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Cite as: [2018] ScotCS CSIH_33, 2018 SC 440, 2018 SLT 511, [2018] CSIH 33, 2018 GWD 15-201

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FIRST DIVISION, INNER HOUSE, COURT OF SESSION

Lord President

Lord Drummond Young

Lord Malcolm

[2018] CSIH 33

CA97/16

OPINION OF LORD CARLOWAY, the LORD PRESIDENT

in the reclaiming motion

in causa

J H & W LAMONT OF HEATHFIELD FARM AND OTHERS

Pursuers and Respondents

against

CHATTISHAM LIMITED

Defenders and Reclaimers

Pursuers and Respondents: DM Thomson QC; Dentons

Defenders and Reclaimers: Upton; Gilson Gray LLP

1 May 2018

Introduction

[1] This is a reclaiming motion (appeal) against an interlocutor of the commercial judge,

dated 5 October 2017, ordaining the defenders to deliver to the pursuers a duly executed

discharge of a standard security granted on 1 February 2010 in terms of an Option

Agreement. The issue is whether the defenders are obliged to discharge the security or

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entitled to refuse to do so pending the resolution of their counterclaim for damages for

alleged breaches of the Agreement.

The Option Agreement

[2] The pursuers are the heritable proprietors of 73 acres in Gartcosh, North Lanarkshire.

The defenders are developers. The parties entered into an Option Agreement dated

21 December 2009 and 1 February 2010, whereby the defenders were granted an option to

purchase the land, or parcels of it, from the pursuers in return for two non-refundable

payments of £60,000 and £75,000 (section 3 Option Grant). The defenders were to promote

the land for private residential development. This included securing that it would be

allocated for such development on the local plan (section 4). If not more than 10 acres were

allocated by a particular date, either party could resile “without penalty”. If only part of the

73 acres were allocated, the provisions of the Agreement would “only apply to the Allocated

Subjects and the Non Allocated Subjects shall not be constrained in any manner whatsoever

by this Agreement” (clause 4.8.2).

[3] Once land had been allocated, the defenders were to apply for planning permission

“in principle” (section 5) and the pursuers were required to assist in that process (clause 5.4).

The pursuers were prohibited from assisting any objector to the application or supporting

any competing application (clause 5.5). Both parties required to act in good faith and fairly

towards each other (clause 20). If planning permission were not obtained by a longstop

date, either party could, again, resile without penalty (clause 5.11).

[4] Assuming that all went well, the defenders would be entitled to sell parcels of the

land to third party developers (section 7). The pursuers would convey the parcels to the

buyers and each party would obtain a share of the sale proceeds (the defenders’ share being

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14% plus certain defined expenses). The defenders would require to discharge the standard

security, in so far as relating to the particular parcel, granted in their favour pursuant to

clause 11 (infra) (clause 7.4.2). If no re-sale were achieved before another longstop date, once

more either party could resile without penalty (clause 7.5). The payments already made to

the pursuers would not, as already noted, be refunded.

[5] Clause 11 of the Agreement required the pursuers to provide a security to the

defenders as follows:

“11. Chattisham Security

11.1 As security for implementation of [the pursuers'] obligations

under this Agreement, [the defenders] shall be entitled to require and [the

pursuers] shall be obliged to provide ... the [standard security] which

shall be released (and progressively restricted in its application) both

pursuant to Clause 11.2 and on completion of Disposals.

11.2 The ... Security Subjects shall initially equate with the Subjects but

following upon the Allocation Date shall thereafter be restricted to the

Allocated Subjects together with such other part or parts of the Subjects to

which any planning gain provisions (previously sanctioned by [the

pursuers]) might apply and [the defenders] shall upon demand by [the

pursuers] subsequent to the Allocation Date execute and deliver to [the

pursuers] a Deed of Restriction duly executed in a Self Evidencing

Manner which shall be reflective of the foregoing provisions in this

Clause 11.2”.

The Agreement provided that the security should be in the form of an annexed draft. This

provided that it was granted “in security of performance of all obligations undertaken [by

the pursuers to the defenders] in terms of the [Option Agreement]” (emphasis added). The

security was executed in those terms on the same day as the pursuers signed the Agreement.

It specifically prohibited the granting of real rights over the subjects without the defenders’

consent.

[6] Clause 11.3 provided that:

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“11.3 Upon the earlier to occur of (a) the expiry of the Option Period

and (b) the termination of this Agreement, [the defenders] shall deliver to

[the pursuers] a discharge duly executed ... of the [standard security].”

[7] The Agreement contained (section 24) provisions relating to defaults; being failures

“in a material respect to perform or comply with the obligations and liabilities undertaken”.

A notice of termination could be served “without prejudice to any other right or remedy

available ... in terms of this Agreement or otherwise” (clause 24.2). Unless a disagreement

arose, the Agreement would thereby terminate. If the defenders were the defaulting party,

they required to discharge the security (clause 24.3.2). The Agreement specifically

prohibited the pursuers from selling, or otherwise disposing of, the land without the

defenders’ consent (clause 26.1.2).

[8] In 2012, the relationship between the parties deteriorated. Access to the land was a

particular problem. The third party sale longstop date had been 28 September 2015. No

sales had been concluded by then. The pursuers terminated the Agreement under clause 7.5

by notice dated 30 September 2015. The pursuers asked the defenders to discharge the

standard security. The defenders refused and counterclaimed for £5 million in respect of

losses suffered as a result of alleged breaches of express and implied terms of the

Agreement. The defenders averred that the pursuers had obstructed the development by,

amongst other things, entering into an agreement with the owner of the land over which

access had to be taken. That claim has been sent for a proof before answer.

Commercial judge’s reasoning

[9] Following debate in the principal action, the commercial judge sustained the

pursuers’ plea to the relevancy of the defences and granted decree de plano ordering the

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defenders to execute the discharge. The issues had focussed on two principal questions.

First, under the terms of Clause 11, did the security cover all of the obligations owed by the

pursuers to the defenders, or solely the obligation to convey the land to the defenders when

the defenders exercised an option to purchase? Secondly, were the defenders entitled to

refuse to grant the discharge, either in exercise of the remedy of “retention” or by

withholding performance at common law, or was this excluded by the clear and

unambiguous terms of the Agreement?

