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OUTER HOUSE, COURT OF SESSION [2006] CSOH 136 |
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CA66/05 |
OPINION OF LORD DRUMMOND YOUNG in the cause MELVILLE DUNDAS LIMITED Pursuers; against HOTEL CORPORATION OF EDINBURGH LIMITED Defenders: ________________ |
Pursuers: Mackenzie, Solicitor; Pinsent Masons
Defenders: Drummond, Solicitor; Shepherd & Wedderburn, W.S.
[1] The
defenders are the owners of the Sheraton Hotel in
[2] In
February 2003 Mr Robert McGowan, an accountant who specialized in the
management of companies in financial difficulty, was appointed by the Bank of
Scotland to take over the management of the pursuers. Mr McGowan gave evidence about his
involvement with the pursuers; that evidence was not challenged by the
defenders. Mr McGowan stated that he
reviewed the pursuers' financial position and recommended that receivers should
be appointed over their property and undertaking. The Bank of Scotland appointed
receivers. Thereafter Mr McGowan
continued to manage the pursuers' business on the receivers' behalf. That involved bringing to a close the various
contracts that had been concluded by the pursuers. One of these was the contract with the
defenders. The works under that contract
had been completed some time previously, but defects had emerged and those
still had to be rectified. In addition
the final account still had to be agreed.
Mr McGowan contacted the defenders with a view to reaching agreement on
the various matters that remained outstanding.
The defenders were also anxious to make progress, and a meeting was held
on
"Spa
MDL [the pursuers] indicated
that they would be willing to complete the outstanding works if instructed to
do so. When the company went into
receivership, their contract was automatically terminated. They have, however, retained a core of staff
to complete and facilitate handovers of existing works and in order for them to
be able to implement our completion works they would require to be instructed
to proceed, by letter, either from yourself or from [Turner & Townsend] on
your behalf.
It is also a requirement of
the Insolvency Act that the Receivers approval is needed to authorize further
works. He cannot do so, however, until
sufficient monies are received from the affected parties to cover the costs. MDL requested, therefore, that we review each
of the snagging items to assess the liability of MDL for any outstanding works
and to assess the possibility for release of a portion of the retention fund to
cover these works.
·
Hydropool cover -- It was accepted that the present
installation was unsatisfactory and that replacement, based on a notional
allowance of £10,000, should be considered.
·
Heat exchanger works - Maximum cost allowance to rectify the
problem agreed at approximately £2000.
·
Floor lights -- Approximate cost allowance to rectify:
approximately £2500.
·
Round table fixings -- Isometrix 'foot' still to be
tested. Further work may,
however, be needed to reconfigure the spindle details: assessed at
approximately £2000.
·
Fixing glass partitions -- Cost allowance to rectify:
approximately £1200.
·
Gobo clocks -- Whilst liability for failure has still to be
defined, provisional allowance for work assessed at £500.
·
Wobbly sinks -- MDL to provide gaskets for Sheraton to
action. Approximate cost allowance
assessed at £500.
·
Staining to limestone: MDL's position is to make a
contribution boards cleaning of the net areas affected of £2000.
·
Glass breakages -- MDL disclaimed responsibility.
The total
value of direct works needed to complete the Spa snagging list, based on the
above, is approximately £20,700.
This excludes
any allowances for consequential losses, such as additional heating costs
associated with the pool cover, or for the costs associated with glass
breakages (in the latter regard, MDL are firmly of the opinion that this is an
insurance matter)".
It is apparent from this letter, and
was confirmed by Mr McGowan's evidence, that the parties' representatives
identified the known defects in the Spa and put approximate figures on the cost
of rectifying each of them. The one exception
to this related to the glass breakages.
As the letter indicates, the pursuers continued to deny that they were
liable in any way for those breakages.
The estimated cost of remedying glass breakages was somewhat less than
£90,000.
[3] The parties' representatives reported on the meeting, and a
further meeting was arranged between Mr McGowan and Mr Boland, to take place on
"Further to our meeting yesterday, my understanding of what was agreed and proposals for addressing some of the detail, are as follows:
...
b) Final Account for Spa agreed at £8,265,000. T&T to issue the necessary paperwork with retention adjusted to £20,700. Of the balance shown on the certificate as due and payable, £90,000 will be withheld by you pending resolution of glazing issue (see d) below).
c) MDL to complete the agreed list of defects (which specifically excludes the glazing issue), at which point COMDG [certificate of making good defects] will be issued and the retention paid to MDL.
d) MDL continue
to refute any liability or responsibility for the glazing issue. We recognize your concerns on recoverability
if you subsequently prove our liability and hence your proposal to withhold the
£90,000. I confirm that we will not
pursue recovery of the £90,000 held by you, provided that you pursue the matter
diligently with your insurers, consultants and other contractors who may have a
responsibility for recovery of your losses.
