Retention Money and Insolvency: A Common Sense Approach?

The retention of a proportion of the contractor's fee is common practice in construction contracts. The parties sometimes agree (usually in unamended industry standard building contracts) that the retention amount is held on trust by the employer in a separate bank account. But what happens if there is no such express provision and the employer becomes insolvent?  

The position is not altogether clear. Previous case law has stated that no trust exists where retention money has not been set aside and that to imply a trust would give the contractor an unfair advantage over other unsecured creditors. By contrast, in another non-construction case it was held that money does not have to be set aside in a trust bank account for a trust to exist.

A recent decision of the Malaysian Court of Appeal (Qimonda Malaysia v Sediabena BLR [March 2012], part 2, 65) has taken a fresh look at the situation. The court tried to reflect the commercial reality, stating that the retention money was held on trust even though there were no express provisions to that effect. The court gave the following reasons for its decision:

• retention money by its very nature and purpose is trust money, held for the benefit of the contractor;
• it did not matter that the money was not set aside before the employer became insolvent;
• returning the retention money to the contractor did not give the contractor an unfair advantage over other unsecured creditors as the money did not belong to the employer in the first place; and
• to allow the money to become part of the assets of the employer on insolvency would unjustly enrich the other creditors.

Clearly, this decision is not binding in England, but its (arguably) common sense approach may influence the English courts in the future. Contractors would no doubt welcome a degree of certainty on this issue, especially in the current economic climate.