What happens to cash retentions if the contractor goes bust and there is no provision in the contract stating that the money was to be held in trust?

Rudi Klein

Together with her husband, Di Johnson runs a successful and highly reputable electrical contracting business in Cheshire.Recently Di had a shock. One of her main contractors, Globe Management Services Ltd, went into insolvency owing her cash retentions totalling £56,000. Luckily Di was able to weather this loss - it would have put some other SMEs into insolvency.

Di’s reaction was: “This is my money and I have not given permission for the insolvency practitioner to hand it over to Globe’s creditors. It should be returned to me.”

The problem was that Di’s view was not supported by the English cases on retentions.  These have generally dealt with the situation where there were express contractual provisions stating that the money was to be held by the recipient in trust and, as such, had to be deposited in a separate and independent bank account. The upshot of these cases was that this protection was lost in the event that the retentions had not been placed in a separate account prior to the insolvency of the recipient of the money.

But then I remembered a Malaysian Court of Appeal case which had been brought to my notice by my friend Philip Harris, construction law partner at Wright Hassall. 

A trust can be implied even where there is no express provision that the money be held in trust. The fact that the money had not been segregated did not defeat the trust

This case was decided by the Malaysian Court of Appeal on 12 July 2011 (Qimonda Malaysia SDN BHD - in liquidation - vs Sediabena SDN BHD).

Interestingly the court placed some reliance on an English case, Re Kayford Ltd (1975: WLR 279). Re Kayford was not referred to in the English retention cases. Mr Justice Megarry held that customer payments made to a mail order company were held in trust by the company. The company had intended to place the money in a segregated account but had not done so prior to its insolvency. The judge held that, since the money was held in trust, the company’s customers had the right to be paid their money in preference to its creditors. Furthermore he held that there was no need to use words such as “trust” if the substance of the transaction was that a trust was intended. The decision was upheld by the Court of Appeal in Re Chelsea Cloisters Ltd (1981). 

In the Malaysian case there was no contractual requirement to place retentions in trust. The client had gone into insolvency. Its general funds exceeded the outstanding retention money. The court held that the money, “by [its] very nature and purpose”, was trust money.  The contractor had not intended to give absolute ownership of the money to the client. It was handed over only on condition that it was to be released unless used to defray the cost of remedying defects.

The judgment is a model of clarity and logic.

A trust can be implied even where there is no express provision that the money be held in trust. The fact that the money had not been segregated did not defeat the trust. Therefore the client’s liquidator would be required to release the money to the contractor before any distribution to creditors.

Trust law is an aspect of equity - a body of rules originally developed to lessen the rigidity of the common law. One of the maxims of equity is: “Equity looks to the intent rather than the form.”

In the Qimonda case the court made clear that retention money had already been earned by the contractor for works carried out:  “[…] the whole purpose of what had been done had been to ensure that the monies remained in the beneficial ownership of the [contractor]; and a trust is the obvious means of achieving this.”

So, here’s my advice. Write to your client/contractor insisting that your retention money is trust money and must be placed in a segregated account. 

If this is not done, refer the matter to adjudication. Ask the adjudicator to decide that the money be placed in a segregated account.  This would, of course, be worth the effort if your retention pot was a large one and you had concerns about the financial stability of the other party.

Professor Rudi Klein is a barrister and CEO of the SEC Group