England and Wales Court of Appeal (Civil Division) Decisions

IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT OF JUSTICE
QUEEN'S BENCH DIVISION
(MR MICHAEL TUGENDHAT QC)

		Royal Courts of Justice Strand, London WC2A 2LL
		2nd April 1998

LORD JUSTICE MORRITT:

1. By his order made on l8th December l996 Mr Michael Tugendhat QC, sitting as an additional judge of the Queen's Bench Division, accepted the argument of the plaintiff ("the Works Contractor") that the sum of £22,695 held by the first defendant ("the Employer") was so held in trust for the Works Contractor. The Employer disagrees and appeals to this court.
2. The trust relied on arose from the provisions of two contracts entered into in July l989 for the purpose of the development of 20 Abbey Road, London, NW8 for and on behalf of the Employer. The first ("the Management Contract") was a contract made between the Employer and John Lelliott Management Ltd ("the Management Contractor") in the JCT Standard Form of Management Contract l987 Edition. The second ("the Works Contract") was made between the Management Contractor and the Works Contractor in the JCT Standard Form of Building Contract (Works Contracts/2) l987 Edition. The material provisions of the two contracts are set out in the Appendix to this judgment.
3. For present purposes it is sufficient to summarise the provisions of the two contracts. The Management Contract provided, as its name suggests, that the building project should be carried out by the Management Contractor in accordance with its terms by means of one or more sub-contracts called "works contracts". The Works Contract provided for the building works to be carried out by the Works Contractor in accordance with its terms. In each contract there was provision for payment on presentation of interim certificates and the retention from the sums so certified of various percentages as a retention fund, such fund to be held on trust.
4. Practical Completion was certified as having been accomplished on 9th August l990. Accordingly the defects liability period expired on 9th August l99l. The final account was agreed between the Employer and the Management Contractor in March l992. The defects inspection took place in December l992 and a Certificate of Completion of Making Good Defects was due when, in April l993, Administrative Receivers of the Management Contractor were appointed. The effect of that appointment was to determine the Management Contract. The loss to the Employer thereby sustained was certified by the Architect, in August l994, to amount to £659,672.
5. The Employer then held a retention fund amounting to £288,l66 which included the sum of £22,695 now claimed by the Works Contractor. By virtue of cl.4.8.l of the Management Contract the Employer held that fund "as trustee for the Management Contractor and for any Works Contractor". This had been confirmed to the Works Contractor on l0th December l99l when, having sought to operate the provisions of cl.4.8.3 of the Management Contract and cl.4.24 of the Works Contract, it received from the Management Contractor a copy of a letter from the Employer dated l3th February l99l confirming the details of the fiduciary account with Barclays Bank plc in which the retention fund was held.
6. The Employer claimed to be entitled to retain the whole of the retention fund by way of set-off against the liability of the Management Contractor to the Employer for the loss of £659,672. That claim was disputed insofar as it related to the sum of £22,695. The Works Contractor issued the writ in this action on l6th January l995 asserting that of the total retention fund the sum of £22,695 was held in trust by the Employer for the Works Contractor and so not available for set-off against a liability of the Management Contractor to the Employer.
7. In his judgment Mr Tugendhat described the point for his determination as a short point of construction

"whether the retention fund was held in trust for the plaintiff as to £22,695, and if so, whether the first defendant was entitled to deduct from the entirety of the retention fund or only that part of it in which they or the Management Contractors had a beneficial interest."

He then set out the relevant provisions of the Works Contract (clauses l-6, 4-l8, 4-l9, 4-23, 4-24, 4-29, 4-34 and 4-36) followed by those of the Management Contract (clauses l-5, l-7, l-l2, 2-l0, 3-2l, 4-l to 4-3, 4-6 to 4-8). He considered that the retention made under the Works Contract was not "money due or to become due to the Management Contractor" within the meaning of cl.4.3.2 of the Management Contract so as to entitle the Employer to exercise a right of deduction. There being in his view no express right of deduction and no room for such an implication he decided that the sum of £22,695 was held by the Employer in trust for the Works Contractor pursuant to cl.4.8.l of the Management Contract and cl.4.29 of the Works Contract.

