Liens in works contracts: How to avoid risks and protect your finances

Works contracts are the cornerstone of many business relationships, particularly in the construction, manufacturing and IT sectors. With their scope and complexity, Works contracts are the cornerstone of many business relationships, particularly in the construction, manufacturing and IT sectors. With their scope and complexity, we often encounter the institution of retainers, also known as retentions. These retainers are a common part of contractual arrangements and serve primarily as a tool for the client to ensure that the contractor's work is properly performed and faultless. It is the part of the agreed price of the work that is not paid immediately upon completion of the work, but only after specific, contractually defined conditions have been met. These conditions may include, for example, the expiry of the guarantee period, the elimination of any defects and deficiencies found, or the successful completion of the final tests of the work.we often encounter the institution of retainers, also known as retentions. These retainers are a common part of contractual arrangements and serve primarily as a tool for the client to ensure that the contractor's work is properly performed and faultless. It is the part of the agreed price of the work that is not paid immediately upon completion of the work, but only after specific, contractually defined conditions have been met. These conditions may include, for example, the expiry of the guarantee period, the elimination of any defects and deficiencies found, or the successful completion of the final tests of the work.

Author of the article: ARROWS (Mgr. Daniela Sobotková, office@arws.cz, +420 245 007 740)

For both parties to the contractual relationship - the contractor and the client - retentions represent an important element with potential for both security and uncertainty. Contractors often perceive retentions as funds withheld that can significantly affect their cash flow and overall financial stability. Prolonged or unjustified retention of these amounts can lead to significant financial difficulties and jeopardise the continuity of other projects. On the client's side, while retentions serve as an important safeguard against defective performance, they can also be a source of complications if the conditions for their release are not clearly and unambiguously articulated. In such cases, even for the client, the retentions can become the subject of disputes and legal complications. These financial and contractual uncertainties naturally provoke a considerable emotional response from both parties as they affect their financial security and confidence in the business partner.

The basic problem with retention payments in the Czech legal environment is that Czech legislation, unlike international accounting standards (e.g. IAS 11), does not contain an explicit legal regulation or definition of the term "retention payment" or "retention". This lack of a specific legal definition creates considerable legal uncertainty and makes the case law of the courts absolutely crucial for the interpretation and application of these arrangements. The decisions of the Supreme Court of the Czech Republic and the Constitutional Court have far-reaching implications for how liens are interpreted, what rights and obligations arise from them, and what risks are associated with them. Therefore, it is essential for every businessman who is involved in the field of works contracts to have an up-to-date overview of legal developments.

At ARROWS, we deal with the issue of suspensions on a daily basis and understand the complexity that this institute brings. Our goal is to protect the interests of our clients, whether they are contractors seeking to claim their rightfully withheld monies or clients who want to be assured of flawless work and minimize their risks.

Suspensions under the magnifying glass: Legal nature and purpose

A retainage is a contractually agreed portion of the price of the work, the payment of which is deferred until specific conditions are met. In practice, these are most often conditions related to the defect-free nature of the work, such as the removal of all defects and deficiencies or the expiry of the warranty period. This mechanism is particularly widespread in the construction industry, where it is also common to see a gradual release of the retained amount, for example 40% of the retainage after two years and the remaining 60% after five years from the completion of the work.

A key legal perspective on suspensions, which has far-reaching implications for both parties to the contract, lies in the case law of the Supreme Court of the Czech Republic. The Supreme Court has repeatedly emphasised that a retainage arrangement is not merely an agreement to postpone the due date of the work. Instead, it is an agreement on the terms of the claim for payment of the price of the work. This difference is crucial. If the standstill is construed as a deferred payment, the claim exists, it is just not yet enforceable. If, however, the suspension is a condition of the claim, it means that the right to payment of that part of the price of the work does not arise at all until the agreed condition is fulfilled.