[10] On the first question, the commercial judge reasoned that clause 11.1 defined the

purpose of the security as being “for implement of [the pursuers’] obligations under the

Agreement”. The language was clear and straightforward. It encompassed primary

obligations brought into existence by the Agreement. It did not extend to secondary

obligations which resulted from a breach. The pursuers’ primary obligation was to convey

the land on a phased basis, if the option were exercised. Clause 11.2 provided for the

restriction of the security to those parts of the land which were allocated for residential

development. Any parts of the land not allocated would be excluded. This suggested a

correlation between the security and the primary obligation.

[11] On the second question, the commercial judge recorded that there was little

consensus on whether the defenders were seeking to exercise a right of retention or a right

to withhold performance. “Retention” was a shorthand way of describing the withholding

performance of obligations, which were accepted as subsisting, according to the principle of

mutuality. The defenders had failed to set out a basis for holding that the requirement of

interdependency was satisfied. The express or implied obligations, which were said to have

been breached by the pursuers, were not the counterparts of the defenders’ obligation to

grant the discharge of the standard security.

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[12] The defenders’ attempt to rely on mutuality was excluded by the clear terms of the

Agreement. Clause 7.5 conferred a right to resile if there had been no sale of the land within

the relevant period. It was commercially sensible that, if progress had not been made within

that period, the pursuers would be free to deal with the land. The right to terminate the

agreement, under clause 7.5, would be of no use to the pursuers without the right to receive

a discharge. The security now secured an option which had not been, and could never be,

exercised.

Submissions

Defenders

[13] The defenders contended that a party to a contract could withhold performance of an

obligation in security for payment of damages for a breach of a contract which had been

terminated (Gloag: Contract (2nd ed) 623, approved in Inveresk v Tullis Russell 2010 SC (UKSC)

106 at para 35; cf McNeill v Aberdeen City Council 2014 SC 335 at para [29]). The commercial

judge had erred in holding that the terms of the Agreement breached by the pursuers were

not counterparts to the defenders’ obligation to discharge the security. The pursuers’

obligations under clauses 5.4, 5.5 and 20 were co-extensive in both content and time with the

defenders’ obligation to discharge the security under clause 11.3. The obligations were

presumed to be reciprocal, in the absence of a cogent reason for holding otherwise (Inveresk

v Tullis Russell (supra) at paras 42-43). The defenders had secured the performance of “all”

of the pursuers’ obligations under the Agreement. The scope of the security included

pecuniary secondary obligations. Excluding the right to damages would be arbitrary. The

security contemplated the possibility of a breach of obligations. It was a mechanism for the

enforcement of pecuniary obligations owed by the pursuers.

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[14] The commercial judge had erred in holding that the parties had excluded the

common law right to withhold performance of an express contractual obligation on the

ground of material breach by the other party. In order to exclude common law rights, a

contract had to contain clear and unambiguous words (Pollock & Co v Macrae 1922 SC (HL)

192; Gilbert-Ash (Northern) v Modern Engineering (Bristol) [1974] AC 689; Lewison:

Interpretation of Contracts (6th ed) at para 12.19; Novasen v Alimenta [2013] 1 Lloyd’s Rep 648;

Forster v Ferguson & Forster, Macfie & Alexander 2010 SLT 867 at para [16]). There was no

reference in the contract to the exclusion of common law rights. The judge had erred in

finding that clauses 7.5 and 11.3 taken together excluded the common law right, when clear

and unambiguous words would have been required. Clause 24.2 had expressly preserved

common law remedies.

[15] The commercial judge had erred: (1) in considering that the pursuers’ interpretation

was commercially sensible; (2) in failing to notice that the security expressly covered “all”

obligations, which would include damages claims; and (3) in relying on the clause relating

to non-refundable option payments, which had been included in the counterclaim. The plea

of retention which the defenders advanced was an equitable one, subject to control by the

court. It did not extinguish the right to a discharge.

Pursuers

[16] The pursuers submitted that the commercial judge had been correct to find that there

was no interdependency between the obligations. The presumption of mutuality was

rebutted by a consideration of the terms of the Agreement. The contractual scheme

demonstrated that the Agreement was that, come what may, the defenders were obliged to

execute and deliver a discharge of the security in certain specified circumstances. There was

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no general rule that any material breach by one party disentitled him from enforcing any

obligation by the other party (Macari v Celtic Football Club 1999 SC 628). Regard had to be

given to the terms of the contract (Bank of East Asia v Scottish Enterprise 1997 SLT 1213 at 1216

under reference to Turnbull v McLean (1874) 1 R 730; Gloag: Contract (2nd ed) 594). The

interdependence of obligations was a matter of circumstances. In contracts which were to be

performed in stages, the counter obligation and consideration for payment was the

completion of the work for that stage (Bank of East Asia (supra) at 1217). Applying these

principles, the purpose of the security was to secure performance of the primary obligation

during the currency of the agreement. The parties had agreed that, on termination, the

defenders were obliged to discharge the security. Upon termination, performance of the

primary obligation was no longer available. It followed that the defenders’ obligation to

discharge the security could not be a counterpart of the contractual obligations which the

pursuers were alleged to have breached.

[17] The task was to identify and give effect to the parties’ intentions based on established

principles of construction. The Agreement did not contain an exclusion of liability clause. A

less exacting standard than that suggested by the authorities was required (Ailsa Craig

Fishing Co v Malvern Fishing Co 1982 SC (HL) 14). It was not possible to construe the

Agreement in any other way than that determined by the judge. Effect required to be given

to its terms (@SIPP Pension Trustees v Insight Travel Services 2016 SC 243). The contractual

obligation on the defenders, under clause 11.3, was the subject of the two contractual

triggers of: (i) the expiry of the option period and (ii) the termination of the agreement.

