Ensuring employer's retention monies are protected

In this case there is a building contract where retention is to be deducted and retained by the Employer from interim payments made to the Contractor. The Contractor has heard rumours within the construction market that the Employer is having difficulty financing its construction projects. The Contractor fears that the Employer may go insolvent and is concerned he will be unable to recover his retention money.

Issue

The issue here is what steps can the Contractor take to ensure his retention monies are protected in the event of the Employer becoming insolvent?

Legal Principle

The principle here is that “the Employer’s interest in the retention money is fiduciary as trustee for the contractor" [1] . This puts E under obligation to keep the retention money in a separate trust fund. The purpose of this trust fund is to ensure the Employer cannot use the retention money to his own benefit. Additionally, if the Employer was to become insolvent, if the retention money was in a separate fund it would be protected from the liquidators.

Authority

There are several areas of authority that the Contractor should be aware of before deciding the action he should take. In the case of Rayack Construction v Lampeter Meat [2] retention was to be held at 50% over a defects liability period of 6 years. After six months of interim payments the retention had amounted to £356,000. There were concerns that Lampeter were encountering financial difficulty and Rayack went to the courts to try to protect its money.

The case of MacJordan Construction v Brookmount Erostin Ltd [3] is of particular importance here as it portrays a scenario where the Contractor will not be able to protect his retention money. Here Brookmount was a property developer who entered into a building contract where interim payments were subject to retention at 3%. No separate fund for the retention was set aside and when Brookmount experienced financial difficulty MacJordan sought to recover its retention money. As there was no separate fund, it was ruled there was merely a general bank account with no identifiable assets specific to the retention money. MacJordan was therefore unable to recover his money.

Resolve

In the Rayack case the court granted two injunctions. The first was that Lampeter had to set up a separate fund for the retention money and the second prevented improper use of the money in this fund. In his judgement Vinelott J [4] said “The Employer is protected by his right to retain a proportion of the sum certified…The Contractor is protected…against the risk that his claim for payment of monies retained by the Employer will similarly rank as an unsecured debt". Therefore both parties are protected from the others insolvency if retention is taken but put in a separate fund. Here the Moorcock principle was applied as the courts were willing to imply a term into the contract to ensure its efficacy.

Another area of authority here is Wates Construction v Franthom Properties Ltd [5] . Here the court granted injunctive relief sought by the contractor after the Employer failed to put retention monies in a separate pot. Bedlam LJ [6] ruled “the only way in which the interest of the beneficiaries in the retention fund could be safeguarded and preserved is if that fund is placed in a separate account and is not used for the purpose of the employers business"

In the MacJordan case, as there was no separate fund, it was ruled there was merely a general bank account with no identifiable assets specific to the retention money. MacJordan were therefore unable to recover their money.

Another example of where a contractor has been unsuccessful in protecting his retention money is the case of Henry Boot Building Limited v The Croydon Hotel & Leisure Company [7] . In this case no injunction was granted as the Employer was owed a higher amount in liquidated damages.

Decision

The authority above shows that there is a chance the Contractor can protect his retention money if he takes the right steps promptly. His first step should be to check with the Employer that the retention money has been put in a separate bank account. If this hasn’t been done the Rayack and Wates cases show that the courts will grant a mandatory injunction to ensure the retention money is protected. This is subject to two qualifications. The first is that an injunction will not be granted if insolvency proceedings have already commenced; hence the necessity to urgently seek this injunction. The MacJordan case highlights the consequences of failing to ensure the retention monies are kept in a separate account as once the Employer had entered insolvency it was too late to recover the money. The second is that the court will not grant an injunction against an employer who is making a claim against this retention money as seen in the Henry Boot case. Therefore the Contractor should immediately apply for the injunction to have the retention money placed in a separate account but must be aware that if insolvency proceedings have already commenced then he will be unsuccessful in his claim.

2)

Facts

C is the Contractor appointed by the Employer, E, under a standard building contract to construct a major private sector commercial development. A portion of the main contract work undertaken by C is described as the “Contractors Designed Portioned Work". Two years after the issue of the final certificate a portion of the external wall collapses causing damage to E and adjacent third parties. E seeks damages from C claiming a satisfactory result in design and construction has not been achieved. C concedes that it is obliged under an express term in the construction contract that it must use all care and skill in carrying out the design work but unless negligence can be proved cannot be held liable for E’s loss.