This jurisprudential distinction between the condition for entitlement and deferred payment fundamentally changes the allocation of risks and the enforceability of stays. Its nuances are often overlooked by parties drafting contracts without specialist legal advice. If the condition is not clearly defined and fulfilled, the right to payment simply does not arise. This has profound implications, particularly in the case of insolvency. If the contractor goes bankrupt before the condition for the release of the retention is met, the amount does not become part of the insolvency estate, which protects the client from having to pay the trustee without receiving consideration such as the rectification of defects. For the contractor, on the other hand, this means that failure to comply with the condition may lead to a complete loss of entitlement to the retention, even if the work is largely completed. This is where the critical importance of precisely defining the conditions for the release of the retainage in the contract becomes apparent. Vague or poorly worded conditions can lead to disputes as to whether the right to payment has arisen at all, making the overall purpose of the retainage uncertain.

Risks for contractors: when can a suspension become a nightmare?

For the contractor, retentions are not only a financial security for the client, but also a potential nightmare if there are obstructions in their release. Imagine a situation where, as a contractor, you complete a major work in accordance with the contract, but the client, for various reasons, prevents you from meeting the conditions for releasing the retention. This could be a refusal to accept the work, not allowing access to rectify minor defects, or deliberately prolonging the process. Your money is blocked and you find yourself in a situation where you have done the work but cannot access your rightful funds, which can have a devastating impact on your business.

Fortunately, Act No. 89/2012 Coll., the Civil Code (hereinafter referred to as the "CC") offers a lifeline in such cases in the form of Section 549. This provision stipulates that if the client deliberately and unjustifiably frustrates the fulfilment of a condition to which the release of the retention is linked, this condition is deemed to have been fulfilled. This means that even if the condition has not been formally fulfilled due to the client's obstruction, the contractor is entitled to the release of the retention. However, four elements are crucial for the successful application of this provision: (i) the impermissibility of the client's conduct, (ii) its intentionality, (iii) its unjustifiability and (iv) the benefit that the client derives from the obstruction of the condition. Intentionality means the intention of the principal to frustrate the condition, and there must be an actual consequence, not a mere effort. As a result of the fulfilment of this legal fiction, the contractor may be entitled to claim the release of the retention. Crucially, section 549 of the CC shifts the burden of proof regarding the "frustration of the condition" to the contractor, which requires careful documentation. When the client deliberately frustrates conditions, it directly causes financial harm to the contractor by withholding legitimate payments

Another critical risk for the contractor is the insolvency of the client. As mentioned in the previous section, if the right to the retention did not arise before the client's insolvency (i.e. the condition for its release has not been met), the claim does not become payable and cannot be filed in insolvency proceedings. If, however, the right to the standstill has already arisen (i.e. the condition was fulfilled before the insolvency), it is absolutely crucial to register the claim in the insolvency register in a timely and correct manner. If the insolvency administrator of the client refuses to perform the work contract, the contractor is entitled to compensation, which is claimed by filing for insolvency proceedings.

Risks for clients: how to ensure quality and avoid disputes?

For the client, the suspension is a key tool to ensure the quality of the work and protect the investment. Imagine you have invested heavily in a construction project or custom fabrication, and after the work is completed, defects are discovered. Understandably, you want the work to perform flawlessly and for your money to be spent efficiently. In such a case, the retainage is your insurance policy and a means of ensuring that defects are rectified or compensation is obtained.

The basis for the effective use of suspensions and minimisation of risks is a precisely formulated work contract. The contract should clearly define the subject matter of the work, its quality, the terms of performance and, above all, the detailed conditions for releasing the retention. The more specific and unambiguous these conditions are, the less room there is for future disputes and ambiguities. The contract should always be "tailored" to the specific project and the relationship between the parties, not just a generic template.

The absence of clear written records, such as detailed handover reports documenting defects, makes it very difficult for the client to prove that the conditions for retention of the retention were not legitimately met. Similarly, late or oral notification of defects may lead to loss of rights due to statutory time limits. All this shows that 'good practice' in contract management is not merely an administrative matter but a direct legal necessity for the enforcement of rights relating to retentions. Failure by the client to follow these practices creates a significant legal and financial risk, as it may be forced to release retentions even for defective work, or lose the ability to claim damages.