Decision

[18] The remedy of withholding performance is available to a party in an ongoing

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contract where the other party has failed and refuses or delays to perform a reciprocal

obligation in that contract. The first party can withhold performance until the second party

performs (see generally Gloag: Contract (2nd ed) 623). It is, at least as a generality, an

alternative to rescission on the grounds of material breach, although it may also be used

where the failure by the second party is not material and rescission is not possible. The

remedy is not normally available when a contract has come to an end, whether by rescission

following upon repudiation, or in terms of the contract itself. It is a remedy intended to

compel performance in a subsisting contract. It is not one normally available to a party who

does not seek performance by the other party, but has resiled and/or only seeks damages for

a past breach of contract which is unlikely to be repeated (McNeill v Aberdeen City Council

2014 SC 335, Lord Drummond Young at para [29]).

[19] Inveresk v Tullis Russell 2010 SC (UKSC) 106 was concerned with the different

situation where liquid and illiquid sums were due under a contract. In that situation, it has

long been recognised that one party can refrain from paying the other (commonly known as

retention) pending the resolution of a compensatory or “offsetting” counterclaim for

damages in respect of breaches arising out of the same (or a related) contract (ibid Lord Hope

at paras [30] and [33]; Lord Rodger at paras [57] and [104] et seq). This is an exception to the

general rule that payment of a liquid debt cannot be withheld in respect of an illiquid debt.

As such the right was not disputed (see Lord Hope at para [27]).

[20] Withholding performance is a remedy available where the obligation, in respect of

which performance is being withheld, is the counterpart of the obligation breached.

Whether such interdependence exists is a matter of contractual construction, even if, as a

generality, all the obligations on one side of the contract must normally be seen as reciprocal

to those on the other in the absence of a clear indication to the contrary (Bank of East Asia v

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Scottish Enterprise 1997 SLT 1213; Forster v Ferguson & Forster, Macfie & Alexander 2010 SLT

867; cf Macari v Celtic Football Club 1999 SC 628).

[21] In this case the scheme of the contract is plain. The defenders had a right to oblige

the pursuers to convey parcels of land to third parties in the event of the defenders being

able to arrange a sale to those parties. Such sales were to involve a financial benefit being

paid to the defenders (section 7). This was the primary obligation to be secured under the

Agreement (clause 11.1, emphasis added). Although there are ancillary obligations on the

pursuers to assist, and not to obstruct, the process leading to the sales, these are not

enforceable, and enforcement of them cannot be compelled, once the contract has been

lawfully terminated and such sales cannot occur. Withholding performance cannot be used

to compel performance even of a reciprocal obligation when it is no longer extant by virtue

of that termination.

[22] The provisions (clause 4.8.2) which permit the release of parcels of land from the

security, in the event that they are not allocated for development, make it clear that the word

“all” relative to “obligations” in the draft, and as executed, standard security (and which

does not appear in the Agreement) is intended to relate only to obligations which remain

prestable and not those which have ceased because they can no longer be performed. Once

land was no longer capable of being developed, it could not remain covered by the security

relative to other obligations under (or arising from) the Agreement. The same is clear from

the terms of clauses 7.5 and 11.3. Once the exercise of an option to purchase ceased to be

possible, either because of the passing of the longstop date for doing so or the contract was

lawfully terminated, with the same practical result, there was a counter obligation to

discharge the security. Put another way, the existence of the security is the counterpart of

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the subsistence of the option itself. Once it becomes impossible to exercise that option, the

security must be discharged.

[23] The above construction is the only one which emerges from the wording of the

contract when looked at as a whole. It is also the only one which makes commercial sense.

If the defenders were correct, the land could potentially be tied up for years pending the

resolution of a litigation, of the type encapsulated in the counterclaim. The Agreement

(clause 24) made it clear that, if a notice of termination had followed upon the defenders’

default, the security required to be discharged. That does not carry with it an implication

that, if it were a pursuers’ default, the security need not be discharged notwithstanding

termination. The security was intended to preserve the land pending the exercise of the

option. Once that exercise became impossible, a discharge was required in terms of

clause 11.3. The parties did not intend that clause to be suspended until the resolution of a

damages claim.

[24] Finally, even if it were competent to withhold performance, it is not equitable to

permit that to occur in the circumstances occurring here. If the defenders wish security for

their damages claim, they are at liberty to apply for a diligence on the dependence of the

action; for example, one inhibiting the pursuers from dealing with the land. If the defenders

were entitled to retain the benefits of the security pending resolution of the dispute, they

would escape the rigours of the modern regime relating to the grant of such diligence

(Debtors (Scotland) Act 1987, ss 15A-N inserted by the Bankruptcy and Diligence (Scotland)

Act 2007). Had it been necessary to do so, I would have moved your Lordships to exercise

the court’s equitable jurisdiction accordingly.

[25] The reclaiming motion should accordingly be refused and the commercial judge’s

interlocutor of 5 October 2017 adhered to.

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FIRST DIVISION, INNER HOUSE, COURT OF SESSION

Lord President

Lord Drummond Young

Lord Malcolm

[2018] CSIH 33

CA97/16

OPINION OF LORD DRUMMOND YOUNG

in the reclaiming motion

in causa

J H & W LAMONT OF HEATHFIELD FARM AND OTHERS

Pursuers and Respondents

against

CHATTISHAM LIMITED

Defenders and Reclaimers

Pursuers and Respondents: DM Thomson QC; Dentons

Defenders and Reclaimers: Upton; Gilson Gray LLP

1 May 2018

[26] I agree with your Lordship in the chair that this reclaiming motion should be

refused. I do so for two reasons which correspond to those given by your Lordship. The

first and primary reason is that the pursuers’ obligation under clause 11 of the Option

Agreement to grant the Chattisham Security is not, for the purposes of the law of retention,

the counterpart of the other provisions of the Option Agreement. The second reason is that,

even if the obligation to grant the Chattisham Security is the counterpart of the other

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provisions of the Agreement, it would not be equitable to permit the defenders to exercise a

right of retention in security of the claim for damages that they have put forward against the

pursuers.

[27] I will consider each of these reasons in turn. Before that, however, I should make

some general observations about the context in which the principle of contractual retention

typically operates; by “contractual retention” I mean the principle whereby one party to a

contract may in certain circumstances withhold performance of its obligations because of a

breach of contract by the other party. Retention in this sense serves as a form of security for

contractual performance. Security is a protection against insolvency, whether absolute

insolvency on a balance sheet test or practical insolvency, in the sense that the grant of the

security is having difficulty in paying debts or fulfilling other obligations as they fall due. A

security is of assistance in the event of actual insolvency, in either of these senses, but it may

also be of utility in dealing with the threat or material risk of insolvency; as a matter of

commercial practice it is used as a matter of course to deal with such risks.