Issue

The question for the court to decide is whether C is liable for the losses suffered by E? If they are held liable then they will have to pay damages to E.

Legal Principle

The principle here is the “fitness for purpose" principle. This principle states that a contractor who takes on a design and build contract will not just ensure the quality of the goods but also ensure that the design they provide will be fit for the purpose intended. If a contractor takes on a portion of the design work these works are treated as the equivalent of a design and build contract. Therefore rulings from design and build cases can be applied to our case facts.

Authority

The leading area of authority on this topic is IBA v. EMI and BICC [8] as the case facts appear similar. In this case EMI was the main contractor for the design and construction of a broadcasting mast in Yorkshire. BICC was a nominated sub-contractor. Three years after construction the mast collapsed in icy weather conditions. IBA claimed damages against EMI and BICC.

Another area of authority is Viking Grain Storage v. TH White Installations [9] . In this case White was the contractor who entered into a contract to design and build a grain storage facility for Viking Grain. The installation later proved to be defective and Viking Grain sought damages. White claimed that it had a duty to use care and skill in the design and use good quality materials but no more. Viking Grain argued that White was obliged to use good quality materials but also to provide a facility that was fit for purpose.

Another case, Greaves & Co Contractors Ltd v. Baynham Meikle & Partners [10] can be used as authority. Greaves was the contractor on a design and build job for an oil storage warehouse. Baynham Meikle was sub-contracted as the structural engineer for the works. The design from Baynham did not allow for vibrations caused by fork lift trucks which subsequently caused a failure to the concrete floor. The client held Greaves liable who sought to recover the damages from Baynham.

Resolve

In the IBA case the House of Lords held that EMI was liable for the quality of the design and construction of the mast. BICC were held to have been negligent in their design of the mast, EMI could be held liable for this negligence as BICC were part of EMI’s contractual chain. It is likely that an implied term to provide a mast that was fit for purpose would have been granted but this was unnecessary because of negligence from EMI and BICC. In his ruling Lord Scarman [11] said “I see no reason why one who in the course of his business contracts to design, supply and erect a television aerial mast is not under an obligation to ensure that it is reasonably fit for the purpose for which he knows it is intended to be used"

In the Viking Grain case the contractor was again held liable for his design and was therefore liable for damages. White had known the purpose of the proposed facility and Viking Grain had relied on White to provide a facility fit for purpose. Judge Davies [12] ruled “The virtue of an implied term of fitness for purpose is that it prescribes a relatively simple and certain standard of liability based on the reasonable fitness of the finished product...In my view such a term is to be implied into this case" As such there was an implied obligation that White’s installation would be fit for its intended purpose. As this was not the case they had committed a breach of contract and Viking Grain was entitled to damages. That they had used reasonable care and skill did not satisfy the courts.

In the Greaves case it was held that Baynham were liable for their defective design. Baynham had been negligent and therefore could be held liable, however even without this negligence they had a duty to provide a design which was fit for purpose. As their design was considered inadequate Greaves was entitled to claim damages from them. Lord Denning [13] made an analogy with going to the dentist saying “when a dentist agrees to make a set of false teeth

for a patient, there is an implied warranty that they will fit his gums".

Decision

Based on the authority above it appears that E should be successful in its claim against C. As in the IBA and Viking Grain cases there will be an implied warranty that C would provide a design that works. It seems likely that E had relied on C’s skill and judgement for its design of the wall, which means they had to provide design that was fit for purpose. As a portion of the wall collapsed it is clear this design has not been fit for its intended purpose. Therefore C has committed a breach of contract. C’s claim that “unless negligence can be proved it will be not be liable" is irrelevant. The Greaves case highlights how fitness for purpose, not negligence is the key issue here.

5)

Facts

SC is undertaking piling work which is found to be defective four weeks after completion. Before remedial works were instructed there was a delay obtaining expert advice. In the total the delay amounted to 44 weeks which includes remedial works lasting six weeks. The architect refuses to grant an Extension of Time to cover the 44 weeks and E withholds £3.3million from C by way of liquidated damages. This figure consists of 44 weeks at a rate of £75,000 per week as stated in the contract particulars.

