There have been a number of court cases arising out of high-profile insolvencies to affect the construction industry in the last few years.
In one recent case, an agreement between an employer and a contractor's receivers relating to defective works was the subject of the court's consideration. The decision sends a warning to all those exposed to or affected by insolvency when entering into agreements with receivers or their representatives.
Melville Dundas Limited v Hotel Corporation of Edinburgh Limited
Melville Dundas Limited and HCEL entered into a contract for the internal fit-out of a spa building.
Following completion of the works various defects appeared, the most significant of which related to cracking around the external glazing. When Melville Dundas was subsequently placed in receivership, the various defects had still to be rectified and the final account agreed.
In order to reach agreement on the outstanding issues, the parties' technical experts agreed a schedule of outstanding defects and put approximate figures on the costs of rectifying each of them, with the exception of the glazing defect.
The receivers' representative then met with HCEL and reached agreement on matters. This agreement was recorded in an e-mail from the receivers' representative to HCEL dated 25 July 2003.
The parties agreement recorded the figure for the final account together with the retention under the contract. Of the figure shown on the certificate as due and payable, £90,000 was to be withheld by HCEL pending resolution of the glazing issue. Crucially, paragraph d) of the agreement provided as follows:
"d) MDL continue to refute any liability or responsibility for the glazing issue. We recognise 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 31 July 2004, you will then do so, except to the extent that it has been established by our agreement or any court action that we are liable."
HCEL paid Melville Dundas the sum certified in the interim certificate less the £90,000. Following payment, however, HCEL claimed that a number of further defects had appeared in the building which were latent at the time of the parties' meeting.
The long-stop date of 31 July 2004 passed and HCEL had failed to release the £90,000. They had not taken any action against Melville Dundas to assert that they were liable to make good the glazing defects nor had any claim been accepted by the defenders' insurers or any other contractors, yet none of the £90,000 had been released.
Key Facts and Issues
The parties were in agreement that the terms of their contract were contained in the e-mail of 25 July and, in terms of that agreement, the £90,000 was due and payable.
What then was the critical question arising in this case?
In failing to release the £90,000, HCEL argued that they had a common law right to retain the sums due to Melville Dundas against the costs of rectifying the defects that had appeared following the agreement of 25 July.
HCEL also argued that they were further entitled to invoke the principle of "balancing accounts on insolvency" to set off the costs of rectifying the latent defects against the £90,000.
Melville Dundas, on the other hand, argued that the terms of the e-mail of 25 July excluded any right of retention against the £90,000 and also excluded any balancing of accounts on insolvency in respect of that sum.
The key question which emerged, therefore, was whether HCEL had the right of retention or balancing of accounts on insolvency in respect of the £90,000 or had the terms of the parties' agreement excluded these rights.
To answer these questions the court had to interpret the agreement reflected in the e-mail of 25 July. For the agreement to exclude the rights of retention and balancing of accounts on insolvency, it required do so expressly or by clear implication.
The court concluded that it was clear from the agreement that the parties intended that those rights be excluded and it reached this view for the following key reasons.
Paragraph d) of the agreement clearly distinguished the contractual retention from the £90,000. The contractual retention figure was agreed and the £90,000 was withheld from the balance payable after deduction of the contractual retention.
The agreement also made it clear that the £90,000 was withheld pending resolution of the glazing issue. This issue had been identified as an area of dispute between the parties.
As responsibility for the glazing issue was in dispute it was quite different from the other defects that had emerged. The glazing issue was therefore in a different category from the other defects.
Those other defects were dealt with under ordinary contractual procedures e.g. the standard contractual retention fund, rectification works and a certificate of making good defects.
For the glazing issue, however, a different procedure was used which was specified in paragraph d) of the agreement. Paragraph d) provided comprehensive and self-contained instructions as to what was to happen to the £90,000 withheld.
These provisions made it clear that the intention of the parties was to deal with the £90,000 quite independently of the contractual retention and quite independently of any other debts that might be due as between the parties or any set off in respect of those debts.
For these reasons the court decided that the wording of the parties' agreement was sufficiently clear to indicate an intention to exclude the principles of retention and balancing accounts on insolvency in respect of the £90,000.
Practical/Commercial Implications
The implications of this case are potentially wide ranging, albeit at first sight it may appear to be simply a matter of interpreting the contract between the two parties. At the most general level, it tells us that where a deal is struck with a receiver the courts will treat it no differently to a deal struck with any other contracting party.
More subtly, however, it provides a note of warning to all those entering into agreements with receivers or their representatives in relation to outstanding or defective works.
In agreeing terms, care must be taken to ensure that those terms do not exclude rights which a party at some later stage may seek to rely upon. Where those rights are excluded and a sum is due to a party, the courts will expect payment of that sum to be made notwithstanding the recipient's insolvency. In this case, HCEL and Melville Dundas had, in effect, ring-fenced the payment obligation from the usual rules that arise on insolvency.
The implications of this case are evident for the construction sector, whether it be employers, contractors or sub-contractors. But its implications extend beyond the construction industry to all sectors exposed to or affected by issues of insolvency.
What, then, is the best way of avoiding the difficulties raised in this case?
Perhaps the answer comes as no real surprise. When making an agreement in relation to outstanding or defective works with an insolvent party, take expert advice on the nature of the defects believed to exist and take legal advice on the terms of the agreement that is reached.
HCEL and Melville Dundas did the right thing in engaging with each other in order to reach agreement on the outstanding issues. Whilst this case should sound a note of caution for parties to take care when entering into agreements with receivers, it should not serve as a deterrent to entering into dialogue to resolve the differences that exist between them.