[28] In one sense insolvency is inevitably unfair: it is a trite observation that those who

have had dealings with the insolvent do not receive what is due to them. Most typically, a

debtor of the insolvent only receives a dividend (if anything is left after payment of secured

and preferential debts), and the same is true of a creditor with a damages claim. The

adverse effect of insolvency is not confined to monetary obligations, however; the

insolvent’s obligations to perform services or to supply goods or other property are usually

not implemented. A security may be a straightforward security for payment of a debt, but it

may equally be a security for an obligation ad factum praestandum or for an obligation to pay

damages in lieu of such an obligation. These considerations illustrate the wide range of

situations in which security may be of commercial importance. In this connection, I would

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note that the right of contractual retention is a very flexible form of security, applicable to a

great range of obligations in a wide range of circumstances. It should in my opinion be

applied in the light of the consideration.

[29] A further factor is in my opinion of importance. While the normal rule on insolvency

is that creditors are dealt with according to their strict legal rights, either by enforcing their

real rights or by receiving a dividend for their established personal rights, in the practical

administration of insolvency the strict application of rules can have unfair results. For this

reason equity plays a significant part in the application of the law of insolvency and in the

associated area of offsetting debts. An illustration of equity’s role is found in the

development of the principle of balancing accounts on insolvency. The right of

compensation or set-off normally applies only to liquid debts. Where one of the parties is

insolvent, however, the right of offsetting is extended on equitable grounds, with the result

that illiquid obligations can be set off against liquid debts: Gloag, Contract, at 626; Bell,

Commentaries, ii. 122. A further intervention by equity which is relevant in this area,

although it does not require actual insolvency, is the extension of the right of compensation

beyond liquid debts, in the strict sense, to debts that can easily be verified: Gloag, Contract,

625. The reasoning here is that, even if a debt is not strictly liquid, if a creditor can readily

establish the amount of his debt it is considered unfair to prevent him from offsetting the

amount due to him against the amount that he owes to the insolvent. The contractual right

of retention is also equitable in nature, a matter to which I will return. This is in my opinion

an important aspect of the right; the unthinking application of strict legal rights on

insolvency frequently leads to manifest injustice.

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Contractual retention

[30] Contractual retention is the right of one party to a mutual contract to withhold

performance in response to a breach of contract by the other party. A classic definition is

that of Gloag and Irvine (The Law of Rights in Security, 303; approved in Inveresk PLC v

Tullis Russell Papermakers Ltd, supra, per Lord Hope at paragraphs [30]-[33]):

“Retention may be defined as a right to resist a demand for payment or performance

till some counter obligation be paid or performed ... Thus the right of a party to

withhold performance of his obligations under a mutual contract, if the counter

obligation is not performed, is often spoken of as a right of retention, and may result

in a right to retain money or goods”.

Retention permits the withholding or the temporary non-performance of the substantive

obligations under a contract, those are obligations such as the supply of goods, or the

provision of services, or the payment of the price: McNeill v Aberdeen City Council, supra, at

[26] -[27]. It is important that the right should be confined to the substantive obligations

under the contract, such as the obligations to supply goods or provide services and the

correlative obligations of payment; the dangers of extending the right of retention more

widely to incidental and ancillary obligations are clearly illustrated by the specific facts of

McNeill.

[31] Retention typically takes the form of a withholding of payment, but it must be

distinguished from two other important rights that defeat an obligation to make payment:

compensation and balancing accounts on insolvency. Compensation is the right to set off

one monetary claim against another, with the result that the smaller claim is extinguished

and the larger claim is extinguished pro tanto. It is generally regarded as founded on the

Compensation Act 1592: see Gloag, Contract, 644. For compensation to operate it is

normally essential that the two debts should be liquid, although as noted above the right has

been extended, essentially on equitable grounds, to debts that can readily be verified. For

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this reason a damages claim can never be the subject of compensation. There are I think two

fundamental policy reasons for confining compensation to liquid debts. First, compensation

involves an offsetting of the debts, and for that purpose it is essential that the amount of the

debt can be instantly verified, so that the necessary entries can be made in the parties’ books

and the debt extinguished. Secondly, if compensation were not confined to liquid debts,

there would be an obvious risk of abuse. If, for example, A owes a liquid debt to B that is

payable immediately, he could delay the need to make payment to B by advancing a

damages claim, perhaps of a contrived or spurious nature, and claim to offset that illiquid

claim against the liquid debt obligation. Confining compensation to cases where both debts

are liquid, or are capable of immediate verification, avoids this difficulty.

[32] Balancing accounts on insolvency is another form of set off. Bell describes it as “not

merely an arrangement of convenience, but an equitable adjustment of mutual debts and

credits, to avoid gross and manifest injustice”: Commentaries, ii.124 (5th ed); ii.122 (7th ed). In

balancing accounts on insolvency liquid and illiquid debts, including damages claims, may

be set off against each other. Such a right is regarded as an equitable extension of the right

of compensation. Two reasons exist for the extension. The first is the fundamental equitable

reason adverted to by Bell: if a debtor who is obliged to pay a debt to an insolvent estate has

a claim against the estate, whether liquid or illiquid or merely in the form of a claim for

damages or unjustified enrichment, it is considered unfair that he should be compelled to

pay his debt in full without offsetting the claim that he has against the insolvent estate. The

alternative would be that, while the debtor had to pay the debt due by him in full, he could

only rank for a dividend in respect of the debt due to him. That might be a logical way of

treating the two obligations, but the law has decided on equitable grounds that offsetting

should be permitted.

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[33] The second reason for permitting an extension of the right of balancing accounts on

insolvency to illiquid debts and other obligations is that, on insolvency, all claims made by

and against the insolvent estate will be under the control of the trustee in bankruptcy,

liquidator or other insolvency practitioner. This has two important consequences. First,

because of the intervention of an insolvency practitioner the risk of contrived or spurious

claims is significantly reduced. Secondly, on insolvency all debts due to and by the

insolvent require to be valued; in the case of claims for damages or other illiquid obligations,

the liquidator or trustee is obliged to place a value of the claim. This means that offsetting is

possible, and indeed offsetting is essential if the affairs of the bankrupt or insolvent

company are to be wound up. I should add that the principle of balancing accounts on

insolvency does not apply to a debt due to the insolvent estate that depends on a

contingency so remote that it is impossible to estimate its present value: Gloag, Contract, 626.