Issues

The issue for the court to decide is whether E is entitled to withhold the £3.3million as liquidated damages for the defective work. If E is not entitled to the liquidated damages, are there any damages that he is entitled to?

Legal Principle

The principle in this case is known as the prevention principle. This principle states that each party will not do anything to prevent or delay the other from performing it. This prevents owners from delaying the contractor in completing the works and then claiming liquidated damages for the delay.

Authority

The oldest area of authority on this topic is the case of Holme v Guppy [14] . Here the plaintiff, Holme, was constructing a brewery in Liverpool with liquidated damages specified in the contract at £40 a week. The project was scheduled to last four and a half months but there was a delay of four weeks before the Contractor was given possession of the site. There were further delays attributable to both the Employer and Contractor. At project completion the Employer sought liquidated damages from the Contractor.

Perhaps the leading area of authority for our case is Peak Construction v McKinney [15] . Here Peak Construction was the head Contractor employed by Liverpool Corporation to construct several high rise buildings. A fault was discovered in one of the piles and construction work was halted. Due to delays by the Corporation an expert was not called in for several months. The inspector recommended that remedial works commence straight away but these were not instructed for another two months. In total there was a delay of 58 weeks from the suspension of the works. The Corporation sought liquidated damages for the entire period from Peak, who in turn looked to recover the money from the sub-contractor, McKinney.

In Rapid Building v Ealing Family Housing Association [16] the contractor was 43 weeks late in finishing the project. Three weeks of delays could be attributed to squatters on one corner of the site resulting in the Contractor not being granted possession of the site. When the project wasn’t completed by the scheduled completion date the Employer sought liquidated damages from the Contractor.

Resolve

In the Holme v Guppy [17] case it was ruled the Employer was not entitled to liquidated damages. In the Court of Exchequer it was held that if a party is prevented by another party from completing the contract then he cannot be held liable for the delays. Parke B [18] Said “if the party be prevented, by the refusal of the other contracting party, from completing the contract within the time limited, he is not liable in law for the default."

A similar ruling was found in the case of Peak Construction v McKinney [19] . The sub-contractor did not have to pay liquidated damages to the contractor because the contractor had not been liable for them in the first place. The contract made no provision for extension of time being granted due to the Employers failure to instruct remedial works. Since time could not be extended there was no date from which liquidated damages could commence. In his judgement Lord Salmon [20] said “I cannot see how, in the ordinary course, the employer can insist on compliance with a condition if it is partly his own fault that it cannot be fulfilled." It was ruled the contractual completion date no longer applied and the Contractor was obliged to complete within a reasonable period. Effectively, time was “at large".

In the Rapid Building Group case it was again ruled that the Employer could not claim liquidated damages where he was partly responsible for the delay. Stephenson LJ [21] ruled “no counter-claim for liquidated damages under clause 22 of this contract can succeed. If the employer is responsible for any delay... it cannot be reasonable for him to have completed the works on the completion date."

Decision

Based on the areas of authority above it appears that the Contractor will not be liable to pay liquidated damages to the Employer. The delay in obtaining the expert appears similar to the facts in Peak Construction v McKinney [22] . Part of the delay can be attributed to the Employer. It appears from the facts that the contract does not permit an Extension of Time for the Employer’s failure to instruct remedial works. As time cannot be extended there is no date from which liquidated commences can commence. Instead time will be set “at large" and the Contractor will be obliged to complete within a reasonable period. The Employer will be able to claim for any damages that the court considers unreasonable.

Section 2 – Case Notes

Blue Circle Industries v. Holland Dredging Co (1987) 37 BLR 40

Variation-Separate Contract-Scope of Original Contract Works-Original Contract Terms

Case Facts

The plaintiff entered into a contract with Holland Dredging for dredging works. The contract stated that the dredged material was to be dumped in areas agreed by the local authority. Local opposition was high and therefore the scheme had to be changed. It was decided that the dredged material could be used to create an artificial bird island. The construction of this island was not fully successful and Blue Circle sought damages for negligence, breach of collateral warranty and misrepresentation.

