Beware Zombie Provisions: Head Contractors’ Rights to Retention Sums Post Termination

By James Fitzgibbon

In this Newsletter/Crash Course, we discuss the role of retention sums in construction contracts and why Head Contractors’ rights to retain the retention sum rarely survives after the contract is terminated.

What is a Retention Sum?

In the building and construction industry, retention sums are used to secure a contractor’s performance of a contract. This includes the timely completion of projects and fulfilling obligations to rectify defective work post-completion. In most traditional building contracts, retention sums are 5–10% of the contract value and are deducted as a percentage from each progress payment by the head contractor. This sum may seem small, but it can represent both the contractor’s profit margin and a safeguard for head contractors against liability for defective subcontractor work.

In construction projects, circumstances may arise where parties elect to terminate an agreement due to repudiation or the need to engage new contractors, resulting in the work being taken out of the original contractor’s hands before practical completion. In these instances, a contractor’s entitlement to the retention sum will depend on multiple factors, ranging from the terms of the agreement to the circumstances of termination.

Does a Head Contractor’s Right to Hold a Retention Survive Termination?

In short, a head contractor’s right to hold and access a retention sum does not survive termination of the underlying contract. However, because retention sums reflect how risk is allocated within a contract, certain rights may survive termination if there are further obligations that warrant a retention sum to secure their performance.

In Galileo Miranda Nominee Pty Ltd v Duffy Kennedy, the contractor (Duffy Kennedy) was issued a show cause notice by the principal (Galileo), followed by a take-out notice, resulting in the contractor’s removal from the job prior to practical completion. Among other issues, a dispute arose over whether Galileo was required to release the retention sum after the take-out notice was issued. Duffy Kennedy argued that because the work was taken out of their hands, they were no longer performing any obligations under the contract and were therefore entitled to the release of the security. However, the Court held that while Duffy Kennedy’s obligation to carry out work had ceased, its contractual relationship with Galileo continued, including obligations to provide certain documents. As such, Galileo was entitled to retain the security to ensure performance of those post take-out obligations.

This case demonstrates the importance of reading the full terms of the contract when dealing with retention sums. Where ongoing obligations arise after a contract is terminated or the obligation to perform work has ceased, such as the payment of liquidated damages or the provision of required documents, head contractors may be entitled to retain retention sums until those obligations are fulfilled.

When Rights May Survive Termination

It is worth noting that the law is not settled regarding entitlements to retention sums after termination. A case from the Supreme Court of NSW, Ceerose Pty Ltd v A-Civil Pty Ltd (No 2), commented that recourse to a retention sum may survive termination where there is no express term or basis for implication in the contract indicating otherwise. The judgment cited the WA Supreme Court case of Perkins (WA) Pty Ltd v Weston (No 2), which noted that the purpose of the retention sum is to secure the due and proper performance of the contract such that:

“If the security was required to be released upon termination of the Building Contract, it would deprive the Principal of the benefit of the security if a failure in the due and proper performance of the Building Contract was only discovered after termination.”

However, there has been no clear determination by the courts as to when retention sums must be released beyond what would be considered ‘reasonable’ and the contractual purpose of the security has been exhausted. Regardless, a question of whether the Principal is entitled to a retention sum after termination prior to completion is dependent on the actual intention of the parties, express or implied.

It remains unclear in law who is entitled to retention sums when a building contract is terminated before completion, and when that entitlement arises. Generally, once a building contract is terminated, the basis on which the retention is held is extinguished and the contractor has a right, by implication of law or equity, to have the sum released to them. However, this will depend on the specific terms of the contract, what the contracting parties’ intentions were, and whether any post-termination obligations have arisen that require a retention sum to secure their performance.

How we can help

The key to avoiding disputes after contracts have been terminated lies in careful drafting, especially regarding entitlements to retention sums. This includes clarity on the conditions of release and the protocols that apply following termination. If you are unsure of your contractual obligations with respect to retention sums, or have any other questions related to building and construction legislation, we recommend reaching out to our experts here at Crisp Law. Contact Crisp Law for advice and information at:

Telephone: +61 2 8042 8701

Email: admin@crisplaw.com.au

References

Galileo Miranda Nominee Pty Ltd v Duffy Kennedy [2019] NSWSC 1157

Ceerose Pty Ltd v A-Civil Pty Ltd (No 2) [2023] NSWSC 345, at [69].

Perkins (WA) Pty Ltd v Weston (No 2), [2022] WASCA 111 at [34].

Eddy Lau Constructions Pty Ltd v Transdevelopment Enterprise Pty Ltd [2004] NSWSC 273, at [95]-[98].