Retention and mutuality

[34] Compensation and balancing accounts on insolvency are conceptually quite distinct

from contractual retention. Contractual retention is based not on the commercial and

accounting convenience of offsetting debts, as with compensation, or on the need to secure

an equitable adjustment of accounts on insolvency, but on the principle of mutuality of

contract. The classic statement of the doctrine is perhaps that of Lord Justice Clerk

Moncrieff in Turnbull v McLean & Co, 1874, 1 R 730, at 738:

“I understand the law of Scotland, in regard to mutual contracts, to be quite clear:

1st, that the stipulations on either side are the counterparts and the consideration

given for each other; 2nd, that a failure to perform any material or substantial part of

the contract on the part of one will prevent him from suing the other for

performance; and, 3rd, that when one party has refused or failed to perform his part

of the contract in any material respect, the other is entitled to insist for implement,

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claiming damages for the breach, or to rescind the contract altogether – except in so

far as it has been performed”.

The importance of the principle of mutuality is emphasized in the two short concurring

opinions of Lord Benholme and Lord Neaves, at 1 R 739, and by the opinion of Lord Justice

Clerk Inglis in the earlier case of Johnston v Robertson, 1861, 23 D 646, at 656. Mutuality is

fundamental to the notion of a bilateral or multilateral contract in Scots law. The underlying

principle is thus that the provisions of a contract are normally taken to be interdependent. It

follows from this that, if one party fails to implement its substantive obligations under the

contract, the other party is entitled to refuse to perform its substantive obligations.

[35] The function of retention is to provide security for future contractual performance. If

one party commits a sufficiently material breach of contract, the other may exercise the right

to withhold performance of his own substantive obligations. For example, in a contract for

the supply of goods by instalments, if the purchaser fails to pay for one instalment the seller

will normally be entitled to withhold delivery of further instalments until payment is made.

In the reverse position, where a party fails to deliver goods or services in accordance with

his contractual obligations, the innocent party may utilize the right of retention to withhold

payment. In principle I do not think that there is any difference between withholding

performance of obligations such as the supply of goods or the provision of services and the

withholding of performance in the form of payment. For the purposes of the law of

retention payment is merely one form of contractual obligation. When obligations other

than payment are withheld, the party exercising the right of retention ensures that as long as

the breach continues he is not required to incur the work and expense necessary to fulfil his

own side of the contract. In this way he reduces the scale of any claim for damages that he

may have following on a breach of contract, which may be important if the party in breach is

Page 19 ⇓

in financial difficulties. When an obligation of payment is withheld, the element of security

is quite straightforward, in that the funds withheld are available for offsetting against any

claim for damages for breach of contract. The security function of retention is in my opinion

of considerable importance in the present case, for reasons that I will discuss subsequently.

[36] Turnbull v McLean & Co makes it clear that the normal rule of Scots law is that the

whole of the obligations on one side of a contract are regarded as the counterparts of the

whole of the obligations on the other side of the contract. There are obvious practical

reasons for such an approach; a contract is negotiated and concluded as a unity, and if it is

not implemented and enforced as a unity a central and vital feature of the parties’ bargain

will be lost. In the words of Lord Benholme in Turnbull v McLean & Co, at 739:

“It is very important that we should express our determination to abide by the well-

established rule of Scotch law that in mutual contracts there is no ground for

separating the parts of the contract into independent obligements, so that one party

can refuse to perform his part of the contract, and yet insist upon the other

performing his part. The unity of the contract must be respected”.

On occasion the principle of mutuality of contract has been extended beyond the provisions

of a single contract, to cover rights and obligations under a related contract; an example of

this is found in in Inveresk PLC v Tullis Russell Papermakers Ltd, supra, where the parties

concluded two contracts, one for the sale and purchase of a brand of paper and related

assets, and the other whereby the seller undertook to continue to manufacture, sell and

distribute certain products during a period of five months following the agreement. It was

held that the obligations in one of those contracts were the counterparts of the obligations in

the other, as the two contracts in reality represented a single transaction.

[37] At this point I should observe that the law relating to contracts performed in stages is

quite clear from cases such as Turnbull v McLean, which concerned a contract for the sale of

coal to be delivered in instalments, with each instalment being paid for after it was

Page 20 ⇓

delivered. The purchaser refused to make payments for two instalments and the seller

withheld further deliveries and ultimately rescinded the contract. It was held that the seller

was entitled to withhold payment. The statements of the law in that case are very clear. The

speech of Lord Jauncey in Bank of East Asia v Scottish Enterprise, supra, must I think be read

subject to the well-established existing law on this matter, and should not be construed as

suggesting that in instalment contracts the presumption of interdependence is in some way

reduced. Indeed, if the principle of mutuality were not applied in its traditional way to

contracts to be performed in stages, the result would be commercially nonsensical. For

example, in a contract for the supply of goods by instalments, the seller might be compelled

to provide successive instalments even when the purchaser had ceased paying and it was

clear that there was a serious risk that he was insolvent. Similar practical difficulties would

arise in other forms of contract that are performed in stages, including building contracts

and leases. The practical importance of these forms of contract hardly requires stating, and

it would be most regrettable if the doctrine of retention were not to be applicable to them, or

were only to be applicable in the restricted manner that appears to be contemplated by Lord

Jauncey. In practice the right of retention is usually the most effective practical security for

contractual performance, including securing the right to damages in the event of breach of

contract. In this connection the fact that English law does not appear to have the same

doctrine is quite irrelevant. English law, or more technically equity, provides security for

contractual performance through the concept of the equitable interest, but that concept has

no place in Scots law. In Scots law security for contractual performance is provided

primarily by the principle of retention, based on the mutuality of contractual obligations.

[38] Nevertheless, although the norm is that contractual obligations are mutually

interdependent, parties may frame a contract in such a way that one or more obligations are

Page 21 ⇓

independent of the other obligations; in such a case one party may demand performance

without tendering performance himself: see Gloag, Contract, 594-595. In the present case I

am of opinion, in accordance with your Lordships, that clause 11 of the Option Agreement,

dealing with the Chattisham Security, falls into this category. The result is that the

provisions for discharge of the Security may be enforced by the pursuers independently of

the other obligations of the parties under the contract. I reach that conclusion for the two

reasons expressed at the beginning of this opinion.

