In Retention Sums, We (Do Not) Trust

Retention sums are monies deducted and retained by an employer (or main contractor) from sums otherwise payable to the main contractor (or subcontractor) under a construction contract, which will be released to the contractor once the conditions for release are fulfilled. It protects the employer against possibility of defective works on the part of the contractor.

The Federal Court in the recent decision of SK M&E Bersekutu Sdn Bhd v Pembinaan Legenda Unggul Sdn Bhd has confirmed that there is no general rule that all retention sums in construction contracts will be implied by operation of law to be monies that are held on trust for contractors or sub-contractors. A trust over the retention sums can only be created if:

  • there are clear terms in the construction contract for the creation of the trust; and
  • where the employer has segregated the retention sums into a separate account.

The mere deduction of retention sums does not manifest the parties’ intention to treat the retention sums as trust monies as security to secure the fulfilment of the contractor’s obligations.

The landmark ruling has effectively removed the presumption that an employer holds retention sums on trust for the benefit of the contractors – even where there are no clear terms in the contract to indicate the creation of such a trust.

This case overrules the previous Court of Appeal decision of Qimonda Malaysia Sdn Bhd (in liquidation) v Sediabena Sdn Bhd & Anor [2012] 3 MLJ 422 in which the Court ruled that a trust did exist, despite the absence of express clause or words to that effect in the contract and the non-segregation of the retention sums.

The Dispute

In the case of SK M&E Bersekutu Sdn Bhd v Pembinaan Legenda Unggul Sdn Bhd, Pembinaan Lagenda Unggul Sdn Bhd (“PLU”) was the main contractor in a construction contract who had employed two sub-contractors to complete certain works. Both the sub-contracts contained a clause which provided that PLU was to retain an amount of money from each interim payment received and release the retention sum to the sub-contractors when the conditions of release are met. PLU did not open any special account to hold the retention sums.

Eventually, PLU went under voluntary liquidation. The retention sums owing to the sub-contractors were classed as “unsecured debts” to be dealt with pari passu with the other unsecured creditors. The sub-contractors took the position that the retention sums were held on trust for them.

The Decisions of the High Court and the Court of Appeal

The issues raised in Court were, amongst others, as follows:

  • Whether the retention sums owed to the two sub-contractors would be dealt with “pari passu” with the other unsecured creditors, or
  • Were the retention sums held on trust for the sub-contractors to be paid in full later on?

The High Court, relying on the reasoning of the Court of Appeal in Qimonda, found in favour of the sub-contractors and decided that the retention sums were held on trust by the main contractor for the sub-contractors. The Court of Appeal in Qimonda had held that retention monies are by their nature and purpose trust monies held by employers as fiduciary to the trust for contractors and subcontractors, and there was no requirement for the retention monies to be kept in separate bank accounts.

However when this case proceeded to the Court of Appeal, the Court of Appeal declined to follow the principles laid down by the Court of Appeal in Qimonda. The Court of Appeal held that there was no implied trust merely because the contract contains provisions for retention sums to be held by the main contractor pending conditions for their release.

The decision of the Federal Court

The issue eventually reached the Federal Court where the following questions of law were posed:-

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 retention sums are met:

(a) Whether it is implied by law that retention sums are to be held on trust by the employer, for the benefit of the contractor? 

The Federal Court answered this question in the NEGATIVE: it ruled that there is no principle that retention sums are to be implied in law as to be held on trust by employers for benefit of contractors.

(b) Whether it is a matter of interpretation of contract terms if retention sums are to be held on trust by the employer, for the benefit of the contractor?

The Federal Court answered in the AFFIRMATIVE: it ruled that it is a matter of interpretation of contract when deciding if the retention sums are to be held on trust by employers for benefit of contractors. If the retention sums are to be impressed with trust, the contract should identify by clear wordings that the retention sums are to be held in trust, and that a requirement to keep the retention sums segregated from and unmixed with other monies of an employer is very much a significant indicator of the parties’ intention.

2. If and where there is an agreement that the retention sums are to be held on trust by the employer for the benefit of the contractor, can the trust of the retention sums be constituted if the employer does not first retain and set aside the retention monies under a separate account/trust fund?

The Federal Court answered in the NEGATIVE: it ruled that employers must set aside the retention sums in a separate trust fund account in order for a trust to be constituted.

Applying the legal principles to the facts of the case, the Federal Court held that the main contractor did not hold the retention sums on trust for the sub-contractors because:

  1. The contract did not contain any provisions requiring the retention sums to be held on trust by the main contractor as the fiduciary or mandating the retention sums to be kept separate from the assets of the main contractor.
  2. There was no clear intention or evidence of strong conduct from the parties that indicated the retention monies were to be accorded the status of trust monies.
  3. The main contractor did not take additional steps to segregate the retention sums that might indicate that the retention sums should be considered as trust monies.

What Next?

The Federal Court was aware of the risk that contractors will now face in light of the overruling of Qimonda, if an employer were to go into liquidation. The Federal Court cited other jurisdictions such as United Kingdom, Australia and New Zealand where similar issues arose, and reforms were made to address them. Echoing the Federal Court’s suggestion, the time is now ripe for legislative reforms to be undertaken in Malaysia, specifically providing for retention sums to be held by employers as trust monies or mandating retention sums to be placed in authorised deposit-taking institutions, like banks.

Practical Tips For Contractors/Sub-contractors

  • Ensure that there are unambiguous and clear wordings in the construction contract for:
    • the retention sum to be held on trust by the employer or main contractor (as the case may be)
    • a separate trust account is to be set up for the retention sum.
  • Write to the employer or main contractor at the beginning of the project to request the employer or main contractor to set up a separate trust account to place the retention sum.
  • Record the contractor’s or sub-contractor’s intention for the retention sum to be held on trust by the employer or main contractor in minutes of meetings or in correspondence.
  • Require the employer to confirm in writing that it had in fact deposited and kept the retention sums segregated in a separate trust account and unmixed with other monies of an employer, and make enquiries about the status of the retention sums periodically.

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By Muhammad Iqram Bin Zulkupri (view profile)
Associate , Azman Davidson & Co (General litigation)
+603 2164 0200 (ext no. 188)
muhammadiqram@azmandavidson.com.my

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