During the course of 2020, both the UK and Scottish Governments are carrying out consultations on cash retentions in the context of construction contracts. In the recent case of Dr Jones Yeovil Limited v The Stepping Stone Group Limited [2020] EWHC 2308 (TCC), His Honour Judge Russen QC analysed the operation of retention in JCT contracts. The judgment confirmed that the proper purpose of retention is to incentivise rectification of any outstanding defects, or as security for the loss incurred if they are not. In addition, the case provides a rare discussion regarding the principle of transferred loss.

The dispute

The claimant was a contractor, Dr Jones Yeovil Ltd (DRJ), which had been engaged under three building contracts to build ten assisted living units and refurbish a building into an additional unit (the “Works”) by the defendant property developer, Stepping Stone Group Ltd (SSG). The two contracts to build the units were in the form of the JCT Design and Build Contract 2005 (Revision 2 2009) as amended by the parties, while the contract to refurbish the eleventh unit was in the form of the JCT Minor Works Contract 2011, meaning DRJ had no design responsibility.

The development site was not owned by SSG; instead it was owned by Nynehead Care Limited (NCL), a wholly owned subsidiary of SSG. NCL retained ownership of the freehold common parts but subsequently disposed of the units on long leases.  

Practical completion of the ten assisted living units was achieved in 2011. However, there were various defects identified in the Works post-completion, including defective exhaust air heat pumps (EAHPs). The total withheld by SSG was £48,761.57 in terms of clause 4.18.3, which provided that half of 'the Retention Percentage ' (of 5%) may be deducted where practical completion had been achieved but a 'Notice of Completion of Making Good' had not been issued. In 2014, DRJ accepted a deduction of £9,280.40 in respect of a list of agreed defects.

DRJ issued its claim for £40,622.80 plus contractual interest on 6 February 2018 in respect of the balance of the sums retained and an outstanding VAT invoice. SSG sought set-off and served a counterclaim for £240,151.90.

Retention

SSG submitted various arguments in order to support its position that retention should not be released. These arguments can be summarised as follows:

  1. The balance of the retention only becomes payable as part of the sums due under the Final Statement under the contracts. Therefore, DRJ has no entitlement to payment if there is no Final Statement or, where a Final Statement has been issued but no Making Good Certificate has been issued and therefore the Final Statement has not become conclusive. 
  2. Even if there is a conclusive Final Statement issued, SSG is entitled to deduct losses caused by the alleged breaches of contract by DRJ.   
  3. The remaining 2.5% was “not an actual sum of money” and “not truly a retention.” SSG submitted that, whereas the first half of the retention became payable upon practical completion, the “second half ceases to be a retention because it does not become payable upon a further event.”

DRJ argued that the trigger for the release of the retention was not the issue of the Final Statement but rather the issue of the Making Good Certificate. DRJ relied on various cases to submit that (i) it was common practice in construction contracts that the first half of retention is released on practical completion and the second half is then released on the completion of the defects liability period (PC Harrington Contractors Limited v Tyroddy Construction Limited [2011] EWHC 813 (TCC)); (ii) retention cannot be held indefinitely (Relicpride Building Company Ltd v Cordara [2013] EWCA Civ 158, 147 Con LR 92); and (iii) DRJ became entitled to the payment of the retention when the Making Good Certificate ought to have been issued, even though the Contractor had failed to do so (Henry Boot Construction Ltd v Alstom Combined Cycles Ltd [2005] 1 WLR 3850.)

The judge accepted that DRJ had made good the design issue over the EAHPs by replacing them with ASHPs, and that the Making Good Certificates ought to have been issued no later than 24 May 2016. Therefore, he held that DRJ was entitled to proceed as if Making Good Certificates had been issued.

Further, the judge recognised that, while retention may be used properly as leverage to ensure that outstanding breaches are rectified, or as security for the loss incurred if they are not, it would be wrong to allow leverage to be exerted by withholding the whole of the retention, regardless of the true extent of SSG’s set-off against the debt it owed to DRJ. 

Transferred loss principle

The principle of transferred loss is where one contracting party (who has suffered no loss) can recover damages from a defaulting counterparty in respect of loss that has been suffered by a third party who is not party to the contract. It is a limited exception to the general principle that a claimant can only recover loss which it has suffered. The rationale underpinning the principle of transferred loss is to avoid a potential “legal black hole” where a party can avoid being held financially accountable for its breach because the other contracting party cannot show it has suffered the relevant loss directly.

The judge held that the key to avoiding this legal black hole relies on it being established that the parties to the contract were aware that third parties were to benefit from the proper performance of the contract and would likely suffer loss if there was a breach of contract. This is known as “the known third party benefit”, as identified by Coulson LJ in the case of BV Nederlandse Industrie Van Eiprodukten v Rembrandt Enterprises, inc [2019] EWCA Civ 596.

SSG submitted that its interest as employer under the three contracts enabled it to recoup the losses suffered by NCL or the leaseholders. However, the judge concluded that SSG could not benefit from the principle of transferred loss as SSG had deliberately and expressly excluded the Contracts (Rights of Third Parties) Act 1999 from applying to the contracts and also chose not to use the collateral warranties or the third party rights available in their standard JCT form. The parties effectively denied any recognition that the contracts were for the benefit of NCL or future leaseholders for the purpose of the transferred loss principle.

SSG’s counterclaim was dismissed in its entirety based on its submissions and the evidence presented. HHJ Russen QC found that DRJ was entitled to the sum claimed by it together with contractual interest from 7 October 2015 (the date that the last EAHP was replaced) to the date of the judgment. 

Conclusions

While the case was generally fact specific, it serves as a useful reminder that retention provisions should be carefully drafted to ensure that the parties are clear about how, and when, retention will be released. In addition, parties should be wary of the consequences of failing to issue certificates when they ought to, as interest may run from the date the certificate ought to have been issued.

In relation to the principle of transferred loss, the court will not recognise the existence of a black hole if the third party who benefits from contractual performance has its own, separate right of redress. In addition, where the parties positively disclaim any third party benefit, the courts will not override the parties’ express agreement and apply the principle of transferred loss. Therefore, care must be taken where the structure of transactions and contracts are concerned to identify those parties who may suffer loss even if they are not a party to the relevant contract and ensure that they have a suitable remedy in the event of a breach.

For more information please contact David Anderson or Jamila Archibald, specialists in our property and infrastructure disputes team, or your usual Shepherd and Wedderburn contact. 

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