Scottish Court of Session Decisions

[1] In March 1991 Charles Brand Limited (hereinafter referred to as "the claimants") and Orkney Islands Council (hereinafter referred to as "the respondents") entered into a contract for various construction works to be carried out by the claimants at the new Ferry Terminals at Loth and Rapness in the Orkney Islands. The contract was subject to the I.C.E. Conditions of Contract, Fifth Edition (June 1973) (revised January 1979) (re-printed January 1986). Certain disputes arose and they were referred to the engineer, the Director of Engineering and Technical Services, Orkney Islands Council at various times during 1994 and 1995. However, the claimants were dissatisfied with certain of the decisions reached by the engineer and they were referred to arbitration by virtue of the arbitration clause in the contract. Mr. Christopher Ford, BSc Ceng FICE of 123 Elderslie Street, Glasgow accepted appointment as arbiter and a Joint Deed of Submission was executed by the claimants and the respondents.

[2] Work under the contract was carried out by the claimants, and the engineer issued monthly certificates of the amounts due to the claimants. In terms of clause 60(2) of the contract the sum so certified each month had to be paid by the respondents within 28 days of the date of delivery to the engineer or his representative of each monthly certificate.

[3] However, in December 1992 the respondents withheld payment of the sum of £165,485.84, which had been certified by the engineer. In January 1993 the respondents withheld the further sum of £51,324.51, which had been certified and in March 1994 they withheld the further sum of £64,070.17 which had also been certified. The total sum withheld by the respondents was £280,880.52. In the amended closed record in the arbitration the claimants averred that the said sum of £280,880.52 had been wrongly deducted by the respondents from monies certified in favour of the claimants by the engineer and in terms of Crave (Tenth) sought payment of that sum from the respondents. The respondents admitted that the sum in question had been deducted by them from monies certified by the engineer but averred that the claimants owed them a sum of the same amount in respect of a separate contract which the parties had entered into in terms of which the respondents had undertaken to supply stone and other services to the claimants. The respondents subsequently amended their pleadings and incorporated an averment that the claimants had been insolvent since at least 31 March 1994.

[4] In July 1997 the arbiter issued a Draft Award and, in relation to the claim made by the claimants in Crave (Tenth) relating to the withholding of the said sum of £280,880.52, and after hearing evidence, held that the claimants were "technically insolvent", and that the respondents were entitled to set-off the said sum. In his Note on Reasons for the Draft Award the arbiter found that the claimants had been insolvent since 31 March 1994 and he also found that the respondents were correct in withholding the sum of £280,880.52 as the claimants were "technically insolvent" in the absolute sense.

[5] The Draft Award was issued against the background that in February 1997 the respondents had raised an action in the Sheriff Court in Orkney for payment of the said sum of £280,880.52 which they alleged was owing to them by the claimants arising out of the contract for the supply by the respondents of stone and other services. That action had been sisted in March 1997 to await the outcome of the arbitration.

[6] The claimants requested the arbiter to state a case for the opinion of the Court of Session on the issue as to whether the respondents were entitled to withhold the disputed sum but they did not proceed with the stated case.

[7] Having issued his Draft Award the arbiter received representations on behalf of both parties and in September 1997, having considered those representations, he reiterated his finding that the claimants were technically insolvent and also found that the respondents had not liquidated their illiquid claim for £280,880.52. He decided not to issue a decree in respect of Crave (Tenth) pending (a) a motion by either party for further consideration of it or (b) evidence by the respondents of liquidation of their claim for the sum of £280,880.52 retained by them. It was accepted by both parties that the respondents' claim had remained illiquid since the Sheriff Court action raised in February 1997 had been sisted in March 1997.

[8] In February 1999 the arbiter issued a Final Part Award dealing with a number of the issues in dispute between the parties but excluding, at their request, the claimants' claim arising from Crave (Tenth) and expenses. The arbiter heard a debate in March 1999 and on 13 April 1999 he issued a Final Part Award (as amended) in relation to Crave (Tenth). He found that the claimants were then solvent and that the respondents had no right of retention of the sum which had been withheld from the claimants. He held that the respondents should pay the claimants the said sum of £280,880.52 once the claimants had provided a valid bank guarantee in respect of the claim made by the respondents under the separate contract for the supply of stone and other services. The arbiter observed that he had originally found that the respondents were entitled to withhold the sum of £280,880.52 as a matter of retention since the claimants were technically insolvent, but not as compensation since the respondents' claim was illiquid. Counsel for the claimants had accepted that the claimants had been in a position of absolute insolvency, in that their assets were less than their liabilities, as at 31 March 1994 but denied that they had been practically insolvent. However, they had now received an injection of capital from their parent company, which had returned them to a state of absolute solvency. The arbiter, having heard submissions from counsel for the parties, decided that because the claimants were now solvent the respondents no longer had a right to retain the sum of £280,880.52. The claimants sought interest on that sum but the arbiter deferred consideration of that matter until May 1999 when he heard the submissions of parties. On 9 June 1999 he found that the claimants were entitled to interest on the sums withheld as set out in Crave (Tenth) from the date when the sums were due, and that interest should be paid on each of the three withheld sums from the date of delivery of the relevant certificate under clause 60(2) until the date of payment. We were informed that the sum of £280,880.52 has been paid by the respondents to the claimants. In his Note giving his reasons for holding that interest was due the arbiter observed that his decision proceeded on the basis that the respondents had a right of retention, not a right of compensation. The sums had been retained against an illiquid debt which might at some time become liquid. The right of retention existed because the claimants were insolvent, but the right was only temporary while the respondents sought, or should have sought, to render the debt liquid. The sums withheld had been held by the respondents as security until such time as their debt became liquid or the claimants' financial circumstances changed whereupon payment by the respondents was due. There was no reason why the respondents should not have pursued their Sheriff Court action. However, the respondents' right of retention had come to an end when the claimants had become solvent.

