UK: Collateral Warranties: Assignment And Rights Of Action To Sue For Breach Of Contract

Last Updated: 11 August 2010
Article by Christopher Hill, Steve Abraham and Donald Warnock

In the following Scottish case the court had to consider the validity of various assignments of collateral warranties to the sub-tenant of a property and the enforcement of those collateral warranties against the parties who originally provided them. The package of collateral warranties available reflected the complex contractual arrangements put in place by the parties. The case is interesting for the pragmatic and commercial approach taken by the judge on enforcement of collateral warranties.

Scottish Widows Services & Anor v Harmon/CRM Facades Ltd [2010] ScotCS CSOH 42

The employer appointed a management contractor (LMS) and an architect (BDP) to design and construct a new head office for the Scottish Widows Fund and Life Assurance Society (the Society) at Port Hamilton, Edinburgh.

One of the constructed building blocks suffered defects as a result of storm damage the effect of which rendered the building no longer wind or watertight. The defects were attributable to the glazing works contractor (Harmon), the roof works contractor (Kershaw) and BDP.

The lease structure of the land appears to be that the original lesee of the land (EDC) assigned its rights to the land to its funder, Scottish Widows (Port Hamilton) (Port Hamilton). Port Hamilton in turn granted a sub-lease to the Society and the Society simultaneously assigned its rights to Scottish Widows Services Ltd (the Sub-Tenant).

The Society received a collateral warranty from BDP, LMS, Harmon and Kershaw.

Port Hamilton received a collateral warranty from Harmon as well as a separate guarantee from Harmon's parent company (WSA) which guaranteed the obligations of Harmon under the collateral warranty (the Guarantee).

The Society and Port Hamilton assigned to the Sub-Tenant the collateral warranties received from BDP and Harmon and the Guarantee from WSA. In relation to Kershaw the Sub-Tenant received an assignment from LSA of Kershaw's works contract.

The remedial works to repair both the glazing/cladding and roofing defects to the building (at a cost of almost £6 million) were carried out by the Sub-Tenant following the assignment of the sub-tenancy from the Society.

Following the assignments of the various collateral warranties, Guarantee and Kershaw works contract, the Sub-Tenant was in possession of a complete package of rights upon which to sue those parties who were responsible for the defects in the building.

Were BDP and Harmon in breach of their collateral warranties?

The Sub-Tenant sought to recover the cost of the remedial works on the basis of the collateral warranties which the Society and Port Hamilton assigned to the Sub-Tenant from BDP, Harmon and the Guarantee by WSA.

In particular the Sub-Tenant argued as follows:

  • The BDP collateral warranty: in relation to Harmon's defective glazing works BDP were responsible for the preparation of performance specifications and tender documents and for carrying out technical checks of the design in so far as that was within the normal expertise of an architect.

BDP failed to carry out such inspections and tests and were similarly in breach of their contractual obligations under the collateral warranty which had been assigned from the Society to the Sub-Tenant.

In relation to Kershaw's defective roofing works, BDP were responsible for regular inspections of the progress and quality of the roofing works to determine that the works were in accordance with the contract documents. BDP failed to carry out adequate checks of Kershaw's design of the standing seam roofs which constituted a breach of their contractual obligations under the collateral warranty which had been assigned from the Society to the Sub-Tenant.

  • The Harmon collateral warranty: the glazing works carried out by Harmon were defective - under their works contract Harmon was obliged to provide workmanship to specified standards and were further obliged to exercise all reasonable skill and care in the design of the works, the selection of materials and the satisfaction of any performance specification or requirement.

The Sub-Tenant maintained that they had suffered a loss as a result of Harmon's breach of these contractual obligations under the collateral warranty which had been assigned from the Society to the Sub-Tenant.

  • The WSA Guarantee: the Sub-Tenant argued that the breaches of the Harmon works contract constituted breaches of the collateral warranty granted by Harmon in favour of Port Hamilton and that as a consequence WSA were in breach of the Guarantee (now assigned to the Sub-Tenant).