On receipt of any sums from any of these sources, you will release the
appropriate amounts to MDL. If you have
not already released the whole amount by
Four days later, on
"Thanks for
this. On behalf of Hotel Corporation of
Re glazing, I am trying to move this forward".
A copy of Mr McGowan's e-mail was appended.
[4] The
parties were in agreement that the essential terms of their contract were
contained in Mr McGowan's e-mail of 25 July.
A dispute arose as to the construction of that contract, however, in the
following circumstances. Following the
meeting Turner & Townsend issued an interim certificate to the effect that
£237,693 was due for payment; this was based on the agreed valuation of
£8,265,000 and the agreed retention of £20,700 specified in paragraph b) of the
e-mail. Thereafter the pursuers made an
application for payment to the defenders of that sum less £90,000,
that being the sum specified in paragraph d) of the e-mail. The resulting balance was paid by the
defenders. There was some correspondence
leading to the issue of Turner & Townsend's interim certificate, but I do
not think that that correspondence is relevant to the present dispute. After the payment to the pursuers, the
defenders claimed that a number of further defects appeared in the Spa
building; these are said to have been latent at the time of the meeting of
[5] In
due course the date specified in paragraph d) of the e-mail of 25 July,
[6] In
the foregoing circumstances the pursuers raised the present action against the
defenders for payment of the sum of £90,000 specified in paragraph d) of the
e-mail of
[7] The
pursuers' primary response to the foregoing arguments for the defenders is that
rights of retention and balancing accounts on insolvency can be excluded by
agreement. They contend that the
agreement of
[8] As
will be apparent from the foregoing discussion, the critical question that
arises in the present case is whether the defenders have a right of retention
or balancing of accounts on insolvency in respect of the sum of £90,000
referred to in paragraph d) of the e-mail; it is admitted that otherwise that
sum is due to the pursuers. A proof before
answer was fixed on that question; the merits of any claims that the defenders
might have against the pursuers were expressly excluded from the scope of the
proof. I propose first to consider the
evidence led at the proof and its significance in determining the issues in
dispute. Secondly, I will consider the
construction of the contract, and in particular whether it has the effect of
excluding rights of retention and balancing accounts on insolvency. Thirdly, I will consider whether the
contractual arrangements involved the holding of money for a specific purpose
in such a way as to exclude the right of balancing of accounts on
insolvency. Fourthly, I will consider
the application of section 111(1) of the Housing Grants, Construction and
Regeneration Act 1996.
Evidence
[9] The
parties were agreed on the general principles applicable to the construction of
commercial contracts. In relation to the
admissibility of oral evidence, these may be stated as follows. First, it is permissible in construing a
contract to have regard to the circumstances in which the contract was
concluded in order to discover the facts to which the contract refers and its
commercial purposes, objectively considered: Prenn v Simmonds, [1971]
1 WLR 1381; Reardon Smith Line Ltd v Hansen Tangen, [1976] 1 WLR 989. Nevertheless, regard may only be had to
matters that were known, or ought reasonably to have been known, to both
parties: Howgate Shopping Centre Ltd v Catercraft Services Ltd,
[10] On the basis of the following principles, evidence is admissible in order to explain two matters, the factual background to the parties' agreement, so far as known to the parties at the time, and the commercial purposes of the agreement. Evidence is not admissible, however, to explore what was said in the course of negotiations. In considering evidence of the factual background and commercial purposes, a further general rule relating to the construction of the contract is important, namely the rule that contracts must be construed objectively. For this reason it is only facts that were or ought reasonably to have been known to both parties that are relevant. Likewise, in considering the commercial purposes of the parties' agreement, it is their common purpose, objectively considered, that must be discovered; commercial objectives held by one party are only relevant if they are communicated to and accepted by the other, or if the other party ought reasonably to have understood those commercial objectives and acceded to them.
[11] Evidence about the meeting of
[12] Mr
McGowan and Mr Dunsmore both gave very clear evidence as to the subject matter
of the meeting of
[13] Mr
McGowan gave certain further evidence about his intentions in concluding an
agreement on
Construction of the contract: exclusion of rights of retention and
balancing accounts on insolvency
Exclusion by contract of rights of retention and balancing accounts on
insolvency
[14] It
is clear that it is competent in a contract to exclude the common law right of
retention, and also the right of balancing accounts on insolvency. There was some disagreement between the
parties' solicitors as to the conditions of such exclusion, however, and
accordingly it is necessary to examine the two main authorities on the point, Redpath Dorman Long Ltd v Cummins Engine Company Ltd, 1981 SC
370, and Gilbert-Ash (Northern) Ltd v
Modern Engineering (Bristol) Ltd,
[1974] AC 689. The former case is the
only Scottish authority. It involved a
clause in a building contract, clause 43, which was in the following terms:
"Whenever
under the contract any sum of money shall be recoverable from or payable by the
contractor, such sum may be deducted from or reduced by the amount of any sum
or sums then due or which at any time thereafter may become due to the
contractor under or in respect of the contract".
