General information only; not legal advice.

Withholding payment is one of the most practical “pressure points” a client (owner/employer) uses when a contractor or service provider (provider/contractor) fails to deliver what was promised. In the Philippines, it can be lawful—but it can also backfire and expose the withholding party to liability if done without a solid legal and contractual basis, or if the amount withheld is excessive, premature, or done in bad faith.

This article explains when withholding is permitted, how Philippine law frames it, how to do it properly, and the common pitfalls—covering both private and government projects and both general services and construction.

1) The Core Legal Idea: Reciprocal Obligations and the Right to Withhold

Most service and construction contracts are reciprocal obligations:

The provider delivers work;
The client pays the price.

Under Philippine civil law, in reciprocal obligations, a party may generally refuse to perform if the other party does not perform or is not ready to perform. This principle is often referred to (in civil-law discussions) as exceptio non adimpleti contractus—the “defense of non-performance.”

Civil Code anchors (concept-level)

Article 1191 (Civil Code): In reciprocal obligations, the injured party may choose between fulfillment and rescission, with damages in either case, if the other party breaches.
Articles 1167–1169: Deal with performance, delay (mora), and consequences—important because wrongful withholding can place the withholding party in delay.
Articles 2200–2201, 2219, 2220, 2232 (damages framework): Influence exposure if withholding is wrongful or in bad faith.

Practical translation: If the provider is in breach, the client may have a defensible basis to suspend payment—but only to the extent consistent with the contract and proportional to the breach.

2) “Withholding Payment” Can Mean Different Things

In practice, “withholding” can be any of the following:

Suspension of payment (not paying a due billing) because the provider’s performance is defective, incomplete, or delayed.
Retention (contractually agreed holdback), typically a percentage of each progress billing as security for defects/corrections/warranty.
Set-off/compensation (deducting amounts owed by the provider—e.g., liquidated damages, backcharges, cost to complete—from amounts the client owes).
Escrow/consignation-like approach (holding funds while disputing entitlement, sometimes depositing to court in specific situations to avoid being considered in default).
Withholding tax (BIR)—a separate, mandatory concept not tied to breach (often confused with “withholding”).

This article is about withholding due to breach, not tax withholding.

3) What Counts as “Breach” That Can Justify Withholding?

Not every defect justifies withholding an entire payment. The breach must be material enough relative to what’s being withheld, and the contract’s payment milestones matter.

Common breach grounds in services/construction:

A. Defective or non-conforming work

Work fails specs, plans, scope, standards, or agreed performance criteria.
Uses substandard materials or workmanship.
Fails tests/commissioning requirements.

B. Incomplete work (partial performance)

Work billed as complete but not actually completed.
Punch list items remain unresolved beyond agreed timelines.

C. Delay

Failure to meet milestones or completion date without valid extensions.
“Time is of the essence” clauses make delay more likely to be material.

D. Failure to correct defects within the cure period

Many contracts require notice + time to remedy. If the provider ignores or fails cure, withholding becomes more defensible.

E. Failure to submit contractual deliverables

Common in construction: as-builts, warranties, test reports, permits, manuals, bonds, insurances, lien waivers (in some contracts), DOLE compliance proof, etc.

F. Abandonment / refusal to proceed

In construction, this can trigger stronger remedies: termination, takeover, calling on bonds, etc.

4) Contract First: Your Best Authority to Withhold

Philippine courts and arbitral tribunals generally respect the parties’ stipulations, so long as they are not contrary to law, morals, good customs, public order, or public policy.

Key clauses that legitimize withholding:

A. Progress billing conditions

Payment due only upon certification (architect/engineer/project manager).
Payment tied to measurable accomplishments (quantities, milestones).

B. Retention money

Commonly 5%–10% retention per billing, released at substantial completion or after defects liability period, depending on contract.

C. Liquidated damages (LDs)

Predetermined damages for delay or other breaches.
Contract usually allows deduction of LDs from payments.

D. Backcharge / cost-to-correct / cost-to-complete

If contractor fails to correct, client may do the work and charge the cost, deductible from billings.

E. Suspension / termination provisions

Notice requirements, cure periods, grounds, and effects (including withholding and applying payments to completion costs).

F. Warranty / defects liability

Justifies holding final payment until turnover acceptance, and sometimes until warranty security is posted or defects are cleared.

If the contract is silent, withholding is still possible under general principles of reciprocal obligations—but it becomes riskier, because you must justify it as proportionate and made in good faith.

5) Proportionality: How Much Can You Withhold?

A common mistake is withholding too much.

A safer approach is to withhold only what is reasonably connected to:

The value of incomplete/defective portions;
The cost to remedy;
Contractually stipulated damages already due (e.g., LDs); and/or
The agreed retention.

Withholding an entire progress payment for a defect affecting only a small portion of the work can be characterized as bad faith or as the client’s own breach, especially if the provider substantially performed the billed milestone.

