Retention Sums – Is It Really Yours?

Tatvaruban explains a landmark decision on retention sums in construction contracts.
Retention sums are usually provided in construction contracts to be withheld by the employer from the sum otherwise certifiable to the contractor. It serves to safeguard the employer against possible defects or non-completion of works on the part of the contractor.
In SK M&E Bersekutu Sdn Bhd v Pembinaan Legenda Unggul Sdn Bhd & Another Appeal [2019] 4 CLJ 590, the Federal Court decided on the issue as to whether retention sums under a construction contract are held on trust by the employer for the benefit of the contractor.
This decision concerned two appeals that arose out of common issues of law in respect of actions brought by two different plaintiffs against the same defendant. The cases relating to these appeals were heard together before the High Court and Court of Appeal. Each court rendered one judgment respectively.
The facts are similar in both appeals. Pembinaan Legenda Unggul Sdn Bhd (“Respondent”) had engaged Geohan Sdn Bhd and SK M&E Bersekutu Sdn Bhd (“Appellants”) to carry out sub-contract works in relation to two different projects. The Appellants completed their works and the respective certificates of practical completion were issued by the architect. Both the sub-contracts contained a clause which provided for the deduction and release of the retention sum. Despite the expiration of the defects liability period and legal demands from the sub-contractors, the Respondent failed to release the retention sum.
On 2 November 2015, the shareholders of the Respondent passed a special resolution for the voluntary winding up of the Respondent. Based on the Respondent’s statement of affairs as at 8 October 2015, there were about 250 creditors, out of which 128 were creditors claiming retention sums. The total amount owed to creditors for retention monies was RM8,230,087.61. This included the amounts owed to the Appellants. The Respondent did not open any separate bank account for the retention monies including the amounts owed to the Appellants.  
Relying on the decision of the Court of Appeal in Qimonda Malaysia Sdn Bhd (In Liquidation) v Sediabena Sdn Bhd [2012] 3 MLJ 422 (“Qimonda”), the High Court held that the retention sums were being held on trust by the Respondent. The basis of such a finding was that while there was no express clause providing for the creation of a trust over the retention monies, a trust could still arise due to the fact that there was a provision for the release of the retention monies upon the completion of any rectification work on any defects and no notice was received from the Respondent requiring any defects to be rectified.
The Court of Appeal reversed the decision of the High Court and held that there could not be a trust because of the lack of an express clause or clear conduct from the parties, as well as the fact that the retention monies were never segregated.   
The Court of Appeal took the view that a trust cannot be implied purely from the nature and purpose of retention monies per se, and that the concept of a trust is not inherent in the use of the word “deductions”. It went on to hold that most construction contracts do not operate via a trust, unless otherwise expressly stated. The Court also observed that there is no general proposition of law in a building contract that retention monies are, as a rule, held by way of trust between an employer and a contractor. The Court of Appeal’s decision is reported in Pembinaan Legenda Unggul Sdn Bhd (In Creditor’s Voluntary Liquidation v SK M&E Bersekutu Sdn Bhd [2018] 2 AMR 641 (“Pembinaan Legenda Unggul (CA)”).
Leave was granted to the Appellants to appeal to the Federal Court on the following questions of law:
  1. Where a building contract provides that a certain percentage of the certified sum for work done by a contractor is to be retained by the employer until the conditions for the release of the sum retained are met:
  1. is it implied by law that the retention sum is to be held in trust by the employer for the benefit of the contractor; or