The pursuers contended that that
clause excluded the common law right of retention. That argument was rejected. Lord Justice-Clerk Wheatley stated the
parties' arguments as follows (at 373):
""Counsel
for the defenders, while accepting that it was for them to establish that there
existed a right of retention of money which was otherwise payable by them under
the contract, maintained... that a right of retention existed at common law
apart from any such right under the contract itself provided the terms of the
contract did not expressly or by necessary implication exclude that common law
right. Counsel for the pursuers accepted
this as a general proposition, but maintained that the terms of this contract
excluded that common law right by necessary implication in that the contract
itself provided exhaustively for the whole rights of the parties in relation to
retention by clause 43".
The Lord Justice-Clerk continued (at
page 374):
"[The
sheriff] proceeded on the basis that any provision in a contract relating to
set off supersedes and is substituted for the common law right. That is not the correct approach. What was said in the Gilbert-Ash case is that you consider the terms of the particular
contract as a whole to see whether there are any provisions therein which,
either expressly or by necessary implication, write out the common law right. Pursuers'
counsel did not quarrel with this approach, but they maintained that Clause 43
of the contract had that effect.... We do not agree. We do not consider that, looking to the
contract as a whole, the terms of clause 43 clearly have that effect. Clause 43 provides for certain remedies under
the contract but these are not exclusive or exhaustive of the manner in which
legal rights arising from the contract may be prosecuted".
It is clear from that statement of
the law that it is competent to exclude common law rights, including the right
of retention, provided that the matter is sufficiently clear from the terms of
the parties' contract. It is, moreover,
clear that common law rights may be excluded either expressly or by "necessary"
implication; that point is important in view of differences of judicial opinion
in Gilbert-Ash.
[15] Gilbert-Ash (Northern) Ltd v Modern Engineering (
"The parties
to building contracts or sub-contracts, like the parties to any other type of
contract are, of course, entitled to incorporate in a contract any clause they
please. There is nothing to prevent them
from extinguishing, curtailing or enlarging the ordinary rights of set off,
provided they do so expressly or by clear implication".
Viscount Dilhorne appeared to adopt a
similar approach at page 707, although he did not state the principle that is
relied on. Lord Diplock, however, at
pages 716-718 appeared to adopt a different approach. He stated at pages 717-718:
"It is, of
course, open to parties to a contract for sale of goods or for work and labour
or for both to exclude by express agreement a remedy for its breach which would
otherwise arise by operation of law or such remedy may be excluded by usage
binding upon the parties... But in construing
such a contract one starts with the presumption that neither party intends to
abandon any remedies for its breach arising by operation of law, and clear
express words must be used in order to rebut this presumption. In the case of building contracts no question
of usage arises to rebut the presumption.... So when one is concerned with a
building contract one starts with the presumption that each party is to be
entitled to all those remedies for its breach as would arise by operation of
law, including the remedy of setting up a breach of warranty in diminution or
extinction of the price of material supplied or work executed under the
contract. To rebut the presumption one
must be able to find in the contract clear unequivocal words in which the
parties have expressed their agreement that is remedy shall not be available in
respect of breaches of that particular contract".
In these passages Lord Diplock,
differing from Lord Salmon, appears to require express words rather than mere
implication to exclude the principle of retention. The solicitor for the defenders attached
great weight to Lord Diplock's speech, and submitted that I should follow
it. In my opinion Lord Diplock's view on
this matter does not represent Scots law.
In the first place, in Redpath
Dorman Long the Lord Justice-Clerk makes it clear that necessary
implication will suffice; express words are not required. That view is of course binding in the Outer
House. In the second place, provided
that the import of the parties' contract is sufficiently clear, it is difficult
to see why express words should be necessary.
To insist on express words involves a purely formal requirement, with no
effect on substance. That type of
formalism seems quite at odds with the approach of Scots law to questions of
construction, at least in modern times.
What is required is not express words but a clear intention contained
within the parties' contract. In this
connection, I respectfully agree with the test put forward by Lord Salmon, that
the exclusion of common law rights must be effected
either expressly or by clear implication.