Issues

The issue that the courts had to decide was whether the additional works were a variation or a separate contract in their own right? If they were only a variation then the claim would be subject to the original contract terms. However, if it was ruled to be a separate contract then the claim would be governed by new terms.

Legal Principle

The principle here is known as the cardinal change principle established in Thorn v Mayor and Commonalty of London. [23] This established that if additional instructed work was so different from what a reasonable person would have counted on then the works would be governed by a separate contract.

Judgement

The Court of Appeal held that the construction of the bird island was beyond the scope of the original contract works and therefore was subject to an additional agreement. Holland Dredging would not be obliged to accept the works as a variation. In his speech Purchas L.J. cited the ruling in Thorn v Mayor and Commonalty of London [24] . In this case Lord Cairns [25] ruled if “additional or varied work were so peculiar, so unexpected and so different from what any person reckoned or calculated upon" it would be governed by a separate contract.

Subsequent Case

In McAlpine Humberoak v McDermott International [26] it was ruled that the additional works were a variation and therefore would not be subject to any additional agreement. McAlpine entered into a contract with McDermott to construct four steel pallets. The number of drawings increased from 22 to 161 and McAlpine claimed this caused delays to their construction work. Lloyd L.J [27] ruled that “the revised drawings did not transform the contract into a different contract". It remained a contract for the construction of four pallets and therefore the works could be considered as variations but not subject to any additional agreement.

Context in Commercial Management

The ruling in Blue Circle is significant because it makes clear what works can be considered a variation and what works will be subject to an additional agreement. A Commercial Manager preparing a claim that additional works should be subject to an additional agreement will need to be aware that the works will have to “different from what any person reckoned or calculated upon". If the works bear a relationship to the original contract works it is likely they will be deemed a variation. Of equal significance is that a contractor would not have to carry out any works that were “peculiar" or “unexpected" in the first place.

Philips Hong Kong Ltd v The A-G of Hong Kong (1993) 61 BLR 41 (PC)

Liquidated Damages-Penalty-Completion Date-Pre-Estimate of Loss

Case Facts

Phillips contracted with the Government of Hong Kong to carry out works for a system of roads and tunnels. The contractor was under obligation to meet key dates as well as the completion date. Failure to meet these key dates created a liability to pay liquidated damages. Phillips failed to complete works by one of the agreed dates and were subsequently charged liquidated damages. Phillips did not argue that the liquidated damages charge was extravagant. Instead they argued that the sum in question had no relationship with the owner’s true loss. The contractor argued that the liquidated damages clause (29) was void and that the sum amounted to a penalty.

Issue

The issue that the court had to decide was whether the figure in question counted as liquidated damages or a penalty clause. If the court ruled that it was a penalty then Phillips wouldn’t be liable.

Legal Principle

The principle here was that laid down in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co. Ltd [28] . This case laid down that as long as the stipulated sum in the contract is a genuine pre-estimate of the loss that was not unconscionable at the time of making it will be considered as liquidated damages and not a penalty.

Judgement

In the Privy Council it was held that the sum was liquidated damages not a penalty and therefore Phillips claim should be dismissed. That the figure was not a reflection of Hong Kong’s actual losses was irrelevant. At the time of making the contract it was a genuine pre-estimate of the loss which both parties had agreed to. In his verdict Lord Woolf [29] stated “arguments of this nature should not...divert attention from the correct test as to what is a penalty provision – namely is it a genuine pre-estimate of what the loss is likely to be?" Although this ruling was from a different jurisdiction it seems likely the ruling would be the same in the U.K.

Previous Case

The Phillips case applied the law established in Dunlop Tyre v New Garage Ltd [30] . Here Dunlop entered into a contract to sell tyres to New Garage. New agreed to pay £5 for every tyre they sold below the manufacturers listed price. New Garage subsequently sold tyres in breach of this agreement causing Dunlop to claim liquidated damages. In his speech Lord Dunedin [31] said “the essence of liquidated damages is a genuine covenanted pre-estimate of damage". As it was a genuine pre-estimate it was ruled to be liquidated damages and not a penalty.

