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What happens when clients retain money – and go bust

Retentions can be more complicated than you think and contractors are concerned about whether the money is safe. By Hamish Lal

The concept of retention is well known but not well understood. The idea that the employer retains a certain percentage of the sums ordinarily due and payable to the contractor during the construction phase – and returns these only at completion – can appear to be outdated. It has caused many to focus on the solvency of the employer. 

The recession has forced many to focus on the exact mechanics of how retention is drafted to work and whether the retention pot is insolvency protected. In a three-part series I will explain how retention is meant to operate, how it works best, the legal and practical problems and offer some practical tips.

In construction and legal circles it is widely accepted that retention exists for the employer’s benefit as it is sum of money offering a safeguard against defective or incomplete work. The 3 per cent and 5 per cent figures are seen to represent the contractor’s profit margin – so that retention then acts as an incentive on the contractor to ensure completion and proper workmanship.

However, this orthodox thinking is up for challenge now that in a recession contractors are very concerned that unless the retention pot is ring-fenced as sums held in a trust, there are no safeguards to the contractor’s money in the event that the employer is insolvent. 

Put simply, express terms in the building contract or sub-contract should set out how the retention monies need to be stored and kept. The commercial battle is normally between the employer (wanting freedom to use the monies as cash flow) and the contractor (which wants to make sure the retention monies are protected in case of employer insolvency). 

The first and most simple point to understand is that unless the retention monies have actually been set aside in a formal trust then the contractor is not best protected.

Cases are rare but as Bodill & Sons (contractors) v Mattu (2007) shows even in the case of the standard JCT wording a mandatory injunction from the courts may be needed to force the employer to actually put the retention monies in a separate bank account, to ensure that a proper trust mechanism is established. 

Clearly, one needs to look at the exact wording to see if a trust is automatically established or whether funds need to be in a separate account. The latter is better since if the employer folds and despite the automatic trust has no funds the contractor is deprived of his 3 per cent or 5 per cent profit.

Next week we look at the problem of employers releasing the retention on time.

Hamish Lal is a partner at Dundas & Wilson

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