  2. is it a matter of construction (interpretation of contract) whether or not the retention sum is to be held in trust by the employer for the benefit of the contractor?
  1. Where in a building contract there exists an agreement (whether arising by implication of law or upon construction of the contract) that the retention sum is to be held in trust by the employer for the benefit of the contractor, can the trust of the retention sum be constituted without the employer first appropriating and setting aside the money as a separate trust fund?
The Federal Court first considered the status of retention sums under English and Scottish law.
English Law
In the United Kingdom, the position in respect of retention sums is governed by standard-term building contracts which contain provisions whereby the employer undertakes to hold the retention sum on trust for the contractor. The Court used the JCT 1998 standard construction contract as an example where Clause 30.5.1 provides that, “the employer’s interest in the retention is fiduciary as trustee for the contractor and for any nominated sub-contractor”. The effect of such a provision is to impose upon the employer a personal obligation to appropriate and set aside as a trust the amount of retention money withheld. If this is successfully carried out, the contractor’s claim to the retention money would take priority over the employer’s general creditors in the event of the employer’s insolvency.
Where a solvent employer neglects to perform its obligation as required by such a clause, the contractor may apply for a mandatory injunction to compel the employer to set aside the retention sum in order to protect the contractor against the employer’s possible insolvency (Rayack Construction Ltd v Lampeter Meat Co Ltd (1979) 12 BLR 30 and Wates Construction (London) Limited v Franthom Property Ltd [1991] 53 BLR 21).
However, if the employer goes into liquidation without having set aside the retention monies as a trust fund, the question of trust does not arise as there is no res to which the trust can attach. Therefore, it is essential under English law that where parties have agreed for the retention monies to be impressed with a trust, for that trust to have been established before the employer’s insolvency. Otherwise, such monies will form part of the monies to be distributed pari passu in the winding up, and the contractor will be unsecured (Mac-Jordan Construction Ltd v Brookmount Erostin Ltd [1994] CLC 581 and Wilmot v Alton [1897] 1 QB 17).
Scottish Law
The position under Scottish law appears to be similar to the English position in that even if the contract provides a mechanism whereby the retention sums deducted are to be held on trust for the contractor, the mere existence of express terms is insufficient to create a trust without any other action (such as setting aside of the monies) by the employer (Clark Taylor & Co. Ltd v Quality Site Development (Edinburgh) Ltd 1981 SC 111 and Balfour Beatty Ltd v Britannia Life (1997) SLT 10).
Legal Principles on Retention Sums
After considering the positions in England and Scotland, the Federal Court summarised the legal principles on retention sums as follows:
  1. An agreement must employ sufficiently unambiguous terms to show that a trust is created with the contractor as beneficiary;

  2. While an explicit clause creating a trust may be of help, it does not mean that an absence of such a clause negates the existence of a trust;

  3. There is no presumption that monies held in a separate account must necessarily be held on trust;

  4. Each case depends on the specific intention of parties as expressed in the relevant construction contract; and

  5. Even where there is a fiduciary relationship between an employer and a contractor, not every fiduciary is a trustee. The nature and extent of a fiduciary’s duties are variable and depend on the circumstances in each case.
Departing from Qimonda
In departing from the Court of Appeal decision in Qimonda, the Federal Court observed that the Court of Appeal in that instance found that there was a trust of the retention sum despite the absence of an express trust clause in the contract and that there was no fund set aside before the liquidation of the employer, nor had the contractor requested for it.
The Federal Court noted that the Court of Appeal in Qimonda had relied on Re Kayford Ltd [1975] 1 All ER 604 for the proposition that it was not necessary to set aside money for the purpose of creating a trust. However, the Federal Court distinguished Re Kayford on the basis that the context of payment in that case concerned customers paying for their goods in advance whereas there was no such advance payment by the contractor in Qimonda but merely an agreement that the employer would release the retention sum to the contractor upon final correction of defects.
The Federal Court’s Findings
Based on a perusal of the evidence and after considering the legal positions set out above, the Federal Court took the position that there were no facts to support a finding that a trust was in existence. The Court noted that there were no express provisions requiring the retention sums to be held on trust with the employer as the fiduciary and there was also no clause mandating that the retention monies be kept separate from the assets of the Respondent. Accordingly, the Federal Court found itself unable to discern any clear intention or evidence that indicated that the retention monies should be accorded the status of trust monies.
For the reasons stated above, the Federal Court answered Leave Question (i)(b) in the affirmative and Leave Questions (i)(a) and (ii) in the negative and dismissed the appeals.
The Way Forward
The Federal Court acknowledged that its decision to depart from Qimonda exposes contractors and sub-contractors to high risks in the event of the employers going into liquidation. It was therefore suggested that legislative reforms be undertaken to address these risks. The Federal Court provided examples from various jurisdictions of measures taken to alleviate the risks for contractors and suggested that legislation be enacted to either mandate that retention sums be placed in authorised deposit-taking institutions such as banks or to declare retention sums as trust monies.
The Federal Court decision is welcomed as it puts an end to the uncertainty that arose from the conflicting decisions of the Court of Appeal on this issue in Pembinaan Legenda Unggul (CA) and Qimonda.
Arising from this decision, and until such time that legislative reforms are introduced to declare that retention monies withheld by an employer under a construction contract are trust monies, a contractor who seeks to establish a trust over retention monies must not only include provisions in the construction contract that not expressly create a trust over the retention monies in its favour but also take proactive steps to ensure that the employer deposits such monies into a separate trust account. The contractor must also exercise vigilance to ensure that the employer appropriates and sets aside the retention monies in a separate trust account while the latter is still solvent.
You may view the full issue of Skrine’s Legal Insights Issue 2/2019 here.