The Court's legal analysis to collateral warranties

The court analysed the purpose of collateral warranties, summarised as follows:

  • The purpose of a collateral warranty is to provide a right of action between parties who would not otherwise be in any contractual relationship.
  • A collateral warranty constitutes a separate contract between the provider of a warranty and the beneficiary under which the provider undertakes that it will perform specified works to a standard of competent workmanship (in the case of a contractor) or will perform services and observe proper professional standards of skill and care (in the case of a consultant).
  • If the provider fails to perform its duties to the required standard, the beneficiary can bring proceedings to compel such performance or recover damages suffered as a result of the defective performance.
  • In tort the right to sue is based on the existence of a duty of care together with breach of that duty and resulting loss caused to the person to whom the duty is owed. In contract, the right to sue is based on the existence of a contractual obligation and breach of that obligation. The contract creates the duty.
  • The main economic consequence of a physical defect in a building is the cost of the repair. This may fall on the owner of the building at the time when the defect manifests itself. Alternatively, the liability may be transferred by the owner to the tenant or another assignee who then takes on responsibility for the cost of the repair.
  • There is no reason that any person who is liable for the cost of repairing a defect in a building should not be entitled to recover that cost provided that he is the beneficiary of a collateral warranty provided by the person responsible for the defect.

The Court's approach to BDP's breach of collateral warranty

The court held that it was clear from the recitals to the BDP warranty that the Society had a financial interest in the Project. Thus at the outset it was contemplated by the parties that the Society may be the party who would suffer losses as a result of breach by BDP. Further, the Society was entitled under the warranty to assign its rights in whole or in part without consent in favour of a subsidiary company (the Sub-Tenant in this case).

BDP raised numerous defences against the Sub-Tenant's claim for breach of collateral warranty, among them the following:

(i) No loss

The argument was that the physical defects in the building became apparent at the time of practical completion and at practical completion neither the Society or Port Hamilton had a proprietory interest in the building and consequently could not recover loss (McLaren Murdoch & Hamilton Ltd v Abercromby Motor Group Ltd, 2003 SCLR 323).

The court held that BDP's argument was incorrect - the error was the assertion that in a case based on breach of contract the only loss suffered was the physical defect in the building. The physical defect was the primary loss but it produced economic consequences in that it had to be repaired. That liability for repair was also a loss and the person who incurred such a loss could seek to recover it if he was in a direct contractual relationship with the person whose breach of contract has produced the loss.

(ii) No obligation to repair in the sub-lease

BDP argued that the sublease did not impose any requirement upon the Sub-Tenant to undertake the remedial works - the Sub-Tenant was merely required to keep the building in good and substantial repair rather than put the building into a good condition where there were existing defects. BDP relied on a number of repairing clause cases namely: Credit Suisse v Beegas Nominees Ltd, [1994] 4 AII ER 80; and Taylor Woodrow Property Co Ltd v Strathclyde Regional Council 15 December 1995 (unreported).

The court decided that it was immaterial which party has the obligation to make the repairs in the lease and sub-lease. What was relevant was the fact that necessary repairs had been carried out to make the building fit for occupation at the expense of a party that was the beneficiary (or an assignee) of a collateral warranty, namely the Sub-Tenant.

(iii) Risk of multiple actions and double recovery

BDP argued that there was a risk that more than one beneficiary of a collateral warranty could raise proceedings in respect of the same loss given the fact that BDP had provided a number of collateral warranties to different parties, all of which were capable of being assigned to other parties.

The court acknowledged the possibility of "double recovery" but was of the view that procedures could be devised to prevent this. The liability of the provider of the warranty was limited to the cost of remedying defects in the building. Once that cost has been recovered, any liability of the provider would come to an end i.e. reparation had been made. Therefore, in the event of multiple proceedings being raised at the same time, it would be appropriate in such circumstances to join all of the actions to ensure that the damages were paid to the correct party. If this was not possible and a subsequent action was commenced after an initial action had concluded then the provider should be entitled to raise as a defence that it had already made reparation for the damage in question.

