Case Update: Federal Court Decides that Retention Sum in a Construction Contract is Not Held on Trust

The Federal Court in the Pembinaan Legenda case has decided on significant areas of law on whether retention sum monies under a construction contract are held on trust. There was uncertainty in light of two conflicting Court of Appeal decisions in Qimonda and Pembinaan Legenda.

In its grounds of judgment dated 13 March 2019, the Federal Court has held that there is no implication at law of retention sum monies being held on trust. The creation of a trust depends on the construction of the contractual terms and also the separation of the monies into a trust account.

Background Facts

Pembinaan Legenda Unggul Sdn Bhd (Pembinaan Legenda) was the main contractor at the time. Pembinaan Legenda had engaged the two sub-contractors to carry out certain works. The terms of the sub-contract provides that each and every payment for interim claims is subject to a 10% retention sum up to a maximum limit of 5% of the sub-contract price.

Pembinaan Legenda failed to eventually release the retention sum and it became insolvent. Pembinaan Legenda was placed into creditors’ voluntary winding up. Pembinaan Legenda classified the retention sum monies owing to the two sub-contractors as essentially unsecured debts. On the other hand, the two sub-contractors took the position that the retention monies were held on trust.

Therefore, it would be a question of whether the two sub-contractors would have their claim as unsecured claims to be dealt with pari passu with the other unsecured creditors. Or could the two sub-contractors have those monies as trust monies and they would have to be paid the retention sum in full, and ahead of the other unsecured claims.

At the High Court, the two sub-contractors succeeded in their arguments on the trust claim. They relied on the Court of Appeal decision in the Qimonda case. At the Court of Appeal, the Court departed from the Qimonda case.

In summary, the Federal Court then addressed the following questions of law below.

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 (retention) sum are met:

(a) is it implied by law that the retention sum is to be held in trust by the employer for the benefit of the contractor;

[The Federal Court answered this in the negative. There is no implication by law of a trust.]

(b) 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?

[The Federal Court answered in the affirmative. Hence, it is a matter of construction of the contractual terms.]

2. 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 answered in the negative. Hence, for the trust to be constituted, the employer would have to set aside the money as a separate trust fund.]

The Reasons for the Decision

The Federal Court first considered the English law position. The standard-term building contracts of the United Kingdom contain a term that the employer undertakes to hold the retention sum on trust for the contractor. The employer has to appropriate and set aside as a trust fund the amount of retention money withheld. If this is successfully done, the contractor’s claim to the retention money takes priority over the employer’s general creditors in the event of the employer’s insolvency.

But where the employer went into liquidation without having set aside the retention money as a trust fund, the question of trust does not arise.

The position in Scotland was also similar to the above English law position.

The Federal Court affirmed the Court of Appeal approach and disagreed with the approach in Qimonda. The retention sums in this case could not be said to be subject to a trust.

First, this is due to the absence of express contractual words or conduct of the parties suggesting a trust had been intended. Thus, the element of certainty of intention to constitute an express trust failed.

Second, the source of the trust property from which the retention sums may be derived was not identifiable. Pembinaan Legenda had not taken any steps to segregate the retention sums that might then indicate that the retention sums should be considered as trust monies. Hence, there was no certainty of subject matter.

The Federal Court was conscious of the risk to contractors and sub-contractors if the employer were to slip into liquidation. Retention sums would then just be mere unsecured claims. Similar reforms like in the UK, Australia and New Zealand would have to be considered. For instance, enacting legislation to enable retention sums to be placed in authorised deposit-taking institutions such as banks. Another solution would be to legislate that retention sums should be deemed as trust monies.

 

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