[39] First, the Chattisham Security is an express security, in the form of a standard

security in the form set out in Part 2 of the Schedule to the Option Agreement. That

standard security is in ordinary form, and is granted in security of the performance of all

obligations undertaken by the pursuers to the defenders under the Option Agreement.

When an express security is granted in respect of one party’s obligations under a contract, it

can reasonably be inferred that the express security is intended to supersede the implied

security conferred by the right of contractual retention. That is especially so where the

express security is conferred over land, rather than merely relying on the withholding of

contractual rights.

[40] Secondly, the Option Agreement in clauses 7 and 11 makes express provision for the

restriction or termination of the Chattisham Security in defined circumstances. Restriction is

contemplated by clause 11.2, which defines the “Chattisham Security Subjects”. These were

initially to comprise the whole of the subjects in respect of which planning permission was

to be sought, as shown on a plan appended to the Option Agreement, but they were to be

restricted to the Allocated Subjects, that is to say subjects in respect of which planning

permission was obtained, once that had happened. Once Subjects had been allocated in this

way, the pursuers might request that the defenders should execute and deliver a Deed of

Page 22 ⇓

Restriction, restricting the scope of the Chattisham Security to the Allocated Subjects.

Further provision for restriction of the security subjects is contained in clause 7.4.2, which

provides that the defenders should deliver a discharge of the Chattisham Security to the

pursuers upon each disposal of a Sale Parcel, that is to say, a parcel of housing land sold or

capable of being sold to a third party developer. Thus the Security contained express

provisions regulating its own restriction, which were not related to the performance by the

pursuers of their obligations under the Option Agreement.

[41] Clause 11.3 of the Option Agreement makes express provision for the termination of

the Chattisham Security. It states that “Upon the earlier to occur of (a) the expiry of the

Option Period and (b) the termination of this Agreement, Chattisham shall deliver to [the

pursuers] a discharge duly executed… of the Chattisham Security”. Termination of the

Option Agreement typically occurs in the circumstances specified in clause 7.5, which

provides that, if no contract for the sale of land to a developer had been concluded by the

date known as the Third Party Land Sale Longstop, either party is entitled to result from the

Agreement without penalty. The expression “Third Party Land Sale Longstop” is defined as

meaning either the third anniversary of the Allocation Date or a subsequent date agreed by

the parties in accordance with clause 7.6. In the present case, the third anniversary of the

Allocation Date had passed; that occurred on 28 September 2015, and no land had been sold

to third party developers by then. The result of that was that either party was entitled to

resile from the Agreement after that date. The pursuers gave notice to terminate the

agreement on 30 September 2015 and requested the defenders to discharge the Chattisham

Security. The provisions of clause 11.3, taken with clause 7.5 and the relative definitions,

contained express and specific provision for the termination of the Chattisham Security in

defined circumstances, and it is those provisions that were invoked by the pursuers.

Page 23 ⇓

Clauses 11.3 and 7.5 were not related to the parties’ performance of their obligations under

the contract in any general sense. The fact that specific provision was made to terminate the

Security, in a manner independent of the mutuality principle, indicates in my opinion that

the discharge of the Security was intended to operate in defined circumstances regardless of

the parties’ performance of other obligations under the contract.

[42] I accordingly conclude that the provisions of clause 11.3 and clause 7.5 are not

interdependent with other provisions of the contract. This result appears to me to accord

with commercial common sense. The Chattisham Security Subjects were a major asset of the

pursuers. The Chattisham Security was granted to provide express security for the

pursuers’ obligation to convey land to third party developers once planning permission was

obtained. When the Option Agreement was terminated in accordance with its terms that

was no longer possible. Consequently there was no commercial reason why those subjects

should remain subject to the Chattisham Security; the purpose for which that security was

granted had ceased to exist. These commercial considerations in my view provide clear

support for the conclusion that the provisions governing the Chattisham Security were

independent of the other provisions of the Option Agreement, and that the Security was to

be discharged if one of the parties resiled from the agreement, regardless of any other claims

that the parties might have against each other.

Equitable nature of retention

[43] Apart from the question of interdependence, it is important in my opinion to take

account of the equitable nature of the right of retention. Retention is equitable in nature.

That is explained by Lord President Cooper in Stobbs & Sons v Hislop, 1948 SC 216, at 223:

Page 24 ⇓

“The latest view is that retention of rents does not rest on any principle peculiar to

the law of leases, but is simply one of the many instances of the general equitable

rule of Scots law that reciprocal obligations arising under a mutual contract are the

counterparts of each other, and that, under suitable circumstances, a party to such a

contract will be permitted to withhold performance of his obligations unless and

until the other party has performed his, or, to put it from the opposite angle, that

failure to perform a material part of the contract on the part of one party will prevent

him from suing the other for performance… The equitable nature of the rule and the

discretionary control asserted by the Court in allowing or refusing retention in

mutual contracts according to the circumstances are illustrated by the cases cited by

Gloag, at page 627”.

Lord Russell also referred to the equitable nature of retention (at 229). Other cases where

the equitable nature of retention was recognized are cited in Gloag on Contract (2nd ed) at

627; these include Graham v Gordon, 1843, 5D 1207; Ferguson v Ardrossan Dry Dock Co, 1910

SC 178; and Earl of Galloway v McConnell, 1911 SC 846.

[44] In my opinion the equitable nature of retention is important. Retention may be

invoked in a wide range of circumstances, and it is essential that it should not be allowed to

become an instrument of abuse, in such a way as to enable a party to a contract to avoid

implementing obligations that are clearly due because of a possible counterclaim of

uncertain merit or for an uncertain amount. That consideration appears to me to be

particularly important in the present case. As I have indicated, an important policy

consideration in restricting the principle of compensation to liquid debts is the risk that

payment of a debt that is clearly due and payable may be resisted because the debtor has a

claim for damages that is uncertain as to liability or amount. In my opinion similar

considerations apply to the principle of retention. This can be illustrated by an example

based on a building contract. Suppose that the contractor is entitled to a stage payment duly

certified by the architect. The employer does not wish to pay, and advances a damages

claim of uncertain merit based on alleged defective work or delay or some other factor that

requires to be established by evidence. In such a case there may be clear equitable grounds

Page 25 ⇓

for holding that the employer should not be able to refuse payment of the certified sum on

the ground of a damages claim, notwithstanding that the obligation of the employer to make

payment and the obligations of the contractor to perform work properly and timeously are

counterparts of each other. This is not to say that equity would deny the defence of

retention in every such case. For example, the delay might be clear, and the compensation

payable might be fixed by a provision for liquidate damages. Everything depends on the

particular circumstances. The fundamental point is that, when a damages claim is put

forward as supporting a defence of retention, the claim must be looked at critically, and it

must be determined whether it is fair and just that it should be allowed as a defence to a

counterpart obligation that is clearly defined and clearly due.