"Clear" implication may well be the same as "necessary" implication, but
the latter word carries a philosophical weight that is inappropriate in this
context; consequently I prefer the expression "clear" implication.
[16] The
two foregoing cases were concerned with the common law right of retention and
its English equivalent. I am
nevertheless of opinion that similar principles apply to the right of balancing
accounts on insolvency, at least in any agreement that is concluded after the
insolvency of one of the parties. While
this right, unlike retention, is a true form of set off, resulting in the
extinction of a debt, I am of opinion that following insolvency it must be
possible to exclude it by contract provided that that is done either expressly
or by clear implication. In an agreement
concluded prior to insolvency, it is possible that public policy considerations
might prevent the exclusion of the right by contract. That could occur in particular if the effect
of the agreement were to confer a preference over general creditors; thus if
the agreement involved the solvent party's ranking in full for its debt,
without any reduction for debts that it owed the insolvent party, that could be
regarded as creating a preference. That
consideration does not apply in the present case, however, and accordingly it
is unnecessary to express any concluded view on the matter. In the present case it seems clear that the
agreement between the parties could not, on any construction, create any
preference in favour of the defenders. I
am accordingly of opinion that the right of balancing accounts on insolvency
may be excluded either expressly or by clear implication.
Legal principles applicable to contractual interpretation
[17] The
parties were agreed on the general principles applicable to the construction of
commercial contracts. These may be
stated as follows. First, a contractual
provision must be construed in the context of the contract in which it is
found; and the contract must be construed as a whole: Gloag, Contract, 399; Capital Land Holdings Ltd v
Secretary of State for the Environment, 1997 SC 109, at 114 per Lord
Sutherland. Secondly, a contract must be
construed objectively, according to the standards of a reasonable third party
who is aware of the commercial context in which the contract occurs. Thirdly, a commercial contract should be
given a commercially sensible construction; this is essentially an example of
the more general rule that a construction that produces a reasonable result
should be preferred over one that does not: Bank
of Scotland v Dunedin Property
Investment Co. Ltd., 1998 SC 657; Mannai
Investment Co. Ltd. v Eagle Star Life
Assurance Co. Ltd., [1997] AC 749.
Consequently, when a court is faced with competing constructions, it
should consider which meaning is more likely to have been intended by
reasonable businessman: Commercial Union
Assurance Co. Ltd. v Hayden,
[1977] QB 804. Fourthly, the court must
give effect the parties' bargain; it must not substitute a different bargain
from that made by the parties.
Construction of contract
[18] The
parties were agreed that the terms of the contract were found in Mr McGowan's
e-mail of
[19] As
indicated at paragraph [12] above, I find that the parties' first specific
objective was to agree the final account for the contract. Their second specific objective was to agree
upon the rectification of the defects identified at the meeting of
[20] Paragraph
b), after agreeing the amount of the final account and the adjusted retention, goes on to deal with a further matter. The third sentence of the paragraph refers to
the balance shown on the certificate as due and payable. This reflects the fact that the balance of
the final account, under deduction of the contractual retention, is a debt
payable by the employer to the contractor.
The same sentence then provides that of that balance £90,000 will be
withheld pending resolution of the glazing issue. There is a reference to paragraph d). That provision is important in my opinion,
because it indicates clearly that the withholding of the £90,000 is distinct
from the contractual retention. The
contractual retention is agreed at one figure, £20,700, and the £90,000 is
withheld from the balance that is payable after deduction of the contractual
retention. Moreover, it is clear from
the last sentence of paragraph b) that the £90,000 is to be withheld pending
resolution of the glazing issue. The
glazing issue had been identified as an area of dispute between the parties. It was an area of dispute that was quite
different from the other defects that had emerged, in that there was no
agreement as to responsibility for it, or as to the appropriate way of
obtaining redress. The pursuers
continued to deny any liability; the defenders were in the process of obtaining
a report from the BRE; and the pursuers had suggested that the defenders should
in any event make a claim against their own works insurance for the
defects. These features all put the
glazing dispute into a different category from the other defects, where
liability was agreed and the pursuers accepted an obligation to rectify. In addition, in relation to the other
defects, matters were dealt with under ordinary contractual procedures, namely
the standard contractual retention fund, rectification works, a certificate of
making good defects and, at that point, payment of the contractual retention
fund.
[21] In
the case of the glazing defect, however, a different procedure was used. In this case, a specific withholding of
£90,000 was agreed. It is noteworthy
that the e-mail uses the expression "withheld" rather than "retained" or a
construction based on the word "retention"; that of itself tends to indicate a
distinction from the ordinary contractual retention. The treatment of this sum is specified in
paragraph d). Paragraph d) begins by
reciting that the pursuers continued to refute any liability or responsibility
for the glazing problem. That simply
represents the factual position at that time.
