Retention demystified?

The ability of one contracting party to withhold performance of its contractual obligations, in response to a breach by the other contracting party, is a regularly invoked “self-help” remedy in Scots contract law. It also has scope for abuse, particularly because, to date, there has been a lack of clarity as to the limits of a contracting party's entitlement to retain performance.

The Scottish Law Commission reported in March that it will not be pursuing recommendations for a statutory restatement of the law of remedies for breach of contract (in its Report on Review of Contract Law: Formation, Interpretation, Remedies for Breach and Penalty Clauses), so we must look to the judiciary to develop the law of contractual retention. The Inner House's decision in the recent case of J H & W Lamont of Heathfield Farm v Chattisham Ltd [2018] CSIH 33 (1 May 2018) is to be welcomed as providing authoritative judicial guidance on the scope of the remedy.

As is noted in all of the authorities on this topic, the terminology in this area is prone to confusion. The language of “retention” crops up in various areas of Scots law, including in relation to the doctrine of compensation and the practice of balancing of accounts in insolvency. The phrase “contractual retention” is used in this article to emphasise that we are concerned here only with the common law remedy of retention of performance based on the principle of mutuality of obligations in Scots contract law.

The options agreement in Lamont v Chattisham

The issue in this case was whether Chattisham was obliged to deliver a discharge of a standard security that Lamont had granted pursuant to an options agreement. Chattisham argued that it was entitled to refuse to deliver the discharge pending resolution of its counterclaim for damages for alleged breaches of the options agreement.

Lamont owned land at Gartcosh in North Lanarkshire. Chattisham, a developer, was granted an option to purchase the land. The parties entered into an options agreement in terms of which Chattisham would promote the land for development and secure planning permission. Lamont would assist in the planning process and both parties were required to act in good faith and fairly towards each other. Either party could resile without penalty if planning permission was not obtained or if sales of the land to third parties were not achieved by a long stop date. As is commonly provided for in options agreements (and because options agreements cannot be registered in the Land Register in order to alert the world at large to the option holder's interest), Lamont granted a standard security in favour of Chattisham which was described as being in security of all of the obligations undertaken by Lamont in terms of the options agreement. The options agreement also provided that the security was to be discharged on the earlier of the expiry of the option period or termination of the agreement.

Unfortunately, the relationship between the parties deteriorated and the land was not developed. Planning permission was not achieved and, accordingly, no sales of land to third parties were achieved by the relevant long stop date. Lamont terminated the options agreement and asked Chattisham to discharge the standard security. Chattisham refused and claimed it had suffered loss as a result of alleged breaches by Lamont of the options agreement. Chattisham argued that it was entitled to withhold performance of its obligation to discharge the standard security pending resolution of its damages claim.

Lady Wolffe in the Outer House concluded that Lamont was entitled to receive a discharge of the standard security. Chattisham was not entitled to rely on the principle of contractual retention in order to refuse to grant the discharge pending the resolution of its counterclaim. Chattisham appealed to the Inner House.

Key points from the appeal judgments

The Lord Ordinary's decision was upheld on appeal in a decision which seeks to clarify the circumstances in which a party is able to retain performance of its contractual obligations. Important points emerging from the judgments include:

• Clarification that the remedy of contractual retention is not normally available when a contract has come to an end, whether by termination following material breach of contract, or in terms of the contract itself. The Lord President, Lord Carloway stressed that: “It is a remedy intended to compel performance in a subsisting contract. It is not one normally available to a party who does not seek performance by the other party, but has resiled and/or only seeks damages for a past breach of contract which is unlikely to be repeated”.
• The remedy of contractual retention can be excluded by implication from the terms of the parties' agreement. While the common law presumption that all contractual obligations are mutually interdependent is upheld, the correct approach to determining whether a claim to contractual retention exists requires construction of the agreement between the parties in order to ascertain whether one party may demand performance of an obligation independently of the other obligations of the parties. In this case, it was concluded that the existence of the security was the counterpart of the option itself. Once it became impossible to exercise the option, the security had to be discharged.
• Equitable considerations play an important role. Lord Drummond Young stressed that “Retention is equitable in nature”, and that the courts would not allow the remedy of contractual retention to “become an instrument of abuse, in such a way as to enable a party to a contract to avoid implementing obligations that are clearly due because of a possible counterclaim of uncertain merit or for an uncertain amount”.

It should be noted that not all points raised in the opinions serve to bring greater clarity to this area of law. In particular, it is thought, following the House of Lords decision in 1996 in Bank of East Asia v Scottish Enterprise 1997 SLT 1213, that when a contract is to be performed in stages, contractual retention only operates within each stage of the contract, As such, performance in respect of one stage of the contract cannot be withheld as a result of a breach arising in another stage. However, in Lamont v Chattisham, Lord Drummond Young casts doubt on this commonly understood position, stating that Bank of East Asia should not be construed as suggesting that in instalment contracts, the operation of contractual retention should be reduced or should differ from the “traditional approach”. While progress has been made, there is further debate to be had before all principles governing contractual retention can safely be treated as settled law.

The question of whether, as a matter of general principle, standard securities granted in respect of an obligation ad factum praestandum secure not only the non-monetary obligation itself but also damages for breach was not addressed by the Inner House, since it concluded that the contractual scheme in this case was clear that, come what may, the standard security had to be discharged on termination of the option agreement. This is an issue which may well be addressed by the Scottish Law Commission in its upcoming review of the law relating to standard securities.

The decision will also be welcomed by practitioners as bringing certainty to the status of land subject to an option agreement (and an accompanying standard security) at termination of the agreement. Had the Inner House's conclusions regarding contractual retention been otherwise, land could potentially be tied up for years pending the resolution of litigation, however spurious a damages claim on the part of the option holder might be.