UK: Retention - Worth Retaining?

Last Updated: 5 January 1999
Retention - Worth Retaining?

Patrick Mears

In October's Construction Press, I discussed the concept of "trust", and concluded sadly that it had but a small place in our modern construction industry. Now that the menacing clouds of economic slow-down are looming again anxiety levels are rising and "trust" becomes an even rarer commodity. No doubt the retention provisions in the JCT standard forms which embody the legal notion of "trust" will once again be brought into sharp focus and the subject of yet further controversy.

The retention provisions under JCT 80 will be familiar. Sums become due to the contractor as and when the employer's architect issues interim certificates. The employer is entitled to retain a proportion of these sums, eventually building up a sizeable fund. The contractor becomes entitled to one half of this fund on practical completion, and the other half on the issue of the certificate of making good defects.

This system is of course designed to protect both employer and contractor against the other's insolvency, but unfortunately (to coin a phrase) it is not an "adequate mechanism". Before any employer reading this rushes off to the sales with retention monies in his back pocket, he should be warned that he is not entitled to treat this money as his own. Both the retention provisions themselves and the common law stipulate that the employer's interest in these monies is "fiduciary as trustee". The contractor can request (and if necessary compel) the employer to set aside a separate trust fund into which such sums are paid.

There are particular problems for the contractor. The fact that a certain proportion of sums owing to him is withheld creates obvious cashflow difficulties, particularly in times of crisis when the retention provisions themselves may propel a tottering contractor into insolvency, the very thing which the provisions are designed to protect against. Further, although the contractor may require the employer to establish a fund, there is always the risk that a poorly advised contractor may simply forget to do so. Should the employer himself then become insolvent, the courts will refuse to compel him to establish a fund, in view of the likely claims of other already secured or preferential creditors.

Of concern to both parties should be inadequacies in the drafting of these retention provisions, which have produced a substantial volume of case law. What precisely are the employer's rights of deduction from the fund while he holds onto it? Do these extend to set-off, claims for negligence and breach of statutory duty as well as to claims for common law damages and breach of contract? Why is it that JCT 80 seems to offer wide scope for deduction, whereas employers under JCT 81 may discover with horror that their ability to deduct liquidated damages is severely hampered? Obviously, the standard forms themselves can be carefully amended to provide the clarity which is currently lacking, but this is of little comfort to the industry as a whole, which produced the standard forms hoping to render such specific tailoring unnecessary.

Nor does deleting the offending provisions in the standard forms greatly assist, since a bewildering array of insolvency, trust and case law will intervene to dictate to the parties what they were unable to agree expressly, with potentially unforeseen and undesirable results for all concerned.

The Latham Report of 1994 sought to remedy these and other deficiencies. After lengthy consultations and cogitations, Latham produced his recommendations, designed to establish a new system within a statutory framework. The new Construction Act of 1996 came into force last year with barely a nod to the issue. Clearly, retention was felt to be a hot potato, which, after being juggled about the industry for some time was finally allowed to drop, perhaps to be re-heated (if you will forgive the analogy) in the microwave of recession, when people's minds were more concentrated.

There are alternatives to the retention system. What about retention bonds? Contractors will shy away from "on demand" bonds, and "conditional" bonds may not be acceptable to employers (who would have to establish default before drawing on the bond), but some form of compromise between the two could satisfy both parties' concerns. Would some kind of industry-wide insurance scheme provide a solution? Can we take lessons from overseas, where contractual retentions are dealt with differently?

I put these questions to my friendly contractor in the pub, who had no answers. However, we both agreed that until the industry re-visits Latham's recommendations, and either re-drafts the standard forms to provide adequate (but fair) protection to the parties, or dispenses with retention altogether, the whole issue is one which should be approached with great caution.

This article was first published in Marcfarlanes' Construction Press March 1999 issue.

Macfarlanes' Construction Press is intended to provide general information about developments which may be of interest. It is not intended to be comprehensive nor to provide any specific legal advice and should not be acted or relied upon as doing so. Professional advice appropriate to the specific situation should always be obtained.

If you would like further information or specific advice, please contact Tony Blackler.

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