The paragraph continues by referring to the defenders' concerns as to
the recoverability of their costs if they should succeed in proving that the
pursuers were liable for the glazing defects.
That sentence continues "hence your proposal to withhold the £90,000". That makes very clear sense; the pursuers
were insolvent, and the defenders' concern is entirely understandable. The paragraph then states "I confirm that we
will not pursue recovery of the £90,000 held by you" provided that a condition
is satisfied. That reflects the fact
that the £90,000 is distinct from the contractual retention, and is a sum
withheld from the balance certified as due and payable. The condition is that the defenders should
pursue the matter diligently with their insurers, consultants and other
contractors who might have a responsibility for the defects. That is wholly intelligible in view of the
fact that the parties were in dispute as to responsibility for the defects, and
about their recoverability under the defenders' works insurance. If left by itself, this sentence would be
inspecific about the remedy for three further possibilities; these are success
in recovering monies from other parties, a failure to pursue the matter
diligently with those parties, and the defenders' succeeding in fixing
liability for the defect on the pursuers.
These matters are dealt with, however, in the last two sentences of
paragraph d). The first of these
contemplates that the defenders may be successful in recovering sums from
another party. In that event a
corresponding amount is to be released to the pursuers from the £90,000
withholding. The two other possibilities
are dealt with in the final sentence of the paragraph. Chronologically, the two parts of that
paragraph should be considered in reverse order. First, it is contemplated that the defenders
might succeed in establishing liability on the part of the pursuers, either by
agreement or by court action. In that
event, although it is not stated in terms, it is clearly contemplated that the
defenders may continue to withhold the £90,000 and reimburse themselves for the
cost of rectification out of that sum.
Secondly, it is contemplated that such liability may not be established
within a specified time. The time
selected is the period of slightly more than one year expiring on
[22] These
provisions make it clear in my opinion that the intention of the parties,
objectively considered, was to deal with the sum of £90,000 quite independently
of the contractual retention and quite independently of any other debts that
might be due as between the parties.
That sum was taken from the certified balance that would otherwise have
been due by the defenders to the pursuers and held pending resolution of a
specific issue, namely identifying the party liable for the cost of making good
the glazing defects. That was clearly an
important issue as between the parties; the sum involved was fairly
substantial, and the evidence established that the parties were in sharp
dispute as to liability. Paragraph d)
then deals with the disposal of the sum so withheld in all the eventualities
that are likely to occur as between the pursuers and the defenders; if the
defenders succeed in establishing liability on the part of a third party, the
sum will be released to the pursuers; if the defenders succeed in establishing
liability on the pursuers' part, by court action or by agreement, the sum may
be withheld and if necessary used to pay for the cost of rectification; and if
neither of those events occurs by 31 July 2004, the sum is to be released to
the pursuers. Paragraph d) thus provides
comprehensive and self-contained instructions as to what is to happen to the
£90,000 withheld. The end point of those
instructions is a positive obligation to release the monies if liability has
not been established by
[23] The
same is true of balancing accounts on insolvency. It was known that the pursuers were in
receivership, and it was obviously know that rights of set off might arise. Against that background, the comprehensive
and self-contained nature of paragraph d) is in my opinion a strong and clear
indication that the £90,000 was to be dealt with according to the provisions of
the paragraph and without reference to any other debts that might be due as
between the parties or any set off in respect of those debts. Once again I consider that to be a
commercially sensible result. Moreover,
in the case both of retention and balancing accounts on insolvency, the result
is one that gives effect to the whole of the provisions of the parties'
contract. It reflects the contrast found
in paragraph b) between the contractual retention of £20,700 and the special
withholding of £90,000. It further
reflects the relatively elaborate provisions found in paragraph d) to deal with
the disposal of the £90,000; these must be contrasted with the way that the
contractual retention is dealt with, which accords with the ordinary provisions
of the parties' building contract.
[24] The
foregoing construction of paragraph d) is in my opinion supported by the
evidence, summarized at paragraph [12] above, as to the parties' commercial
objectives. According to the evidence of
Mr McGowan and Mr Dunsmore, which I have accepted, the parties' objective was
to allow retention of part of the certified sum while the defenders attempted
to establish liability on the part of the pursuers through the BRE report but
to provide for payment of that sum to the pursuers by a specified closing date. That indicates that the provisions dealing
with the £90,000 were designed as a self-contained code. It is clear, moreover, that the structures of
that code were based on a compromise deal agreed between the parties; the
compromise was between the pursuers' desire to obtain payment of the certified
sum and the defenders' desire to have security for payment should they succeed
in establishing liability on the part of the pursuers. One further consideration is also highly
significant. The £90,000 was a sum
certified for payment. If it had been
intended that the defenders could retain that sum against any contractual
payments due by the pursuers, including liability for making good other
defects, the straightforward way of achieving that result would have been to
make it part of the agreed contractual retention. In other words, instead of being dealt with
separately, it would simply have been added to the sum of £20,700 which was
agreed as the contractual retention in paragraph b). That was not done, however. That is in my opinion a strong indication
that the £90,000 was intended to be dealt with in a manner quite independently
of all other debts arising as between the parties.