8. The Employer contends that the judge was wrong. First, it is suggested that the judge fell into error because he read the agreements "bottom upwards" from the point of view of the Works Contractor rather than "top downwards" from the Employer's and, it is implied, the logical point of view. The suggested consequence is that he failed to appreciate that under the Management Contract cl.4.8 and the Works Contract cl.4.24 the interests of both the Management Contractor and the Works Contractor were defeasible upon the exercise of the Employer's right of recourse to the retention. With regard to the judge's conclusion that the money in the retention fund was not "money due or to become due to the Management Contractor" it is submitted that all retentions out of sums certified to be due under the Management Contract are, by definition, due to the Management Contractor.
9. This is disputed by the Works Contractor. It contends that sums certified as due under the Management Contract in respect of a works contract are not due to the Management Contractors. Reliance is placed on cl.4.6.l of the Management Contract. It is suggested that the consequence is that retentions in respect of sums due under works contracts are not within the provision for set-off contained in cl.7.4.4 of the Management Contract.
10. Provisions for retention funds have been considered in three reported cases to which we were referred, namely Rayack Construction Ltd v Lampeter Meat Co.Ltd [l979] l2 BLR 30; Re Arthur Sanders Ltd [l98l] l7 BLR l25 and Hsin Chong Construction Co.Ltd v Yaton Realty Co.Ltd [l986] 40 BLR ll9. None of those cases was decided on agreements in the same form as those in this case. Thus, as counsel recognised, none of them is of direct assistance. We were also referred to the decision of this court in Hermcrest v Trentham [l99l] 25 Con L.R. 78 for the proposition that clause 7.4.4 of the Management Contract conferred a right of set-off between the Employer and the Management Contractor. As that proposition was not disputed it is unnecessary to refer to that case any further.
11. In my view the proper approach to the problem is to start with the Management Contract. It does not stand alone but is the primary source for the obligations affecting the money emanating from the Employer. The prima facie result of construing and applying the Management Contract must then be traced through to the Works Contract for the two should be reconciled if possible.

The Management Contract

12. By clause 4.l the Employer is to pay the Management Contractor in accordance with the provisions of clause 4.l to 4.l2 the Prime Cost of the Project, ascertained in accordance with the second schedule, and the management fee. Under the second schedule the Prime Cost includes the amounts due and payable under the works contracts. Payment to the Management Contractor is to be in accordance with the system of certificates laid down in clauses 4.2 (times for certificates), 4.3 (times for payment) and 4.4 (valuations). By clause 4.6.l the amount to be stated in the interim certificate is to include "the amounts due and payable under the respective works contracts...after deduction of any retention deductible in accordance with the works contract". The retentions authorised to be made by the Employer are limited by clause 4.7 to the specified percentage of the sums referred to in clause 4.6.2. But those sums do not include sums due under the works contracts for they are ascertained in accordance with part 2 of the second schedule not any of the parts of that schedule prescribed by clause 4.6.2. There is no provision specifically dealing with the release of the retentions authorised by clause 4.7. The requirement and authority for such release is to be implied into clause 4.7 as being the converse of the authority to retain which is express. Thus half of the 3% is to be released at practical completion to be certified in accordance with clause 2.4 and the remaining half on the issue of a Certificate of Completion of Making Good Defects in accordance with clause 2.6.
13. It follows, as the judge observed, that until clause 4.8 becomes operable retentions made under the works contracts are dealt with separately from those made under the Management Contract. However clause 4.8 lays down the rules which follow to "the Retention including that held in respect of all Works Contracts". Clause 4.8.l prescribes that the Employer's interest in the Retention "is fiduciary as trustee for the Management Contractor and for any Works Contractor.." Clause 4.8-2 and -3 confirm that the beneficial interests in the retentions made under the Management Contract and the Works Contracts respectively are different; otherwise there could be no point in specifying the separate retentions for which those sub-clauses make provision.
14. Thereafter clauses 4.9 and 4.ll make provision for that part of the prime cost attributable to the works contracts to be ascertained for the purpose of inclusion in the final certificate to be issued pursuant to clause 4.l2. Thus the certificate to be issued in accordance with clause 4.ll will include sums equivalent to the works contract retentions which were excluded from the previous interim certificates. But by then, namely after the issue of the Certificate of Completion of Making Good Defects, the works contract retentions will have been released because the authority to retain them conferred by clause 4.23 of the Works Contract, which corresponds to clause 4.7 of the Management Contract and is referred to in paragraph l5 below, will have lapsed. The certificate issued under clause 4.l2 will prescribe as due by the Employer to the Management Contractor as a debt the total of the prime cost, that is without deduction for any retention. But that does not mean that the retentions already made under the works contracts and held in trust are sums due by the Employer to the Management Contractor.