[9] The respondents lodged a minute requesting that a case be stated, and the arbiter has duly stated the following question for the Opinion of the Court of Session:

[10] Clauses 60(2) and (6) of the I.C.E. Conditions of Contract, Fifth Edition (June 1973; revised January 1979) are in the following terms:

[11] Counsel for the respondents submitted that the arbiter had erred in law in finding that the claimants were entitled to interest during the period of retention. At the outset he accepted that the respondents' claim to be entitled to withhold the sums in question was based on their own claim for payment from the claimants arising from a quite separate contract and that the respondents' claim had all along been illiquid. As the claimants had not given any reasons for not paying the respondents' invoices, the respondents had originally believed that their claim was not disputed. However, in the early stage of the arbitration it became clear that the claimants were disputing the respondents' claims for payment. At that point the respondents sought to justify their continued retention of the money on the different basis that the claimants were insolvent, and the arbiter held that they did have a right of retention on that basis. The respondents were not now contending that they had had a right of compensation of debts at any stage. The arbiter had found that the respondents were entitled to retain the sums in question and although the claimants had requested a stated case with a view to challenging the arbiter's decision, they had not proceeded with that stated case. Accordingly, it was clear that the respondents had established that they had had a right of retention. In these circumstances the only issue before the court was whether the claimants were entitled to interest ex contractu during the period of retention.

[12] Counsel submitted that the reference in clause 60(6) to a "failure" by the employer to make payment should not be construed as meaning only non-payment but that a more qualitative test was applicable. It was not disputed that this had been a case of non-payment. However, it was submitted that the respondents' right of retention was based on the principle of balancing accounts in bankruptcy, and it was sufficient if the claimants were shown to have been insolvent. Reference was made to Gloag on Contract, page 626 and Ross v. Ross (1895) 22 R. 461 per Lord McLaren at pages 464-5. Counsel had been unable to find any authorities on the question as to the proper meaning to be given to "failure...to make payment" but there were cases which had considered what was meant by "failure" on the part of the engineer to certify (Nash Dredging Limited v. Kestrel Marine Limited 1986 S.L.T. 62 at page 64; Hall & Tawse Construction Limited v. Strathclyde Regional Council 1990 S.L.T. 774 per Lord President Hope at page 780 and Secretary of State for Transport v. Birse-Farr Joint Venture (1993) 62 B.L.R. 36 at page 57-59), and they indicated that it was appropriate to make a qualitative assessment of what the engineer had done. Further, counsel submitted that Farrans (Construction) Limited v. Dunfermline District Council 1988 S.L.T. 466 (at pages 470-1), while not dealing with the I.C.E. Conditions of Contract, was a case which had "the flavour of wrongful withholding". In this case the respondents had been found to have been entitled to retain the sums in question, and therefore to withhold payment, on the principle of balancing accounts in bankruptcy and, that being so, there had not been a "failure" on their part to make payment in terms of clause 60(6). They had thus not failed to make payment of sums which they had been found to be entitled to retain while the claimants were insolvent. Counsel made it clear that he was not submitting that there had not been a failure to pay during the period prior to the claimants becoming insolvent. On the whole matter the arbiter had not reached the correct decision and the question in the stated case should be answered in the affirmative. If, however, the court took the view that the arbiter had erred in awarding interest for the whole of the periods in question, but that interest was due in respect of a limited period or periods, then the question should be answered in the affirmative and the case remitted back to the arbiter to determine the period or periods in respect of which interest was payable.

