When retentions cannot be retained – A cautionary tale

With the construction industry's downturn and prevalence of liquidations across the industry, security in construction contracts is front-of-mind for Principals and Contractors alike.

The High Court in Stevensons Structural Engineers 1978 Ltd (in liq) v McMillan Lockwood (PN) Ltd (Stevensons) has recently weighed in on the legality of retentions clauses in Subcontracts which tie release of retentions to completion of works under the Head Contract. The added twist in this case was that Stevenson was in liquidation and the liquidators had disclaimed the Subcontracts. The two Head Contractors wished to use the retentions they held to offset their losses arising from the liquidation and part-completed subcontract works.

The relevant clause in Stevensons specified that retentions would be released as follows:

(a) 50% would be released within 30 days of the completion of certain works under the Subcontract; and

(b) The remainder would be released within 30 days of the 'issue of a certificate of practical completion, or earlier, as detailed in the head contract'.

Associate Judge Skelton concluded that because the trigger for release of the second part of the retentions was contingent on Practical Completion under the Head Contract, the retentions clause was prohibited under section 18I(a) of the CCA. Section 18I(a) prohibits terms in construction contracts which make the payment of retention money conditional on something other than the performance of the party's obligations under the contract.

As the issue of practical completion under the Head Contract Works was dependent on matters other than the performance by the Subcontractor of its obligations, including that of the Head Contractor and a multitude of other subcontractors, it fell within the category of terms prohibited in s 18I(a).

The Court did not consider that the term breached s 18I(b) of the CCA, which prohibits terms that make the date on which payment of retention money is payable later than the date on which the party has performed all its obligations. This was because the defects liability period in the Subcontract, and the Subcontractor's obligation to remedy notified defects in its works, ran from completion of the Subcontract Works through to the end of the defects liability period in the Head Contract (which, in turn, continued for 12 months following the date of Practical Completion of the Head Contract Works). Accordingly, the retentions clause required the first part of the retentions to be released on Practical Completion of the Head Contract and the Subcontractor would not have performed its obligations under the Subcontract until 12 months after Practical Completion of the Head Contract Works (the date on which the Subcontract defects liability period ended).

Having found that the retentions clause was prohibited under s 18I(a), the provision was 'invalid and ineffective' and, as a result, the entire retentions regime in the Subcontract was of no legal effect. The Court considered that the retention regime was 'an indivisible whole' and the provision requiring release on Practical Completion of the Head Contract could not be severed from the balance of the retentions regime.

The Contractor was not entitled to withhold retentions at all under the Subcontract and, while the retention money trust in favour of the Subcontractor continued, the funds had been retained invalidly and the Subcontractor had a right to payment of those funds. The right to the retentions accrued prior to it being placed into liquidation and prior to the liquidators disclaiming the Subcontracts

This case makes clear that clauses which require release of retentions on Practical Completion of the Head Contract Works are contrary to s 18I(a).

But could there be a scenario where release of retentions was tied to the Head Contract but nevertheless be effective?

For example, if the release date had been the end of the defects liability period (12 months after Practical Completion of the Head Contract Works) rather than on Practical Completion of the Head Contract Works, would the result have been the same?

There are arguments either way. On one view, because the trigger date for the defects liability period is Practical Completion under the Head Contract (which is dependent on matters other than the Subcontractor's performance), the date the defects liability period ends is also driven by matters other than the Subcontractor's performance and it could be argued that we end up in the same place by a different route.

On another view, because the Subcontractor has an obligation to remedy defects during the defects liability period and release is to be once that obligation has come to an end, it could also be argued that the release is conditional on performance of the Subcontractor's obligations and does not offend s 18I(a). This issue was not considered by the Court because it did not arise on the facts.

In any case, it is a timely reminder for Contractors to exercise caution when adopting a clause that ties retention release under the Subcontract to the Head Contract in any capacity and to consider on a case by case basis whether such a clause may be found to be invalid. This is particularly important given the Court's conclusion that because one of the dates was unlawful, the entire regime was rendered ineffective.

Post script: what has happened to the retention money? It is being held on trust by the Head Contractors, but in circumstances where it never had a contractual right to deduct retentions. Accordingly, the Court has asked the parties to calculate the specific sums repayable together with interest. A further decision (summary judgment) will then be issued.