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Insolvency clauses: final confirmation of the validity of the discount arrangement in the event of the contractor's insolvency

The bankruptcy of the contractor is a huge threat to the client. Modern works contracts should therefore contain so-called insolvency clauses. These clauses typically negotiate a reduction in the price of the work (often by the amount of the retainage) in the event of the contractor's bankruptcy. Recent decisions of the Supreme Court of the Czech Republic have clearly confirmed the validity of such clauses. It concluded that if the right to the retainage did not arise before the contractor's bankruptcy (i.e. the condition for its release was not met), there is no reason for the insolvency administrator to seek its repayment to the estate. This clause is now a common and required institute in commercial dealings, which provides a clear tool for principals to minimise the risks arising from the potential bankruptcy of the contractor and to prevent the insolvency administrator from claiming a surcharge on the retentions to the estate if the right to the retention did not arise before the bankruptcy.

Administration of suspensions can be challenging - proper contractual setup and careful documentation will help avoid confusion and disputes. The retainage should be an incentive for both parties to complete the work and remedy defects smoothly, not a source of uncertainty. If it is well set up, the contractor knows what he must do to get the money and the client knows he has an effective tool to secure his rights. Otherwise, there is administrative wrangling, recrimination and, in the worst case, litigation for relatively small sums - which pays no one.

Interest on late payment and compensation for damages: when are you entitled to interest on a wrongfully withheld retention?

If the retention is unjustified, the contractor is entitled to interest on the delay. The Constitutional Court has repeatedly emphasised that interest on late payment has a reparative function and is crucial for effective judicial protection and full compensation. Denial of the right to default interest would allow the obligor to successfully evade its obligations without any penalty. The disallowance of default interest may be allowed only exceptionally in justified cases.

However, it is important to distinguish correctly between default interest and damages. A creditor is entitled to compensation for damage caused by the non-performance of a monetary debt only if this damage is not covered by default interest. In commercial relations, default interest is set off against the compensation for the damage caused by the delay in the performance of a monetary obligation. The correct assertion of these claims is crucial to obtaining full compensation for funds wrongfully withheld.

Current case law you need to know: Views of the Supreme Court of the Czech Republic

Recent court decisions confirm the existing approach to suspensions, but also provide specific lessons for different situations. Below are some examples from recent case law and key conclusions:

• Judgment of 25 March 2019, Case No. 29 Cdo 561/2017: the Supreme Court confirmed that an agreement on a price reduction in the amount of the retainage in case the contractor goes bankrupt and is unable to provide warranty repairs is valid. Such a clause expresses the value of the unused warranty - in other words, if the contractor goes bankrupt, the client is allowed to keep the retainage as a discount on the price of the work. This decision (published in the Collection of Judicial Decisions) gives clients the assurance that similar arrangements to secure warranty obligations are accepted by the courts.
• Resolution of 20 November 2024, Case No. 33 Cdo 3199/2023: In this dispute, the contractor completed the work properly, the client accepted it without reservation and the work was handed over without defects. Nevertheless, the client refused to pay the retainage, citing a contractual penalty for failure to remedy the defects. However, the lower courts (and the Supreme Court dismissed the appeal) found in favour of the contractor: if the work was completed without defects, the client is not entitled to a contractual penalty for failure to remedy the defects and must pay the retainage. In other words, an unjustified penalty cannot justify the non-payment of the retention. This judgment emphasises that the client may withhold the retention only if the defects or the contractor's failure to fulfil its obligations actually occurred, not arbitrarily.
• Judgment of 2 July 2024, Case No. 23 Cdo 2220/2023: The Supreme Court has repeatedly confirmed that a retainer is not a simple postponement of the payment of a part of the price, but an agreement on the creation of the right to its payment only after the condition has been fulfilled. Until the agreed conditions are met, the contractor has no claim to the suspended amount and no such claim exists at all. An action for payment of a retention of debt brought before the condition precedent has been fulfilled would therefore be dismissed. This concept is consistent with the purpose of the standstill as an instrument of protection for the client - the client obtains security that the contractor will fulfil its obligations under the guarantee. If it were only a suspension of payment, the contractor would become a creditor of that part of the price after the lapse of time even if he failed to fulfil his obligations, which would defeat the purpose of the retention. Thus, the courts insist that a properly worded retainage operates as a contingent claim - it accrues to the contractor only upon proper performance of what it has undertaken to do (e.g., remedy defects).