[25] For
the foregoing reasons I am of opinion that the wording of the parties'
agreement, as contained in the e-mail of 25 July 2003, is sufficiently clear to
indicate an intention to exclude the principles of retention and balancing
accounts on insolvency in respect of the sum of £90,000. The solicitor for the defender submitted that
the wording used was not clear and unequivocal.
He pointed out that Mr McGowan had taken considerable care in the
drafting of the e-mail. I agree that Mr
McGowan had taken care about the wording of the e-mail; I think that appeared
clearly from his evidence. The solicitor
for the defender went on to submit that, if Mr McGowan had intended that
the effect of the agreement should be to exclude any further deductions or
cross-claims, it is likely that he would have said so in terms. In my opinion that is not an inference that
should be drawn in this case. It is very
common, indeed perhaps normal, for the draftsman of a contract of this nature
to say what is to happen rather than what is not to happen, because that is the
primary matter dealt with by the contract.
In such a case what is not to happen is left to inference; that applies
to matters such as the exclusion of rights of retention or set off or other
cross-claims. In my opinion that is what
happened here; in the e-mail of 25 July 2003 Mr McGowan stated what was to happen
to the £90,000 rather than what was not to happen, and in my opinion he did so
in such a way as to make it clear that rights of retention and balancing
accounts on insolvency were to be excluded.
[26] The
solicitor for the defender further submitted that other forms of wording could
have been used if the intention had been to exclude rights of retention and set
off. Examples given included the
following: "The £90,000 is to be paid without any deductions"; "Any further
rights of set off and retention are excluded"; and "All common law rights are
excluded". If such wording had been used
the position would have been put beyond doubt.
Because it was not used, however, the defenders' solicitor submitted
that no clear inference could be drawn that rights of retention and set off
were excluded. In my opinion it is
rarely helpful in construing a contract to consider other forms of wording that
might have been used. It is usually
possible to suggest a wide range of alternative formulations, some indicating
the meaning contended for by one party, others indicating the meaning contended
for by the other party. The existence of
such alternatives does not help in choosing between those meanings. The fact is that the parties have not used
those alternatives; they have chosen a particular form of words, and it is
those words and no others that must be construed by the court. In the present case I do not think that the
existence of alternative forms of wording is of assistance.
[27] A
further argument for the defenders was that all that the parties had agreed in
the e-mail of
Balancing accounts on insolvency: funds held for specific purpose
[28] In
relation to the principle of balancing accounts on insolvency, a further line
of authority supports the conclusion that a general right of set off is not
available. It is established that the
principle of balancing accounts on insolvency does not apply to any money that
is held for a specific purpose. That principle
is explained by Lord Ross in Mycroft,
Petitioner, 1983 SLT 342. In that case a firm of accountants had
collected monies on behalf of a company.
After the company went into liquidation the accountants claimed that
they could set those monies off against their claim for fees due to them for
work performed. It was held that they
were not permitted to do so. Lord Ross
referred to a range of cases where compensation and, it would seem, balancing
accounts on insolvency cannot be pleaded.
The first of these is deposit; where monies are the subject of either
proper or improper deposit balancing of accounts on insolvency is
excluded. The second is where an agent
has received money from or on behalf of his principal; the agent's obligation
to pay or account for such funds to his principal cannot be set off against
debts due to the agent by the principal.
The third is where money is held for a special purpose. This rule applies to funds held on trust and,
it would seem, to funds that have been dedicated to a special purpose. Indeed, the two earlier cases, deposit and
funds held by an agent for a principal, can probably be regarded as examples of
this rather wider principle. Lord Ross
considered what a special or specific purpose is in this context, and held that
the funds held by the accountants were held for such a purpose, namely to
provide a fund upon which the company could draw to make payments. He then stated (at 344):
"The reason
why specific appropriation precludes a plea of compensation is that
compensation cannot be pleaded if to do so would be inconsistent with the terms
of the contract express or implied".
That in my opinion represents the
general principle that underlies all of the special cases where set off has not
been permitted.
