Retention Sum in Construction Contracts

Can we really trust that the retention monies deposited to an employer in a construction contract be returned? -- Time for Malaysia to wake up and recognize the commercial realities faced by contractors.

All standard form construction contracts in Malaysia, with the exception of Public Works Department Contract PWD 203/A, contain a provision for the retention of monies due to the Contractor by the Employer ultimately serving as a safeguard against the possibility of the Contractor’s failure to complete works or defective works. The retention monies are normatively portioned out into two moieties where the first moiety will be released upon Certificate of Practical Completion (“CPC”) of the Project and the second moiety being released upon Certificate of Making Good Defects (“CMGD”). Now, envisage a scenario where the Employer at the tail end of the construction contract goes into liquidation, does the retention monies held by the Employer due to the Contractor be regarded as trust monies or merely a simple debt owed?

Up until a month ago, it has always been implied that retention monies are by their nature and purpose, trust monies held by the Employer for the Contractor for specific purposes i.e. for payment on the costs incurred by the Employer to rectify defective works or to complete the works left uncompleted by the Contractors. (Qimonda Malaysia Sdn Bhd (in liquidation) v Sediabena Sdn Bhd [2012] 3 MLJ 422).

However in March 2019, the Federal Court case of K M&E Bersekutu Sdn Bhd v Pembinaan Legenda Unggul Sdn Bhd (In Creditors’ Voluntary Liquidation) concluded that for retention sums to be deemed as monies held on trust, there must be clear contractual language as well as a separation of the retention sums into a trust account. The Federal Court went further and held that a trust cannot be implied in law in the absence of an express clause to decipher that a trust is in existence and that the word “deduction” of retention sums does not manifest parties’ intention to regard retention sums as trust monies as security to secure the contractor obligations.

The upshot of the decision is alarming, leaving a vulnerable set of circumstances for contractors and subcontractors as they are now considered unsecured creditors. In light of the decision of the Apex Court, the following safeguards can be taken by contractors concerning retention sums being declared as trust monies:

1. Contractors should write to the Employer from the very inception to set-up a trust fund;

2. Contractors should segregate this retention monies and place them in authorized banking institution to be deemed as trust monies; and

3. In the absence of the above, having an exchange correspondence to manifest clear intention of parties to regard retention monies as trust monies.

...a trust cannot be implied in law in the absence of an express clause...

Notwithstanding the abovementioned safeguards, I respectfully am of the view that the Apex Court has not taken into consideration the commercial realities of the construction industry, particularly in the Malaysian context. The reported case laws in Malaysia would reveal that there were only a handful of cases where a contractor had actually applied for the preservation of retention monies during the pendency of the contract, and was done so after the Employer had gone into liquidation. There could be many reasons why the fund was not set aside; the obvious ones being that the contractor would not want to jeopardize the commercial relationship of the parties when the contract was still subsisting; the contractors would not really apply their minds to taking such action to preserve the retention funds especially when the employer was paying monies under the payment certificates; and so on.

To this end, I think time has come for Malaysia to consider reforms in the UK, Australia and New Zealand by enacting legislation to mandate retention monies to be kept in banking institutions.

*Next up, we will delve on the reforms by Commonwealth Countries in relation to the status of retention sums and how Malaysia should tackle same.*

The information and views set out in this note are those of the author(s) and do not necessarily reflect the official opinion of Thomas Philip.