The court's approach to Harmon's breach of collateral warranty

As with the BDP collateral warranty, the court considered it was clear from the recitals that Port Hamilton (in its capacity as fund) had a financial interest in the Project. It was plainly contemplated that Port Hamilton might be the party responsible for meeting the costs of any defective work incurred as a result of a breach by Harmon. The assignment clause entitled Port Hamilton to freely assign its rights to the Sub-Tenant.

Harmon raised a number of defences which were similar to BDP's, all of which were unsuccessful. In summary, the court held that it was a practical necessity that the Society or its assignees - the Sub-Tenant in this case - had to carry the remedial works out to ensure that the building was wind and watertight. Harmon's warranty contemplated this. It was immaterial that the loss first emerged before the Society had any interest in the property because the purpose of the collateral warranty was designed precisely to protect the position of a party that might subsequently come to have an interest in the property.

The court's approach to WSA's liability under the Guarantee

The underlying purpose of the Guarantee was to provide security in the event of the insolvency of Harmon or its non-performance of its obligations in the collateral warranty.

Assignment of the collateral warranty was clearly permitted and the Guarantee clearly stated that WSA's liability would not be affected by any assignment of the collateral warranty.

In summary the court was of the view that:

  • the loss was the construction of the building with defective cladding caused by breach by both Harmon (and BDP) of their contracts and collateral warranties;
  • WSA guaranteed Harmon's obligations;
  • the defective condition of the building represented a single physical loss with economic consequences of repair to render the building wind and watertight;
  • the cost of repair could fall on Port Hamilton or its assignee, the Sub-Tenant, because it was the person with the current interest in the building that has the primary (or economic) interest in having it repaired;
  • the Harmon warranty contemplated that the cost of repair might be sustained by a person who acquired an interest from Port Hamilton;
  • the party who suffered the economic loss should be entitled to sue for that loss provided that a contractual relationship existed between the party responsible for the defective condition of the building and the person who suffered the economic consequences; and
  • this was the result that collateral warranties were designed to achieve.

Kershaw's breach of contract

It should be noted that as regards Kershaw's position:

  • The Sub-Tenant claimed damages for breach of the collateral warranty provided to the Society which was assigned to the Sub-Tenant.
  • In addition the Sub-Tenant sought to argue that by virtue of an assignment of the roofing works contract from the employer (not a collateral warranty) the defects in the roof were attributable to breaches of Kershaw's obligations in its works contract in respect of which the Sub-Tenant sought to recover its loss.

Kershaw adopted the same arguments that Harmon and BDP had tried to unsuccessfully raise and therefore the position in relation to Kershaw was similar to Harmon and BDP.

Editors' comments

This Scottish case confirms the effectiveness of collateral warranties and provides guidance on their interpretation. Despite the number of challenges raised by the providers of the collateral warranties in this case the court was prepared to construe collateral warranties in such a way as to further their essential purpose, namely to ensure that the party who suffers loss has a right of action against any contractor or member of the professional team who has provided defective work.

As the judge commented:

"the crucial point of collateral warranties is that in the event that work is defectively carried out, the person who ultimately performs the necessary remedial work will have a right of action against those who are responsible provided that it is the beneficiary of collateral warranties granted by those persons".

The court was not persuaded that looking at whose responsibility it was to repair the building under the respective repairing obligations in the lease and sub-lease arrangements or analysing the date on which the physical loss occurred to the building would prevent liability. The physical defect produced economic consequences because the building needed to be repaired to enable it to be "fit for occupation". If the person who carried out the repairs could establish that the provider of a collateral warranty was responsible for the defects, the person who suffered the financial cost of carrying out the remedial works would be entitled to make a claim.

The court also accepted that net contribution clauses in collateral warranties should be taken into account as to reduce any damages to a "just and equitable" assessment of a party's contribution to the overall loss.

View: Scottish Widows Services & Anor v Harmon/CRM Facades Ltd [2010] ScotCS CSOH 42 [2010] ScotCS CSOH 42

This article was first published in the Norton Rose Construction and infrastructure updater June 2010

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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