Substantial performance matters

Philippine civil law recognizes the concept that if there is substantial performance in good faith, the obligor may recover payment subject to deductions for defects (commonly discussed alongside Article 1234 and 1235 on substantial performance and acceptance/waiver). This is a major reason tribunals often prefer deductions/backcharges over total non-payment when work is largely complete.

6) Notice and Demand: The Procedure That Prevents Backfire

Even when withholding is justified, process matters.

Step-by-step best practice

Document the breach
- Site instructions, inspection reports, test results, photos, minutes of meetings, punch lists, daily logs, correspondence, third-party assessments.
Issue a written notice of non-conformance / delay / default
- Identify exact contract provisions, specs, and deliverables breached.
Give the contractually required cure period
- If the contract is silent, give a reasonable cure period depending on the nature of the defect.
State the payment consequence
- “We will withhold ₱X from Billing No. __ corresponding to __” (be specific and itemized).
Offer measurable cure conditions
- e.g., “Payment will be released upon passing hydrostatic test / submission of as-builts / completion of punch list items.”
Preserve funds (don’t treat it as a windfall)
- If later found wrongful, you’ll owe the amount plus interest and possibly damages.
Keep paying undisputed portions
- This reduces the chance you’ll be tagged as the party in breach.

Why demand matters (delay / mora issues)

Under Article 1169, delay generally begins upon demand (judicial or extrajudicial), subject to exceptions. If you withhold without proper notice and the billing is clearly due, the provider may claim you are in delay.

7) Set-Off / Compensation: Deducting Damages From Billings

When the contractor owes the client money (e.g., LDs, backcharges), the client often deducts those amounts from progress payments.

In Philippine law, legal compensation (set-off by operation of law) requires conditions (both parties creditors and debtors of each other, debts are due, liquidated, demandable, etc.). In many construction disputes, the “damage amount” is contested, not liquidated—so legal compensation may not strictly apply yet.

Solution in practice: use contractual compensation (an express clause allowing deductions) or a clear, itemized backcharge process.

Good practice for backcharges/LD deductions

Reference the clause allowing deduction.
Compute transparently (dates, rates, quantities).
Give supporting documents (quotes, invoices, daily logs).
Notify before deduction (some contracts require prior notice).

8) Retention Money: Security, Not a Penalty

Retention is widely used because it’s predictable and contract-based. But it must be implemented consistently with the contract:

Apply the exact percentage stated.
Track retention separately per billing.
Release retention when contractual conditions are satisfied (often: acceptance, completion of punch list, end of defects liability period, submission of warranties/as-builts).

Common dispute: client refuses to release retention long after acceptance without specific defect grounds. That can be treated as wrongful withholding.

9) Final Payment Is a Special Category

Final payment often has stricter prerequisites:

Substantial or final completion certification
Turnover and acceptance documents
As-builts, O&M manuals
Warranties/guarantees
Clearance of punch list
Release of claims (if contract requires)

Because final payment is frequently tied to formal acceptance, withholding it is often easier to defend if acceptance has not occurred or acceptance is conditional.

But if acceptance is clear and unconditional, indefinite withholding invites liability.

10) Government Projects: Additional Rules and Audit Realities

Government construction/procurement is governed heavily by:

Republic Act No. 9184 and its IRR (procurement framework), and
COA rules/audit requirements,
Standard government contract forms and DPWH/agency guidelines (depending on the agency/project).

In government projects, withholding happens for reasons like:

Lack of required supporting documents for progress payments
Negative slippage beyond thresholds
Defective work requiring rectification
Unliquidated cash advances (where applicable)
Pending COA observations or incomplete deliverables
Retention requirements

Practical difference: Even if an agency wants to pay, it may be unable to process payment without complete documentation, certifications, and compliance with procurement/audit rules. This creates “withholding” that is procedural rather than punitive.

11) Construction Disputes and CIAC Arbitration (A Major Practical Point)

Many Philippine construction contracts fall under the jurisdiction of the Construction Industry Arbitration Commission (CIAC). Under the CIAC’s enabling framework, construction disputes—especially involving progress billings, retention, variations, delays, and defects—are commonly resolved through arbitration rather than ordinary courts when the contract has an arbitration clause (and CIAC has broad coverage in practice for construction-related controversies).

Why this matters: If you withhold payment, the likely battlefield is:

CIAC arbitration (common for construction), or
court litigation (more common for pure services without arbitration clauses), or
a mix (e.g., provisional relief from courts, merits in arbitration depending on clause).

Withholding decisions should be made with an eye to how an arbitrator/judge will read the paper trail.

12) Wrongful Withholding: What You Risk

If withholding is found unjustified or excessive, possible consequences include:

A. You may be treated as the party in breach

Especially if the provider substantially performed and payment was due.

B. Interest

Monetary awards commonly carry interest (often guided by jurisprudential standards on legal interest; the applicable rate and reckoning depend on the nature of the obligation and the period).