[29] In
my opinion the foregoing principle is applicable to the present case. The sum of £90,000 was withheld for a special
purpose, namely to provide a fund that was available for a limited period to
satisfy the cost of rectifying the glazing defects, should it be proved that
the pursuers were liable, and was otherwise payable to the pursuers. If the £90,000 had been paid to a third party
to satisfy the purposes specified in paragraph d) of the e-mail of 25 July
2003, that would have created an improper deposit, where there is very well
established authority that balancing of accounts on insolvency is
excluded. In my opinion the result
should be the same even though the monies in question were retained by the
defenders; the monies were still a fund held for a special purpose. That conclusion is strengthened by the fact
that the £90,000 was an amount certified for payment, and should have been paid
immediately but for the parties' agreement; that fact strengthens the analogy
with improper deposit.
Housing Grants, Construction and Regeneration Act 1996, section 111
[30] The
solicitor for the pursuers presented a further argument under section 111 of
the Housing Grants, Construction and Regeneration Act 1996. This was to the effect that, if the defenders
wished to withhold payment of a sum certified as due to the pursuers, they
required to give an effective notice of intention to
withhold payment in terms of that section.
Section 111(1) provides as follows:
"A party to a
construction contract may not withhold payment after the final date for payment
of a sum due under the contract unless he has given an effective notice of
intention to withhold payment".
Section 111 was considered in SL Timber Systems Ltd v Carillion Construction Ltd, 2002 SLT
997, where Lord Macfadyen pointed out (at paragraph [20]) that the provision is
concerned with the situation where a sum is shown to the due under the contract
but the party by whom it is due seeks to withhold payment on some separate
ground. In the present case, the
solicitor for the pursuers submitted, the sum of £90,000 was clearly due, and
the defenders sought to withhold payment on the basis that other defects
existed in the contract works. That was
precisely the situation covered by section 111.
It was not suggested that the defenders that any notice of intention to
withhold payment had been issued.
Consequently the defenders' attempt to invoke the principles of
retention and balancing of accounts on insolvency was misconceived.
[31] The
solicitor for the defenders submitted that the present contract was not a
construction contract; it was rather to be regarded as a settlement or
compromise agreement, standing by itself, independently of the underlying
construction contract. Section 111 only
applies to construction contracts; consequently it could not apply to the
present agreement. The decisions of
Judge Humphrey Lloyd in Shepherd
Construction Ltd v Mecright Ltd,
[2000] BLR 489, and Sheriff Principal Bowen in Quality Street Properties (Trading) Ltd v Elmwood (Glasgow) Ltd, 2002 SCLR 1118, were cited in support of
this contention.
[32] I
agree with the defenders' contention that section 111 only applies to
construction contracts; and that anything that is properly to be regarded as an
independent settlement agreement will not fall under the section. The wording of the section makes clear that it
only applies to construction contracts.
These are defined in section 104(1) as meaning, in essence, any
agreement for the carrying out of construction operations, arranging the
carrying out of construction operations or providing labour for the carrying
out of construction operations. If
parties conclude an independent settlement agreement, that contract does not
fall within the definition in section 104(1), and for that reason I
respectfully agree with the views of Judge Humphrey Lloyd and Sheriff Principal
Bowen in the two cases cited in the last paragraph. Nevertheless, it is important in my opinion
to draw a distinction between settlement agreements that are independent of the
underlying construction contract and agreements, which might in some circumstances
be described as settlement agreements, which merely determine sums that are due
under the construction contract. An
example of the former category is an agreement to accept payment of a specified
sum in full and final settlement of all claims arising out of a construction
contract. An example of the latter
category is an agreement that the amount of the contractual retention under a
construction contract should be fixed at a specified sum. In the latter type of case all that the
parties have done is to agree a particular sum that is relevant for the
purposes of their construction contract; that agreement will be given effect through
the mechanisms available under the construction contract. An agreement of that nature must in my
opinion be considered part of the underlying construction contract, because it has
no existence independent of that contract.
It is only settlement or compromise agreements that can properly be
regarded as independent of the construction contract that escape the provisions
of section 111. This is recognized by
Judge Humphrey Lloyd in Shepherd
Construction Ltd v Mecright Ltd,
at paragraph 14, where he points out that the effect of a settlement
agreement is to replace the original agreement to the extent to which the settlement
agreement applies.
[33] In
some cases, of course, parties may conclude an agreement part of which are to
be considered an independent settlement agreement and other parts of which are
to be considered as giving effect to the construction contract. In my opinion this is such an agreement. The provisions of paragraph b) that agree the
final account and the contractual retention, together with the consequential
certification, merely give effect to the construction contract, and must be
operated through that contract. That
must be contrasted with the provisions of paragraphs b) and d) that agree that
£90,000 should be withheld pending resolution of the glazing issue and the
manner in which that sum is to be dealt with and the glazing issue
resolved. Those provisions are in my
opinion an independent settlement of a discrete element in the parties'
disputes. That settlement is not
referable to the construction contract, but rather stands by itself. I am accordingly of opinion that section 111
does not apply to that part of the agreement.