The Works Contract

15. The system of payment under interim certificates is different under the Works Contract to that prescribed for the Management Contract. Thus the amounts to be directed in interim certificates, as provided for by clause 4.l8, are elaborate and comprise items to be included in the amount and others to be deducted. But that clause makes plain that retentions, as provided for by clause 4.23, on the amounts set out in clause 4.24 are not to be included in such a certificate. Not all such items are subject to retention as clauses 4.l9 to 4.22 make plain. The right of deduction from sums due is given by clause 4.23 to the Management Contractor though the right of retention is conferred on the Employer. Thus the deduction is notional for the amount of the retention will have remained in the hands of the Employer. As in the case of the Management Contract the requirement for the release of such retentions is to be implied into that clause as the converse of the right to retain. By clause 4.24 the rules as to retention contained in clause 4.8 of the Management Contract are to apply. Thus, as it seems to me, the circle is completed. The sum deducted by the Management Contractor from sums due under the Works Contract are retained by the Employer on trust for the Works Contractor under clause 4.8.l of the Management Contract. If there were any doubt about the matter clause 4.29.l makes it plain that any interest the Management Contractor might have in the works contractors retention is fiduciary and held as trustee for the Works Contractor.
16. The right of set-off against the retentions made under the works contracts is, by clause 4.33, conferred on the Management Contractor, not the Employer. The implication in the Works Contract of any further rights of set-off would be, as the judge observed, impossible in view of the provisions of clauses 4.35 and 4.36.

Conclusion

17. The issue is, as the judge observed, whether the provisions of clause 4.3.2 of the Management Contract entitle the Employer to have recourse to that part of the retention fund as represents a retention made by the Management Contractor pursuant to the Works Contract. That depends in turn on whether such part of the retention fund as represents retentions made by the Management Contractor under the Works Contract may be regarded as "monies due or to become due to the Management Contractor".
18. Though the Management Contract and the Works Contract are both detailed and complicated the overall effect is, in my view, clear. The sums deducted by the Management Contractor from the sums due to the Works Contractor and retained by the Employer pursuant to clause 4.23 of the Works Contract and clause 4.8.l of the Management Contract were never due or payable by the Employer to the Management Contractor.
19. Down to the date of practical completion there were two parallel provisions for retentions, namely the retentions under the Management Contract pursuant to and in respect of the items specified in clause 4.6.2 and the retentions under the Works Contract pursuant to and in respect of the items specified in clause 4.23. The latter retentions never had been money due to the Management Contractor for they were specifically excluded from the interim certificates to be issued under clause 4.6 of the Management Contract. From the time the respective retentions were made they were held in one fund by the Employer in trust in the amounts of the respective retentions for the Management Contractor and the Works Contractor pursuant to clause 4.8.l of the Management Contract.
20. After practical completion the Management Contract retentions did become due by the Employer to the Management Contractor for the authority to retain them ceased at that stage and at the later stage of the Certificate of Completion of Making Good Defects. Thus the right of set-off of the Employer under clause 7.4.4 was exerciseable against those retentions. But in my view it is clear that such right was never exerciseable against the Works Contract retentions. Those retentions had not been and never became money due to the Management Contractor. They were held by the Employer in trust for the Works Contractor. By the time for the preparation of the interim certificate prescribed by clause 4.ll of the Management Contract the Works Contract retentions should have been released because the authority to retain them had lapsed pursuant to clause 4.23. In that event clause 4.3.2 could not be applied for the Employer would no longer hold the retention. But if for some reason the Certificate of Completion of Making Good Defects had not been granted at the time when the certificate required by clause 4.ll was prepared it would make no difference. At all times since the Works Contract retentions had been made they had been held by the Employer in trust for the Works Contractor. The interim certificate required by clause 4.ll could not operate so as to make the Works Contract retentions due to the Management Contractor rather than the Works Contractor.

2l. In my view the judge reached the correct conclusion. I would dismiss this appeal.

LORD JUSTICE ROBERT WALKER: I agree.

LORD JUSTICE STUART-SMITH: I also agree.

Order: Appeal dismissed with costs;

application for leave to appeal

to the House of Lords refused.