C. Damages

Actual damages (proven losses)
Temperate/moderate damages (when loss is evident but not precisely proven)
Moral/exemplary damages (usually require bad faith, fraud, wanton conduct)
Attorney’s fees (in specific circumstances)

D. Rescission or termination consequences

If your non-payment is treated as substantial breach, the provider may seek:

rescission/termination,
payment for accomplished work,
damages for lost profit (depending on proof and contract).

E. Project disruption liability

If withholding causes suspension of work and delay, you may face counterclaims for idling costs, demobilization/remobilization, or opportunity losses—especially if the provider can show the withholding was the real cause of stoppage.

13) Can the Contractor/Provider Stop Work if You Withhold?

Often yes—depending on contract terms and the seriousness of non-payment.

Many contracts allow suspension for:

non-payment beyond X days after due date, after notice.

Even without an express clause, persistent failure to pay can justify suspension/termination under general principles of reciprocal obligations—though providers still typically must follow notice and cure requirements to avoid being tagged as the breaching party.

14) Practical Scenarios and How Philippine Practice Usually Handles Them

Scenario 1: Minor punch list items remain, but substantial completion achieved

Safer approach: Pay the bulk, withhold a reasonable amount corresponding to the punch list value (or rely on retention) rather than withholding everything.

Scenario 2: Serious defects that undermine functionality or safety

More defensible: Withhold the portion tied to the defective scope, require corrective method statement, and condition payment on passing tests/inspection.

Scenario 3: Delay with liquidated damages clause

Common approach: Deduct LDs from billings (with transparent computation), but keep paying for verified accomplishments.

Scenario 4: Contractor fails to submit required closeout documents

Common approach: Hold final payment/retention release until submissions are complete.

Scenario 5: Disputed variation orders (VOs) and billing includes disputed items

Safer approach: Pay the undisputed base scope accomplishments; withhold only the disputed VO amounts pending resolution.

15) Tools to Strengthen Your Position When Withholding

A. Certification mechanisms

Use third-party certification:

architect/engineer certification,
independent testing labs,
consultant assessments.

B. Cure protocols

Create a documented cure workflow:

nonconformance report (NCR),
corrective action request (CAR),
reinspection schedule.

C. Escrow or structured holding

For large disputes, parties sometimes agree to hold disputed sums in escrow while work continues (contract amendment or interim agreement). This can reduce project disruption and bad-faith allegations.

D. Clear computations

Itemize what you withheld and why:

line-item backcharges,
quantity survey computations,
LD day counts with milestone references.

16) Consignation and Related Concepts (When the Payor Wants to Pay, But There’s a Dispute)

Consignation is the act of depositing payment with the court (after proper tender) in specific situations to extinguish the obligation when the creditor refuses to accept payment or cannot accept it, or when there are competing claims, etc.

In service/construction disputes, consignation is not the default tool, but it can matter when:

the client acknowledges an amount is due but the provider refuses partial payment unless the disputed amount is included; or
there are multiple claimants to the same receivable (less common in standard projects).

Because consignation has strict requirements (tender, notice, proper grounds, deposit), it’s usually used only with careful legal handling.

17) Drafting and Negotiation: Clauses That Prevent “Withholding Wars”

Well-drafted contracts reduce disputes dramatically. Clauses that help:

Detailed payment milestone definitions (what “complete” means, what documents are required).
Objective acceptance criteria (tests, tolerances, commissioning steps).
Cure periods and notice addresses (avoid “we never got notice” defenses).
Retention and release rules (timebound release; clear conditions).
Backcharge procedure (notice → opportunity to cure → third-party work → documentary support → deduction).
LD clause clarity (rate, cap if any, how computed, how deducted).
Dispute escalation and interim payment rules (pay undisputed portions; fast-track determination of disputed items).
Arbitration clause (often CIAC for construction) with rules on interim relief.

18) A Practical “Do/Don’t” Checklist

Do

Tie withholding to specific breaches and specific amounts.
Follow notice and cure procedures.
Keep paying undisputed portions.
Maintain a clean paper trail (site memos, minutes, reports).
Use contractual retention/backcharge tools as designed.
Treat withholding as security, not punishment.

Don’t

Withhold everything for minor defects.
Skip notice/cure and rely on verbal complaints.
Inflate backcharges or LD computations.
Use withholding as leverage for unrelated issues (that reads as bad faith).
Ignore acceptance milestones and still refuse release without documented grounds.

19) Bottom Line

In the Philippine setting, withholding payment for breach can be lawful when grounded on:

reciprocal obligation principles, and
clear contractual rights (retention, certification conditions, LD/backcharge deduction, suspension/termination clauses), and when executed with:
proportionality,
proper notice and cure, and
documentation and transparency.

Do it poorly—especially by withholding excessive amounts without process—and the withholding party can end up liable for interest, damages, and even be deemed the breaching party.