The above decisions confirm that a stay is a legal and effective instrument if it is clearly negotiated and used in accordance with the contract. At the same time, however, they warn that its misuse or formal defects may lead to litigation or unenforceability.

Practical tips for your work contract

A proactive approach to the creation and management of work contracts is essential to minimise risk and protect your financial interests. The following practical tips, supported by recent case law and practical experience, will help you ensure that your contracts are a solid foundation for your projects.

How to correctly formulate the conditions for the release of the suspension

Since the stay is in a legal sense a condition precedent to the right to payment, it is critically important to clearly and unmistakably define the conditions for its release in the contract. Avoid vague and general wording that may lead to differing interpretations and disputes. Specify exactly what the contractor must do (e.g. handover of the work free of defects and deficiencies, expiry of a specific guarantee period, submission of a certificate of approval) and within what timeframe. Consider the possibility of releasing the retainage gradually depending on project milestones or the expiration of part of the warranty period, which can improve the contractor's cash flow while preserving your security.

The recurring theme of "frequent mistakes" and the judicial emphasis on strict compliance with procedural requirements (e.g., timely notification of defects, proper handover protocols) reveals a significant gap between common commercial practice and legal necessity. This gap often stems from a lack of awareness or underestimation of legal risks, leading to avoidable financial losses. Informal approaches to contractual documentation and communication, such as reliance on verbal agreements, lead directly to a "need for proof" in legal proceedings. The absence of clear documentary evidence, such as detailed handover reports documenting defects, makes it very difficult for a party to prove that the conditions for retention of the retention were not legitimately met. Similarly, late or oral notification of defects may lead to loss of rights due to statutory time limits. All of this shows that "good practice" in contract management is not merely an administrative matter, but a direct legal necessity for the enforcement of lien rights. Failure to follow these practices creates a significant legal and financial risk, as a party may be forced to release retentions even for defective work, or lose the ability to claim damages.

Don't be caught off guard - With ARROWS you are safe

Liens in works contracts are a powerful but tricky tool that requires careful attention and deep legal understanding. Their legal nature as a condition of entitlement to payment, rather than a mere deferred payment, has far-reaching implications for the financial stability and legal position of both the contractor and the client. Thus, retentions can be a great servant but a bad master. When set up correctly, they protect both parties - the client is assured of getting what it pays for, and the contractor knows that it will be fully remunerated when it has fulfilled its obligations. But when they are negotiated sloppily or abused, they become a source of disputes and mistrust.

Don't be caught off guard by the complexity of the law and the constantly evolving case law. Whether you're a contractor trying to collect on your liens or a client looking to ensure impeccable work and protect your investment, ARROWS lawyers are here to help.

Expert lawyers can save considerable sums with timely advice - for example, in the e-book "Lawyers Advise on How to Save Millions" we share a number of tips on how to avoid unnecessary losses by setting up contracts correctly. So don't set up retainers or other important clauses in work contracts unprofessionally. The lawyers at ARROWS Law Firm have extensive experience in this area and can help you set contract terms that are clear, enforceable and in compliance with the law and case law. They will also guide you through the resolution of any disputes - from negotiation, to out-of-court settlement, to representation in court if necessary. Investing in professional legal assistance pays off in this respect: you will avoid the risk of invalid agreements, lengthy disputes and the loss of money you are rightfully entitled to or rely on to ensure the quality of the work.

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