Subsequent Case

In a subsequent case, Jeancharm Limited v Barnet Football Club Limited [32] it was held that charging an annual interest rate of 260% was not a genuine pre-estimate of the loss. Therefore it was deemed a penalty and not liquidated damages. However it is important to note that no construction case has ever followed such a ruling.

Context in Commercial Management

This case simplified the rulings on liquidated damages. Contractors who have been charged liquidated damages need to be aware that it is irrelevant if the amount seems extravagant or not a reflection of the Employer’s true loss. If at the time of drafting it was viewed as a genuine pre-estimate of loss then they will be liable to pay. As discussed above it seems unlikely a contractor will succeed in claiming the amount charged is extravagant or unconscionable.

Young & Marten Ltd v McManus Childs Ltd [1969] 1 AC 454; 2 All ER 1169; 9 BLR 77 (HL)

Construction Contracts-Product Liability-Warranty-Defective Products-Latent Defect-Fit for Purpose-Merchantable Quality

Facts

McManus Childs were developers for a housing estate who sub-contracted Young and Marten for the roofing works. Prior to works commencing McManus suggested that the roof tiles in the original quote should be changed. Young and Marten subsequently ordered the required roof tiles from the manufacturer but within twelve months they showed signs of damage due to a latent defect. The Employer began proceedings against McManus Childs who in turn brought in Young and Marten claiming liability should rest with them for supplying defective tiles.

Issues

The issue for the court to decide was whether the sub-contractor should be held liable for the defective roof tiles? Was there a contractual duty for the sub-contractor to use care and skill? Did the fact that the defect was latent and that no reasonable person would have spotted it satisfy the care and skill obligation?

Legal Principle

The principle here is that laid down in G.H. Myers & Co v Brent Cross Service Co [33] . This case highlighted that a party supplying materials warrants that the materials will be of good quality and fit for the purpose they are being used for.

Judgement

The House of Lords ruled that the sub-contractor should be held liable for the defective roof tiles he supplied. There were two types of warranty that could be implied under the Sale of Goods Act 1893. The first is that goods shall be reasonably fit for any purpose which the buyer makes known to the seller. The second is that the goods shall be of merchantable quality. The first implied term was excluded as it could not be said that the buyer had relied on the seller’s skill or judgement. However, the second warranty which was to ensure the products were merchantable still existed which led to the sub-contractor being held liable. Lord Pearce [34] ruled “employer's choice of Somerset 13 tiles, which were manufactured by only one firm, is not in itself sufficient to exclude the warranty of quality".

The court cited the ruling in G.H. Myers & Co v Brent Cross Service Co [35] where du Parcq J [36] stated “a person contracting to do work and supply materials warrants that the materials which he uses will be of good quality and reasonably fit for the purpose for which he is using them, unless the circumstances of the contract are such as to exclude any such warranty."

Relevant Case

In Gloucester CC v Richardson [37] the contractor was not held liable for the defective pre-cast concrete columns he had supplied. The contractor had been instructed by the Architect to use a specialist sub-contractor and therefore was bound by his terms. These terms included an exclusion of liability for its product. The courts held that if the supplier should be able to benefit from this then so should the contractor. This case was an example of circumstances that could avoid the two implied warranties discussed above.

Context in Commercial Management

The Young and Marten case holds great significance in a commercial management context. Suppliers have to ensure that goods are of merchantable quality, even if the product type has been specified by another party. They need to be aware that the law can imply a warranty that the materials will be of merchantable quality. If they are not of merchantable quality, he will be held liable, regardless of whether the defect is latent or not.

Peak Construction v McKinney (1970) 1 BLR 111

Building Contracts-Defective Works-Liquidated Damages-Time Limits

Facts

Peak Construction was the head contractor employed by Liverpool Corporation. McKinney was the nominated sub-contractor for the foundation works. In October 1964 a fault was discovered in one of the piles. Due to delays by the Corporation, an expert was not called in until February 1965. The expert reported in May 1965 that remedial works should be carried out immediately. However, these were not instructed until 30th July 1965. When remedial works finished there had been a delay of 58 weeks from the suspension of the works. The Corporation sought liquidated damages from Peak Construction, who in turn sought to recover these from the sub-contractor.