[13] Counsel for the claimants accepted that, so far as the respondents' common law right of retention was concerned, there had been a period when the claimants had been absolutely insolvent (described by the arbiter as technical insolvency) and that a right of retention could arise even in a case of supervening insolvency. But the question in the present case was whether the right of retention affected the running of contractual interest under clause 60(6). Counsel submitted that, while the respondents had a common law right of retention during the limited period when the claimants were insolvent, their right of retention did not affect the running of interest in terms of clause 60(6). That clause provided that the claimants were entitled to interest if there was a "failure" by the employer to make payment in accordance with sub-clauses (2) (3) and (5) of clause 60 and "failure" to make payment meant non-payment of sums which had been certified by the engineer as being due to the claimants in terms of clause 60(2). In the present case the sums in question had been certified by the engineer as being due to the claimants and in terms of clause 60(6) the claimants were entitled to interest in these sums up until the date when they were paid. A failure to pay, and wrongful withholding of, sums due were quite separate and distinct concepts and in the present case it was not contended that there had been wrongful withholding of sums due to the claimants. None of the cases cited by counsel for the respondents was authority for the proposition that the exercise of a common law right of retention stopped the running of contractual interest, as opposed to interest which might be due at common law. The respondents' omission to make payment was not justified by any of the contractual provisions, but by their common law right of retention. The effect of the right of retention was that the respondents held the principal sum and accruing interest as security for their alleged debt during the period of the claimants' insolvency. Retention had the effect of suspending the respondents' obligation to pay over the sums retained but did not affect the character of the debt, namely principal and accruing contractual interest. It was common ground that no right of compensation ever arose. Reference was made to Bell's Principles, paras. 575 and 1410; Trayner's Latin Maxims, on the meaning of jus exigendi, referred to by Bell; and to Green's Encyclopaedia, volume IV, pages 157-8. There had been a failure by the respondents to make payment in accordance with clause 60, and the claimants had a prima facie right to interest during the period of retention. The claimants' right to interest during the periods when they were not insolvent was not disputed. When the claimants' insolvency ceased, they became entitled to immediate payment of the principal sums together with accrued interest. In the circumstances the arbiter had reached the correct conclusion and the questions in the stated case should be answered in the negative.

[14] In our opinion the submissions made on behalf of the claimants are well-founded. It was accepted by the respondents that interest is due on the total sum of £280,880.52 in relation to the periods when the claimants were not shown to have been insolvent and the dispute is whether interest is due, in terms of clause 60(6), during the period of their insolvency which commenced on 3 March 1994. During that period the respondents admittedly had a right of retention and it was contended on their behalf that in those circumstances there had not been a "failure...to make payment" on their part in terms of clause 60(6). Accordingly, the question for determination is whether interest is due ex contractu for the period when the respondents were exercising their common law right of retention. It is important to note (1) that it was not contended in this case that a right of compensation of liquid claims arose and (2) that the claim for interest was made in terms of clause 60(6) of the contract and not at common law on the basis that the principal sum had been wrongfully withheld.

[15] The common law principle of retention, commonly referred to as balancing accounts in bankruptcy, is "nothing more than an implied security...a right to withhold payment or performance till satisfied of some counter demand" and "it may be pleaded in security of debts, future contingent or illiquid" (Bell's Principles, para. 1410). The effect of retention of a debt is "to deprive the creditor of his money retained till satisfaction be given" (ibid, para. 1417). In Borthwick v. Scottish Widows Fund (1864) 2 R. 595 Lord Justice-Clerk Inglis stated (at page 607):

[16] In the present case the respondents were held to be entitled to retain the sum of £280,880.52 while the claimants were insolvent and the question which arises is whether that entitlement has the consequence of removing the respondents' decision not to pay the retained sums from the ambit of the concept of "failure to make payment" in terms of clause 60(6) of the I.C.E. conditions, thereby eliding any contractual obligation to pay interest under that clause, during the period of justified retention.

[17] In Hall & Tawse Construction Limited v. Strathclyde Regional Council 1990 S.L.T. 774 Lord President Hope observed as follows (at page 780):

[18] It may well be that in the present case the claimants would not be entitled to interest at common law during the period of retention. However, the claimants were found by the arbiter to be entitled to payment of the principal sum and payment of that sum has since been made by the respondents. It is conceded that interest was due, in terms of clause 60(6) for the period prior to 31 March 1994 and in respect of the period after the claimants became solvent again, so that there were "failures" to make payment during those periods. So far as the period of insolvency is concerned the respondents were found to be entitled to withhold payment of the principal sum only in order to provide them with security for a separate debt. In the particular circumstances of this case we have reached the conclusion that the withholding of payment may properly be regarded as constituting a "failure" on their part to make payment in accordance with sub-clauses (2) (3) and (5) of clause 60. Payment was withheld simply because the claimants were insolvent and by reason of the respondents' common law right of retention in respect of a separate debt, rather than any breach of a contractual provision within the construction contract. In our opinion that right of retention entitled the respondents to withhold as security not just the principal sum but also the interest on that sum which continued to accrue in terms of the contract (in so far as not exceeding the amount of the debt, with interest, pursued in the Sheriff Court action). In the circumstances it seems to us that there is no merit in the contention that during the period of retention interest ceased to run on the principal sum to which the claimants had been found to be entitled. In our opinion, this is a case where clause 60(6) should be given a wider rather than a more restricted application and it is reasonable that the claimants should be entitled to interest ex contractu on the principal sum, which represents the value of the work carried out by them on behalf of the respondents but which they could not recover while they were insolvent, the respondents having had the advantage of the use of the money which was being withheld and effectively not having made any attempt to render their own alleged claim liquid, upon which interest is sought in the Sheriff Court action. As we have reached the conclusion that interest ex contractu continued to accrue during the period of retention, it follows that the question in the stated case must be answered in the negative.