[45] The present case appears to me to be one where considerations of equity are

important. The defenders’ damages claim is set out to some extent in the pleadings, but the

averments are inspecific and the critical averments are not founded on written documents.

The defenders’ claim is based on alleged acts by the pursuers that were intended to frustrate

the Option Agreement by persuading a neighbour to deny access to the development land.

Those acts are said to be a breach of the pursuers’ obligation to assist the defenders in

connection with their planning applications (clauses 5.4 and 5.5 of the Agreement), and also

a breach of the pursuer’s obligation to deal with the defenders in good faith for the purposes

of the agreement (clause 20). In summary, it is averred that difficulties were experienced in

obtaining planning permission for the site, and that the neighbour declined to grant access

over his land, giving as a reason an agreement that he claimed to have made with the

pursuers which precluded him from granting the accessory rights. Those averments are

based on inferences, largely from oral conversations, and they are denied by the pursuers.

No attempt seems to have been made to recover documentation to establish the defenders’

Page 26 ⇓

claim. I also observe that the defenders’ averments of loss are seriously lacking in

specification.

[46] Furthermore, the defenders may be able to obtain security for their damages claim by

applying for diligence, in the form of an inhibition, on the dependence of their counterclaim.

Alternatively, they may raise a separate action and seek an inhibition on the dependence of

that action. Inhibition is, of course, subject to sections 15A-15N of the Debtors (Scotland) Act

1987, introduced by the Bankruptcy and Diligence (Scotland) Act 2007. The defenders

would accordingly require to satisfy the requirements of those provisions, relating both to

the arguability of that case and the need for security in the light of the pursuers’ financial

position. If they can satisfy the statutory requirements, however, inhibition would be

available to provide security for their claim. That in my opinion strongly supports the view

that use of the contractual right of retention on the basis of the defenders’ damages claim

would not be equitable in present circumstances.

[47] For both of the foregoing reasons I agree with your Lordships that the defenders

should not be permitted to avail themselves of the contractual right of retention in the

present case. The reclaiming motion should accordingly be refused.

Page 27 ⇓

FIRST DIVISION, INNER HOUSE, COURT OF SESSION

Lord President

Lord Drummond Young

Lord Malcolm

[2018] CSIH 33

CA97/16

OPINION OF LORD MALCOLM

in the reclaiming motion

in causa

J H & W LAMONT OF HEATHFIELD FARM

Pursuers and Respondents

against

CHATTISHAM LIMITED

Defenders and Reclaimers

Pursuers and Respondents: D M Thomson QC; Dentons

Defenders and Reclaimers: Upton; Gilson Gray LLP

1 May 2018

[48] I agree with your Lordship in the chair that the reclaiming motion should be refused.

I wish to add the following in support of the views expressed by your Lordship. The issue

in this reclaiming motion can be resolved on a construction of the parties’ contract. In this

regard, I reject the submission for the defenders to the effect that a common law right of

retention will apply unless it is expressly excluded; and this for the reasons explained by

Lord Drummond Young in Melville Dundas Limited v Hotel Corporation of Edinburgh Limited

Page 28 ⇓

2007 SC 12 at paragraphs [14]-[16]. If such a right would otherwise arise, it can be excluded

if such is the clear implication of the parties’ agreement.

[49] In clause 11 the parties provided for a standard security to be granted in favour of

the defenders in respect of certain obligations incumbent upon the pursuers. Clause 11.3

stated that the standard security shall be discharged on the earlier of the expiry of the option

period or the termination of the agreement. Presumably this was upon the basis that the

security’s purpose was then over – its purpose being to provide reassurance that the option

subjects would not be alienated or burdened, thereby defeating the defenders’ rights under

the agreement.

[50] With regard to the proposition that the standard security was intended to cover

damages claims arising out of an alleged breach of the contract, clauses 11.2 and 11.3

demonstrate that it was not part of the agreement that the security would cover ongoing and

outstanding damages claims. The time-limited nature of the standard security was part and

parcel of the parties’ bargain. I do not consider that it is open to the defenders to retain the

security notwithstanding that, as is admitted, the circumstances provided for in clause 11.3

have occurred. (The only possible exception to this in terms of the contract would have been

if the defenders had terminated it under the self-contained default provisions in clause 24 in

respect of a default on the part of the pursuers which had been established as a result of an

exercise of the provisions in clause 16.)

[51] The above is sufficient for the disposal of this appeal, but even if it is erroneous, I am

not persuaded that the defenders’ claim to retain the standard security should be upheld. In

an area of the law bedevilled by overlapping and confusing terminology, it might be helpful

to review certain recent authoritative decisions in an effort to provide some clarity. I have in

mind particularly the speech of Lord Jauncey in Bank of East Asia Limited v Scottish Enterprise

Page 29 ⇓

1997 SLT 1213 and the judgment of Lord Rodger in Inveresk Plc v Tullis Russell Properties

Limited 2010 SC (UKSC) 106.

[52] Where stipulations are imposed on the parties in a bilateral agreement which are

conditional upon each other, performance of one of them cannot be demanded by the other

party unless that party has performed or is able and willing to perform the counterpart

obligation incumbent upon him. Thus, for example, a supplier of goods need not deliver

unless the purchaser has paid or is willing and able to pay the price. A tenant can retain the

rent if the landlord has excluded him from all or part of the leased subjects; his obligation to

pay being suspended by the landlord’s non-performance of a duty upon which the right to

rent is conditional. This kind of retention is sometimes called “mutuality retention”. Absent

the necessary mutuality or conditionality, retention of this kind does not arise.

[53] In Bank of East Asia Limited, Lord Jauncey (page 7) cited with approval Lord Shand in

Pegler v Northern Agricultural Implement and Foundry Co Ltd (1877) 4 R 435 at 442.