The parties' present dispute is, of course, concerned with the ability
of the defenders to continue to withhold the sum of £90,000 specified in that
part of the agreement. It follows that
section 111 does not apply to the present case.
For this reason the pursuers' argument based on that provision must be
rejected.
Additional arguments
[34] Certain
additional arguments were presented by the parties' solicitors. In the first place, the solicitor for the
pursuers suggested that, if the provisions of the parties' contract relating to
the withholding of £90,000 and the resolution of the glazing issue were
regarded as an independent settlement agreement for the purposes of
section 111, that would have certain further consequences. In the first place, he submitted that the
normal consequence in Scots law would be that the common law right of retention
could not operate as between that contract and the parties' construction
contract. The right of retention is
based on the principle of mutuality of contractual obligations, and that
principle can only apply within a single contract. In the second place, he submitted that the
right of balancing accounts in insolvency was also excluded as between the
settlement agreement and the contractual contract. The construction contract was a
pre-insolvency contract; the settlement agreement was an independent
post-insolvency contract. In these
circumstances, in accordance with the well-known principle laid down in Asphaltic Limestone Concrete Co v Glasgow Corporation, 1907 SC 463,
pre-insolvency and post-insolvency debts cannot be set off against each
other. Consequently the £90,000 due by
the defenders under the settlement agreement could not be set off against any
liability that the pursuers might have under the construction contract. It followed that either the provisions of the
contract of July 2003 were to be regarded as part of the construction contract,
in which case a notice of withholding should have been issued under section 111,
or they formed an independent contract, in which case rights of retention and
balancing of accounts on insolvency could not apply.
[35] Initially
I found these arguments attractive. On
further consideration, however, I have come to the conclusion that they present
a significant difficulty. In addition,
the arguments were only raised in the second speech for the pursuers, and I do
not think that they were sufficiently canvassed for me to use them as a basis
for my decision. The particular problem
that seems to me to arise on these arguments is as follows. The arguments are only relevant as a ground
of decision if I am wrong in holding that, in respect of the glazing agreement, all rights of retention and set off are
excluded. In that event, these arguments
involve splitting the agreement of July 2003 into two distinct parts and
treating only one of those parts as independent of the construction
contract. That agreement, however, was
plainly negotiated as a package, and if it cannot be held that rights of
retention and set off are excluded as between its two main parts (final account
and contractual retention on one hand; the glazing issue on the other hand) the
normal rule would be that rights of retention were available as between those
two parts. The first part of the
agreement, however, was clearly closely integrated with the construction
contract, to the extent that it can probably be described as a mere
modification of that contract. If that
is so, rights of retention would normally be available in respect of any claims
arising under the construction contract or the first part of the agreement of
July 2003. In that event, it is
difficult to see how rights of retention would not be available generally as between
the construction contract and the agreement of July 2003. The problem is essentially that of
determining what is a part of the construction contract
and what is an independent contract; I do not think that it admits of an easy
answer. In relation to balancing
accounts on insolvency, parallel problems arise. If a pre-insolvency contract is modified
after insolvency, that may still count as a
pre-insolvency contract. Once again, the
problem is that of determining the identity of the contracts involved. As I have indicated, these matters came
towards the end of submissions, and I do not think that they were fully
argued. For that reason I prefer to rest
my decision on the basis set out above, namely that on a proper construction of
the agreement of 24 July 2003 rights of retention and set off are excluded as
between the glazing agreement and the parties' other contractual relationships.
[36] The
solicitor for the defenders drew my attention to the decision of the House of
Lords in Bank of Credit and Commerce
International SA v Ali, [2002] 1
AC 251, and in particular to certain observations of Lord Bingham of Cornhill
at paragraphs 8-10 of his speech. In
that passage, which represents the views of the whole of their Lordships, Lord
Bingham states that a party may, in a compromise agreement, agreed to release
claims or rights of which he is unaware and of which he could not be aware, if
appropriate language is used to make plain that that is his intention. In the absence of clear language, however,
the court would be slow to infer that a party intended to surrender rights and
claims of which he was unaware and could not have been aware. On the basis of
that passage, it was submitted that I should reject the proposition advanced by
Mr McGowan in his evidence that the parties' agreement of
Conclusion
[37] For
the reasons stated previously, I conclude that the agreement of