The “right” of retention

It is generally accepted that a defendant in an action for damages cannot exercise the right of “set-off” on the basis of a mere “claim”, which has not crystallised. For example, while the law permits a defendant to set off debts owed to him by the plaintiff against a successful claim in court, he cannot normally resist the plaintiff’s case on the basis that litigation is pending in other courts, resulting potentially in a decree worth more than the sum due to the plaintiff. The rationale for this rule is that a plaintiff who has successfully pursued an action against a defendant cannot have his claim frustrated on the mere possibility of a decree against him in the future.

There are, however, exceptions to this rule, and the right of “retention” is perhaps the most well-known exception. There is terminological confusion over exactly what the term “retention” means, and it has been used to denote two allied but very different legal concepts. Recently, the United Kingdom Supreme Court considered this issue elaborately, in Inveresk plc v. Tullis Russell, [2010] UKSC 19. Although the issue arose as a part of Scots law, Lord Collins observed that English law is no different.

Inveresk had agreed to sell certain intellectual property to Tullis, and the commercial arrangement between the parties was captured in two contracts, which, as Lord Hope notes in his judgment, is common in these transactions. Under the first contract, Tullis agreed to pay an initial sum of £5 million, and subsequently “Additional Consideration”, depending on the volume of sales in a defined time period. Under the second contract, Inveresk agreed to continue manufacture, sale for the same period, and ensure that the value of the assets did not diminish in the course of completing the formalities of transfer. Subsequently, disputes arose between the parties as to the sum of Additional Consideration payable by Tullis, and Inveresk brought an action to recover approximately £900,000. Tullis, meanwhile, brought an action against Inveresk alleging a breach of the second contract, since Inveresk had allegedly not dealt with customers in accordance with the terms of the contract, resulting in a drop in the value of the assets Tullis was to buy. This claim was for about £5 million – substantially greater than the sum Inveresk claimed.

The matter was heard by the Supreme Court on two narrow points, of which one turned on the language of the particular contract. The second point, however, was Tullis’ plea that should Inveresk succeed in its claim of £900,000, it was entitled to “retain” that sum pending resolution of its claim for £5 million against Inveresk. This, naturally, is contrary to the general rule of law that a mere uncrystallised claim cannot be the subject of a set-off, and the Court therefore had occasion to consider the scope of the exception to this general rule, and the circumstances in which it becomes applicable.

Lord Rodger’s judgment is particularly significant. He begins by noting that the term “retention” is “most unhelpfully” applied to two different legal doctrines. The first is the well-accepted principle that a party is not required to perform his obligations under a contract unless the other party does so as well. For example, a tenant can lawfully withhold rent if he alleges that he has not received possession, as can a buyer who claims that he has received “materially defective goods”. At times, this right is also known as “retention”, and is normally allowed when a party is able to establish that the two obligations in question are “counterparts” of each other.

What is more controversial is the claim that a party is entitled to withhold or “retain” the debt, regardless of the performance of the other party of the contractual obligations giving rise to the debt, on the ground that other claims are pending against that party, and that it is therefore “just and equitable” to “postpone” or “retain” this debt. The concept is clear from the following words of Lord Rodger, extracted from paragraphs 57 and 77 of his judgment:

Firstly, a defender has a right to withhold or “retain” payment of, say, the price of goods which he says are materially defective, until the pursuer proves that he has supplied goods which are conform to the contract. But the term “retention” is also applied to the (different) situation where a defender admits that, say, the price of goods is due. In that situation he cannot have any right to withhold payment of the price. But he can submit to the court that he should not be obliged to pay the price until some unliquidated claim which he has against the pursuer (here, a claim for damages) is resolved. In effect, the defender asks the court to allow him to “retain” the price meantime so that, if his claim for damages succeeds, he can offset the liquid damages against the liquid price.

It is important to carefully distinguish between the two types of retention that Lord Rodger refers to above. Lord Rodger traced the “second” right of retention (of illiquid claims) to the Compensation Act, 1592 and cases on the scope of that statute and allied rights. As is obvious, retention, in the proper sense of the term, is not a right as much as it is a remedy in equity, to be granted by a court at its discretion. Lord Rodger was able to demonstrate, therefore, from the authorities on the subject, that a court has the power to allow a defendant to retain a “debt” pending resolution of a claim “arising out of wholly different circumstances”.

Two points are noteworthy. First, Lord Rodger was careful to note that this power of the court to allow the equitable remedy is an “exception” to the general rule that the law will not permit a defendant to postpone the payment of a liquid debt against him in order to have the opportunity to crystallize his own illiquid claim against the plaintiff and then set it off against the plaintiff’s claim. The general rule remains, and courts may resort to the exception only when, for some reason, that would be the just and equitable way to proceed in the particular circumstances”. Secondly, while there is naturally no exhaustive answer to what those particular circumstances are, the fact that the two claims arise out of the same contract or transaction is “a relevant factor”. Another possible factor is the relationship between the magnitude of the claims – if the defendant seeks to retain a debt against a substantially larger claim, he has a better prospect of succeeding.

This issue has never arisen directly in India. Two Supreme Court decisions on the possibility of setting off a mere “claim” – Union of India v. Raman Foundry, AIR 1974 SC 1265, overruled in Kamaluddin Ansari v. Union of India, AIR 1984 SC 29 – turned on a specific clause in a contract. It will be interesting to observe whether Indian courts follow the UK approach, for retention, although sparingly granted, is a powerful remedy for a defendant.

Further analysis of this judgment is available on Legal Developments.