterclaim”, if it really means “setoff ”. Despite the potential for jurisdictional challenges as a result of the incorrect use of terms, what is absolutely clear is that an Adjudicator will go to the root of the nature of the dispute in order to establish his jurisdiction. Regardless of the use of the term “counterclaim”, the Adjudicator would be unwise not to consider carefully whether the defence was indeed a true defence to the dispute referred.

Is the set-off a significant material issue which led to the dispute as referred in the first place? If so, then it is likely that the Adjudicator will admit these issues into the adjudication. An example may be where the quality of the work is the response to a claim of wrongful or inadequate payment for that work; this response would likely be a defence of Abatement.

However, if the issues in defence are merely related to the same contract, but are sufficiently divorced from the dispute as referred, it is likely that these issues will fall outside the Adjudicator’s jurisdiction. An example may be a contention by the Responding Party that liquidated damages are payable due to late completion by the Referring Party as a defence to the Referring Party’s claim for wrongful payment of an interim application.

Clause 20 of the Scheme is useful. The Adjudicator “may take into account any other matters which the parties to the dispute agree should be within the scope of the adjudication or which are matters under the contract which he considers are necessarily connected with the dispute”. Note the difference. The former requires party consent - and it would be unusual for the Referring Party to agree when it would be advantageous for him not to. The latter allows the Adjudicator the ability to decide whether the matters are connected with the dispute. It does not require party consent and provides an alternative to stop a recalcitrant Referring Party from deliberately denying consent.

Another significant issue is whether the material facts of the set-off and/or counterclaim can be taken to be in dispute. This is likely to derive from any Notice of Withholding, as provided for within Clause 10 of Part 2 of the Scheme and Clause 111 of the Housing Grants, Construction and Regeneration Act 1996, due to the alleged set-off and/or counterclaim issues. It is generally held that adjudication will be premature unless there has been a breakdown in the negotiations on the subject being referred. Therefore, if the set-off and counterclaim issues have not similarly been through a process of failed negotiation prior to the Referral, they cannot be taken to be in dispute, and therefore an Adjudicator is likely to consider that these issues fall outside his jurisdiction.

A comparison can be drawn with the decision in Edmund Nuttall Limited and R.G.Carter Limited. It was held that in order for a dispute to arise “there must have been an opportunity for the protagonists each to consider the position adopted by the other and formulate arguments of a reasoned kind”. Note that this is a two-way negotiation and both parties must have had the opportunity to consider the position of each other. The judge concluded that the constituents of the dispute was wider than the claim itself (rejected by the other party), but included “the whole package for arguments advanced and facts relied upon”. A refining of the strong arguments and abandonment of weak points would likely be permissible, but advancement of totally new argument and facts would likely not be permissible. A similar line of argument would apply to the Responding Party’s defence.

Effectively, there is a strong probability that there will be no right to set-off or counterclaim unless an effective Notice of Withholding covering these issues has been issued by the Main Contractor against the Sub-Contractor. This would also need to have been issued in accordance with the periods set out in the contract or those of the Scheme, and prior to the commencement of Adjudication. This is supported by the judgment of HHJ Hicks QC in VHE Construction plc v RBSTB Trust Co Ltd where he said:

“The first subject of dispute as to the effect of section 111 is whether section 111(1) excludes the right to deduct money in exercise of a claim to set-off in the absence of an effective notice of intention to withhold payment. … I am quite clear, not only that it does, but that that is one of its principal purposes. … The words "may not withhold payment" are in my view ample in width to have the effect of excluding set-offs and there is no reason why they should not mean what they say.”

Consequently, in the absence of an effective notice, the right to deduct money by way of set-off is excluded.

If there has been an effective Notice of Withholding, the issues of set-off and/or counterclaim may be part of the dispute, and the Adjudicator will be mindful of the need to consider whether the issues in defence are closely linked to the root of the dispute as referred prior to deciding their incorporation within his jurisdiction.

In summary:

1. No Notice of Withholding on the defence issues indicates the likelihood that they are not yet formally in dispute and in all probability the Adjudicator will not consider them in his adjudication.

2. No mention of set-off and/or counterclaim issues in the Notice of Adjudication and/or Referral places the Adjudicator in the position of considering how closely linked the defence issues are to the root cause of the Referred Dispute and Section 20 of Scheme gives him wide powers to decide.

3. Should the Responding Party have doubt themselves whether there is a sufficiently close link of their defence issues to the matters being referred, they would be well advised to keep their powder dry and run a parallel or later adjudication on the set-off and/or counterclaim issues. Set-off and/or Counterclaim against Adjudicator’s awards is another story and has different principles. This will be the subject of a future article.

Richard Swan is an Associate Director and is based at Trett Consulting’s London office