“I venture to think the sound principle is rather this, that if the defence be founded

on an obligation fairly arising out of the contract, and the performance of which is

reciprocal to and contemporaneous (viz. exigible or prestable at the same time) with

the obligation which is the foundation of the action, then the defence is good.”

His Lordship commented that Lord Shand “was clearly envisaging not the totality of

obligations due under a contract but rather specific obligations which were the direct

counterpart of other obligations due thereunder.” It is not the case that each and every

obligation by one party to a mutual contract is necessarily and invariably the counterpart of

each and every obligation by the other. “It must be a matter of circumstances”. Thus his

Lordship rejected the proposition that any claim under a mutual contract can be set against

any other claim thereunder howsoever and whensoever such claim may arise. Counter

obligations, in the sense of mutually interdependent duties, are “corresponding and

Page 30 ⇓

contemporaneous claims” which must be “exigible or prestable at the same time.” In Macari

v Celtic Football and Athletic Co Ltd 1999 SC 628, Lord President Rodger described Lord

Jauncey’s explanation of mutuality retention as an “authoritative gloss” on somewhat

“sweeping” statements in earlier decisions (pages 639/41).

[54] Applying the above to the present case, it becomes clear that the defenders cannot

rely on mutuality retention. They are not attempting to force the pursuers to perform a

contractual duty, let alone one that is the counterpart of the defenders’ current obligation to

discharge the standard security. That obligation came into existence only on the termination

of the option agreement, and cannot be characterised as reciprocal or conditional upon any

of the pursuers’ duties under the contract. (The document itself was not a counterpart of the

pursuers’ duties, but was granted by them in security of their performance of those

obligations.)

[55] The defenders are seeking to withhold performance of an admitted obligation to

discharge the standard security because of their disputed claim for damages for alleged

breach of the pursuers’ duties under the contract. At best for the defenders, this is related,

not to retention based on mutuality of contract, but to a wholly different concept,

confusingly also called retention, of the type described in detail by Lord Rodger in Inveresk.

[56] Plainly non-performance of a contractual obligation can trigger a remedy in

damages. Until established and ascertained, such is an illiquid claim. In Inveresk

Lord Rodger observed that it is “beyond all doubt that in certain circumstances, the court

does permit a defender to retain a liquid debt which he would otherwise be required to pay

to the pursuer” (paragraph 77). Earlier in his speech, having described when a defender has

a right to withhold or retain payment, at paragraph 57 he explained the concept as follows:

Page 31 ⇓

“… the term ‘retention’ is also applied to the (different) situation where a defender

admits that, say, the price of goods is due. In that situation he cannot have any right

to withhold payment of the price. But he can submit to the court that he should not

be obliged to pay the price until some unliquidated claim which he has against the

pursuer (here a claim for damages) is resolved. In effect, the defender asks the court

to allow him to ‘retain’ the price meantime so that, if his claim for damages succeeds,

he can offset the liquid damages against the liquid price.”

Lord Rodger considered that the case before their Lordships could be analysed on the basis

that, even if the additional consideration claimed was liquid, it would be just and equitable

to allow the defenders to retain it until their damages claim was resolved. Though it had not

been argued on that basis, his Lordship discussed the matter at some length, given its

“general importance”.

[57] Lord Rodger commented that the case law and literature on defenders’ claims for

damages in actions for the price of a contract are “notoriously confusing” (paragraph 66).

His major contribution in the Inveresk judgment was to take the time and effort to chart a

course through these difficult matters and offer reasoning and conclusions which his

colleague, Lord Clarke, described as “convincing”. His Lordship’s general approach can be

summarised as follows. Retention of debts is allowed “where that would be equitable

having regard to the essential purpose of the Compensation Act” (paragraph 81). The

general rule is that a liquid claim will not be held up pending the resolution of an illiquid

claim. However that general rule can be set aside on “a matter of sound judicial discretion

and equity”, this not being limited to bankruptcy cases. Once the illiquid claim is

ascertained it can then be set off against the debt owed to the pursuer.

[58] It is well established that one of the recognised circumstances in which this form of

retention can arise is when both claims arise out of the same contract. However, discussion

of the law in such a context often fails to notice the different types of retention, namely (a) in

respect of reciprocity under a mutual contract or (b) because one party is using a damages

Page 32 ⇓

claim based on the pursuer’s breach of the contract to resist payment. Regarding the latter,

necessarily there are competing monetary claims, one unliquidated and the other

ascertained and due. The two kinds of retention have different legal origins, one the

doctrine of mutuality in bilateral contracts, the other an equitable extension to statutory

compensation allowing, ultimately, the setting off of both claims against each other.

Mutuality retention is an aspect of the law of contract. Where it applies, it is available, not

by way of an exercise of an equitable discretion by the court, but as a matter of right (albeit

the court can regulate issues of procedure). This is because the parties have agreed that the

performance of one obligation is dependent upon the performance of the other. It is not a

question of setting off claims against each other.

[59] In Inveresk Lord Rodger made it clear that the non-mutuality “different kind” of

retention, which has been dubbed “special retention”, is to be operated with regard to the

equities of the particular circumstances. That both claims arise out of the same contract is a

favourable factor for allowance of this kind of retention; but in itself this is not sufficient to

hold up payment of the liquid claim. The full circumstances of the case, including the

structure of the agreement, must be considered. Importantly, in the circumstances of the

present case, and as the common use of the term “retention of debts” illustrates, this kind of

retention concerns the ultimate set off of competing monetary claims. Plainly, obligations of

a wholly different kind cannot be set off against each other.

[60] Reverting to the circumstances of the present case, the pursuers are not seeking

payment from the defenders. They want a discharge of the standard security, as per the

agreement. Neither the pursuers’ obligations while the agreement was in force, nor any

potential liability in damages for a breach thereof, are the counterpart of the defenders’

obligation to grant the discharge. It follows that “mutuality” retention does not arise. Nor

Page 33 ⇓

can there be any question of one claim being set off against the other, hence “special

retention” is not applicable. Even if there was, as your Lordship in the chair has observed,

the equities are plainly in favour of the pursuers. In any event, as explained earlier, if some

form of retention would otherwise arise, it is excluded by the clear terms of the parties’

agreement.