What is Retention?
Legal retention, also known as set-off, is the retention by one party to a contract, of payment or performance of a contractual obligation, against the non-performance of another party’s contractual obligation. This is based in Scots law on the mutuality principle, which is that one party does not have to fulfil its obligation if the other party is not fulfilling its reciprocal obligation. The obligation retained is not extinguished but is suspended pending performance by the other party of its reciprocal obligation. The non-performance retained against must be more than trivial. This type of retention is not restricted to a single contract; it may operate across different contracts.
Sometimes, contracts expressly provide for retention or set-off for that contract or across separate contracts. This is a more certain way to set up these rights, than to rely on the general law. This article discusses the general law only.
Retention has a particular and separate meaning under construction and engineering contracts. Under those contracts, retention is the term commonly used for a portion (usually 5%) of an interim payment retained by an employer pending completion of the works or the end of a defects period. That retention is not the subject of this article.
Differences North and South of the Border
The differences in this area of law between Scotland and England are considerable. Any party to a contract should be aware of the legal limits applied to the principle of cross contract retention or set-off for transactions north of the border. Under English law, equitable set-off is a remedy that can be used across contracts that are not dependent on each other. The cases below illustrate the contrasting limitations under Scots law.
Glen Clyde Whisky Limited v Campbell Meyer & Company Limited
The facts of this case are as follows. The Pursuer imports and distributes whisky; the Defender produces bottles and packages whisky.
In a contract for the supply of whisky, the Defender retained its performance on certain contracts where the Pursuer had failed to pay for whisky under other contracts. It did this on the basis of the principle of mutuality of contract. The principle of mutuality can be explained as a general presumption that a contract is viewed as a whole, and that the stipulations under that contract are counterparts and consideration given for each other. Therefore, should there be a failure by one of the parties under the contract, this will justify the other in withholding performance of his obligations under the contract, dependent on the seriousness of the breach by the other party.
The principle of mutuality can also extend outwith a single contract. Therefore, if different contracts between the same parties are so closely related that they are inter-dependent then, where one of the contracts is breached, retention can be exercised under the other contract. This cross contract retention, also known as set-off, is illustrated in the case of Inveresk plc v Tullis Russell Papermakers Limited, which is discussed below. Generally, in order for the requisite interdependency to exist, the courts will look for contracts interacting in such a way as to bring about a single outcome. It will be important that each contract is responsible for an integral aspect of the process which results in this outcome. The test is a high one and was the decisive issue upon which this case turned.
In Glen Clyde the Defenders argued that as the contracts themselves were of exactly the same nature, they were interdependent for the purposes of the exclusive supply agreement that they had with the Pursuer. A large part of the evidence led in the Court of Session concerned how exactly each contract was concluded and when payment would be made under each contract. Whilst all of the contracts were the same in procedural terms, this was not sufficient for the Court to determine that there was the interdependency required to justify retention of performance across those contracts.
Comparing Glen Clyde and Inveresk plc v Tullis Russell Papermakers Limited
In the Glen Clyde case, the Court of Session in Scotland took the approach that the contracts that were concluded for the supply of whisky were all standalone contracts that were capable of operating independently. That fact that these contracts were procedurally the same and all part of the same arrangement that Glen Clyde would receive their whisky exclusively from Campbell Meyer, did not of itself make these contracts interdependent. What is necessary is a reliance on the different contracts all being completed successfully in order for a single outcome to be achieved. Without this, the only way to achieve cross-contract set off would be by way of a specific contractual clause.
The UK Supreme Court took a different approach in 2010 in the case of Inveresk plc v Tullis Russell Papermakers Limited. The facts of the case were that Inveresk sold their paper brand to Tullis Russell under two contracts. The first was an Asset Purchase Agreement (APA) and the second was a Services Agreement (SA). Under the APA the paper brand, customer information and related assets were sold for £5 million. Under the SA, Inveresk was to keep producing and delivering the paper for 5 months after the sale was concluded. The APA contained an additional payment provision, which allowed Inveresk to recover the money Tullis would make during the 5 month transition when Inveresk was still producing paper.
Inveresk sued for the additional amount due under the APA, some £909,395. However Tullis retained payment of that amount because it had raised a separate action claiming that Inveresk had breached the SA by not making paper of a sufficient quality. The Supreme Court held that Tullis was entitled to withhold payment on the basis of the principle of mutuality. The court held that the APA and SA were part of the same agreement and that the additional payment was counterpart to Inveresk meeting its obligations under both contracts.
The Glen Clyde and Inveresk cases highlight a distinction between two types of cases. Glen Clyde involved a set of independent contracts which formed part of an exclusive supply agreement. The corresponding obligations were for payment and delivery of the whisky under each individual contract. These individual contracts for the purchase and supply of whisky did not require anything from each other in order to be fulfilled. This can be contrasted with Inveresk v Tullis where the APA and the SA were clearly related in a substantial way, the SA having only been drafted to effect the transfer of the full benefit under the APA.
The above cases illustrate that under the general law in Scotland the scope to operate cross-contract retention or set-off is much narrower in Scotland. Under English law, there is greater scope to do so based on equitable remedies. In either jurisdiction, express provision for the exercise of such rights would give greater certainty.