Trentham v. Lawfield Investments

Factual and Procedural Background

The Plaintiff is a building contractor and the Defendant is a property developer. In the summer of 2000, the Defendant commenced the conversion of buildings at 70 Howard Street, The City, into a block of shops and flats. On 17 June 2000, the parties entered into a contract under the Scottish Building Contract Contractor's Designed Portion (without quantities) (January 2000 revision), whereby the Plaintiff agreed to carry out construction and part of the design work. No quantity surveyor was appointed, so the usual valuation, certification, and payment mechanisms under the contract could not operate. Instead, the parties agreed a substituted payment mechanism based on subcontractor liabilities plus uplift and the Plaintiff’s own work plus uplift. Interim valuations were issued monthly by the Plaintiff and mostly paid by the Defendant, who had these valuations checked by a quantity surveyor retained by the Defendant’s financier, Dunbar Bank PLC.

The Plaintiff claimed that the contract, as varied, was a "construction contract" within the meaning of the Housing Grants, Construction and Regeneration Act 1996, thereby implying certain statutory payment provisions. By the time the action was raised on 8 March 2002, the works were nearly complete. The Plaintiff's interim valuation no. 17 dated 7 February 2002 valued work at over £3.3 million, with a sum due after deductions of approximately £364,864.29. The Defendant did not issue any statutory notices under sections 110 or 111 of the 1996 Act, making the sum payable under the implied terms due on 8 February 2002, with a final payment date of 25 February 2002. No payment was made, prompting the Plaintiff to sue for the sum claimed.

The Plaintiff sought a warrant for inhibition on the dependence of the action, supported by averments indicating a significant risk of the Defendant’s insolvency. These included the Defendant’s prior audited accounts showing a net deficiency of assets over liabilities, the funding limit reached with Dunbar Bank PLC, and the Defendant’s failure to pay the interim valuation no. 17 in full. The court granted the inhibition ex parte on the basis of a significant risk of practical insolvency.

The Defendant subsequently moved to recall the inhibition, arguing that it had adequate funds to meet the claim and that continued inhibition was contrary to the European Convention on Human Rights. The Defendant produced extensive financial material to support its position. The Plaintiff maintained that a significant risk of practical insolvency remained, justifying the retention of the inhibition. The court followed the approach established in Karl Construction Limited v Palisade Properties PLC, 2002 S.L.T. 312, and proceeded to consider the issues.

Legal Issues Presented

1. Whether there was a significant risk of the Defendant’s insolvency justifying the grant or retention of inhibition on the dependence of the action.
2. The appropriate approach to assessing the risk of insolvency at the stage of a motion to recall inhibition, including the allocation of the burden of proof.
3. The relevance of the Defendant’s alleged defence to the Plaintiff’s claim in determining the appropriateness of inhibition.
4. The validity of the Defendant’s argument that inhibition in cases involving heritable property as stock in trade creates a circularity that should prevent its use.

Arguments of the Parties

Defendant's Arguments

• The Defendant argued that the onus is on the Plaintiff to justify the use of inhibition both initially and on a motion for recall.
• It submitted credible financial evidence showing that the Defendant was neither absolutely nor practically insolvent, with a surplus of assets over liabilities in audited accounts.
• The Defendant contended that the Plaintiff’s claim was disputed and therefore could not justify a finding of practical insolvency.
• It argued that practical insolvency as a justification for inhibition in cases where the Defendant’s stock in trade is heritable property is circular, because inhibition prevents the Defendant from realizing assets to pay debts.

Plaintiff's Arguments

• The Plaintiff accepted the onus resting on it to justify inhibition but maintained that a significant risk of insolvency persisted despite the Defendant’s financial material.
• The Plaintiff highlighted discrepancies and risks in the Defendant’s financial position, including a narrow surplus margin, dependency on the successful sale of the entire development, discrepancies in sales valuations, and unaccounted-for future interest payments.
• The Plaintiff argued that the Defendant’s offer to settle the final account at a figure close to the claim indicated acceptance of the majority of the claim, undermining the defence of dispute.
• The Plaintiff contended that the Defendant’s section 111 notice was not timeous and thus ineffective in relation to the claim at issue.
• The Plaintiff rejected the circularity argument, noting practical solutions such as caution or consignation, or recall of inhibition on individual properties with appropriate conditions.

Table of Precedents Cited

Court's Reasoning and Analysis

The court began by confirming that the burden of proof for justifying inhibition rests on the Plaintiff at both the initial application and any subsequent motion for recall. It emphasized that the court must consider the entirety of the financial material available at the recall stage, including future risks, to assess whether a significant risk of insolvency exists. Both absolute insolvency (liabilities exceeding assets) and practical insolvency (inability to pay debts as they fall due) suffice to justify inhibition.

In assessing the Defendant’s financial position, the court noted that while the latest audited balance sheet disclosed a surplus of assets over liabilities, this surplus was modest (approximately 2.5%) and dependent on the successful sale of the entire development at projected prices. The court found discrepancies in the valuation of the flats, which were being offered at prices lower than those assumed in the accounts, creating a real risk that the Defendant might become insolvent if some units failed to sell.

The court also highlighted that the accounts appeared to omit or inadequately account for future interest payments on loans, including a substantial loan from a former director, and noted unexplained discrepancies in cash balances. Additionally, the court considered the likely VAT liability, which had not been fully accounted for.

Considering these factors, the court concluded that there was a significant risk that the Defendant would be unable to pay the Plaintiff’s claim if upheld by the court at the time payment fell due. The court also rejected the Defendant’s argument that the existence of a disputed claim precluded a finding of practical insolvency, noting that the Defendant had offered to settle most of the claim and that the statutory notice relied upon was not timeous.

Regarding the Defendant’s circularity argument about inhibition preventing realization of heritable property, the court found this argument misconceived. It observed that the risk of insolvency arose from the Defendant’s financial position and the development’s risks, not from the inhibition itself. The court identified practical solutions such as offering caution or consignation or recalling inhibition selectively with conditions, but noted that the Defendant had not sought such relief.

Finally, the court held that the Plaintiff had established a good prima facie case on the merits, sufficient to justify the continued inhibition.

Holding and Implications

The court REFUSED the Defendant’s motion to recall the inhibition on the dependence of the action.

The direct effect of this decision is that the Plaintiff’s warrant of inhibition remains in place, providing judicial security for the Plaintiff’s claim pending resolution of the action. The court did not establish any new legal precedent but applied established principles regarding insolvency risk and the use of inhibition in the context of construction contract disputes and the Housing Grants, Construction and Regeneration Act 1996.