Issues

The question that the court had to decide was whether Peak Construction was entitled to recover the liquidated damages from McKinney?

Legal Principle

The principle in this case is known as the prevention principle. This principle states that each party will not do anything to prevent or delay the other from performing their obligation. This prevents owners from delaying the contractor in completing the works and then claiming liquidated damages for the delay.

Judgement

The Court of Appeal held that Peak Construction was not entitled to recover liquidated damages from McKinney, as they themselves had not been liable in the first place. The contract made no provision for extension of time due to the Employers failure to promptly instruct remedial works. Since time could not be extended there was no date from which liquidated damages could commence. Lord Salmon [38] said “I cannot see how, in the ordinary course, the employer can insist on compliance with a condition if it is partly his own fault that it cannot be fulfilled." The contractual completion date no longer applied and the Contractor was obliged to complete within a reasonable period. Effectively, time was “at large".

Previous Case

One of the oldest areas of authority on this topic is the case of Holme v Guppy [39] . The plaintiff was constructing a brewery in Liverpool and the project was scheduled to last four and a half months. There was a delay of four weeks before the Contractor was given possession of the site. The Employer sought liquidated damages against the Contractor for the delay but in the Court of Exchequer it was held they were not liable. Parke B [40] Said “if the party be prevented, by the refusal of the other contracting party, from completing the contract within the time limited, he is not liable in law for the default."

Subsequent Case

Gaymark Investments v Walter Construction Group [41] is a case from a different jurisdiction but there seems no reason why the ruling would not be applied in the U.K. Walter entered into a contract with Gaymark for a construction project in Darwin, Australia. Walter were to give 14 days notice of any delay, a failure to do so would result in no extension of time being granted. Walter were delayed in completing the works by Gaymark but failed to comply with the stipulations. It was held Walter was not liable to pay liquidated damages as the contract failed to provide for a situation where the Employer delayed the works and Walter failed to notify. The obligation to complete by the end date fell away and the Contractor was instead obliged to complete within a reasonable time.

Context in Commercial Management

In a commercial management context this case is of great significance when dealing with liquidated damages. A Commercial Manager dealing with a liquidated damages claim will have to be aware that his party will lose the right to claim liquidated damages if the delay can be attributed to that party and there is no provision in the contract for an extension of time for that event.

Table of Cases

Case

Citation

Blue Circle Industries v. Holland Dredging Co

(1987) 37 BLR 40

Dunlop Pneumatic Tyre Co. Ltd v New Garage and Motor Co. Ltd

[1915] AC 79 (HL)

Gaymark Investments v Walter Construction Group

[1999] NTSC 143

G.H. Myers & Co v Brent Cross Service Co

[1934] 1 KB 46.

Gloucester CC v Richardson

[1969] 1 AC 480; [1968] 2 All ER 1181 (HL)

Greaves & Co Contractors Ltd v. Baynham Meikle & Partners

[1975] 1 WLR 1095; 3 All ER 99 (CA)

Henry Boot Building v Croydon Hotel & Leisure Co

(1986) 36 B.L.R. 41

Holme v Guppy

(1838) 3 M&W 387)

IBA v. EMI and BICC

(1980) 14 BLR 1 (HL)

Jeancharm Limited v Barnet Football Club Limited

[2003] EWCA Civ 58

MacJordan Construction v Brookmount Erostin Ltd

(1991) 56 BLR 1 (CA)

McAlpine Humberoak v McDermott International

(1992) 58 BLR 1 (CA)

Peak Construction v McKinney

(1970) 1 BLR 111

Philips Hong Kong v. AG of Hong Kong

(1993) 61 BLR 41 (PC)

Rapid Building v Ealing Family Housing Association

[1984] 29 BLR 5 CA

Rayack Construction v Lampeter Meat

(1979) 12 BLR 30

Thorn v Mayor and Commonalty of London

(1876) 1 App Cas 120

Viking Grain Storage v. TH White Installations

(1985) 33 BLR 103, 3 Con LR 52

Wates Construction v Franthom Properties Ltd

(1991) 53 BLR 23

Young & Marten Ltd v McManus Childs Ltd

[1969] 1 AC 454; [1968] 3 All ER 1169 (HL)