Contract Law – Review of Retention: consultation

Difficulties with the Law

5. Based on the views of the Scottish Law Commission, the more recent judgments and 2 reviews^[4] by Lorna Richardson of the law of retention, on which we’ve heavily drawn, we understand the main difficulties and criticisms of the existing law around the remedy of retention to be as follows:

Counterpart Obligations

6. The operation of the assumption that all of the obligations on Party A under a contract are the counterparts to Party B’s obligations under the same contract, in relation to contracts performed in stages, is currently unclear (as can be seen in the differing treatments of Bank of East Asia^[5] in Inveresk). Furthermore, the suggestion^[6] that retention is only available in relation to a contract’s ‘substantive obligations’ seems to unhelpfully narrow the utility of the remedy.

Material Breach

7. The current law is thought to be that the breach needs to be material but not so material as would justify rescission. It is unhelpful to have materiality used in these differing senses. It is also unclear how serious the breach has to be to allow retention, i.e., how far away from the materiality needed for rescission it can be.

Abuse of the Remedy and its Equitable Control

8. There is the potential for abuse where the obligation that Party B has failed to perform has a much lower value or is of much less significance that the counterpart obligation for which Party A seeks to withhold performance as a result of Party B’s breach. An example of this is an obligation that has been substantially but not completely performed.

9. In respect of both the materiality of the breach and the abuse of the remedy, the SLC thought that the solution may lie in international models such as the European Principles and the UNIDROIT Principles which contain an overriding principle that rights must be exercised in good faith. The view that such a proportionality or reasonableness requirement would be of benefit was shared in the reviews referred to in footnote 4.

10. The court has equitable control of the right to retain performance but there is a lack of clarity both around when the court should exercise its discretion and how it should do so. The operation of the discretion is underdeveloped in the case law. In order to improve how this control operates, and so that it is better understood, it has been suggested that the remedy be subjected to an additional requirement - that the value of the performance being retained should not be clearly disproportionate to the effect of the breach. The onus of proving the clear disproportion would be on the party considered to have breached the contract and against whom the remedy was being used. In addition, and to avoid retention being used abusively, partial retention would be possible rather than the current position in terms of which a party retaining performance can retain all of his unperformed counterpart obligations when faced with a breach.

11. It is important to make it clear that retention is a remedy which is ordinarily available subject to the court’s discretion to refuse it rather than the court permitting retention, in much the same way that a party has the right to specific implement, with the court having a discretion to refuse it in exceptional circumstances. A parallel may also be drawn with the remedy of lien, which is closely related to retention: there the court is empowered to prevent use of the remedy to prevent abuse and unfair oppression of the debtor (see Steven, Pledge and Lien, para 15.05).

12. Lorna Richardson’s review examined all of the controls on the right to retain, of which the court’s equitable control is one. For completeness those current controls have been analysed as:

Anticipatory Breach

13. While not being a particular difficulty, for completeness we discuss anticipatory breach. The remedy of retention doesn’t appear to be available in relation to an anticipatory breach even if it is clearly going to happen and would be a material breach. The Vienna Convention and European principles recognise this issue.

14. The SLC suggested that the law could be reformed by:

• Recognising that a creditor may withhold performance in response to an anticipatory breach, and
• Enabling a creditor to seek clarification of the debtor’s position where the creditor has reasonable doubts about the debtor’s intention to perform.