Scottish Widows Services Ltd v Harmon/CRM Facades Ltd (in liquidation), Building Design Partnership, W.S.A. Inc and Scottish Widows Services Ltd v Kershaw Mechanical Services Ltd, Building Design Partnership Outer House, Court of Session.

Despite the best efforts of legislators and industry drafting in recent years to kill off collateral warranties through the Contract (Rights of Third Parties) Act 1999 (in England and Wales), a proposed increased reliance upon our own beloved Ius Quaesitium Tertio and inclusion of third party rights as an option instead of collateral warranties in the new suite of SBCC contracts collateral warranties have proved to be remarkably resilient and have hung on in there.

Now the courts have finally taken a stand and reinforced the commercial reasoning behind collateral warranties and the rights of the beneficiaries to rely upon their terms when something goes wrong.

In this case, recently determined at the Scottish Court of Session (23 March 2010), Lord Drummond Young confirmed the long held argument that having collateral warranties was more than a simple box ticking exercise, and that they provide a genuine and enduring source of comfort for a third party who was not a direct party to the original contracts and appointments for the works.

In summary the case was in relation to defects arising from the design and construction of the Scottish Widows Headquarters building in Fountainbridge. The works were for three five storey rectangular block and an eight storey curved block over a car park.

The works were carried out originally for Scottish Widows Fund and Life Assurance Society.

The usual range of contractor and sub-contractor warranties were provided. Eventually the roof and curtain walling leaked and significant costs were incurred in rectifying the defects. The collateral warranties were assigned to Scottish Widows Services Limited (as permitted under the collateral warranties) and they raised claims against various professionals for the cost of repairing defects to the roof and curtain walling under the collateral warranties.

The court found on a number of points but the main one upholding the principle of collateral warranties was to give effect to the commercial intention of the collateral warranties – basically it reinforced the rights of beneficiaries of the collateral warranties to seek payment of their costs incurred in repairing the defects in the works despite (1) not being party to the original building contracts or appointments and (2) receiving permitted assignations of the collateral warranties.

Lord Drummond Young said:-

"In my opinion [collateral warranties] must be construed 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."

and that the "fundamental purpose" of a collateral warranty is:-

" provide a right of action to a person who is liable to suffer loss as a result of defective performance of a building contract or a contract for professional services in connection with a building project."

To be clear this case was not about determining the extent of the parties' claims, it was to see if collateral warranties themselves allowed claims to be made and it really could not be stated any clearer. If you have a collateral warranty, and the granter of that warranty has carried out defective work at the premises for a third party and you have suffered loss, you can sue them.

The decision then goes on to look at assignation of collateral warranties and the effect of net contribution clauses on joint and several liability amongst other points but these will be commented upon in a subsequent update.

To paraphrase Mark Twain then, rumours of the death of collateral warranties have been greatly exaggerated.

It is clear from this case that in Scotland, at least, the BEST way that you can protect yourself when funding, buying or renting a newly constructed or a premises currently being constructed is to make sure that you have a full package of collateral warranties from all parties involved in the design and construction of the works. I would include any design sub-contractors and any sub-contractors with a substantial build input for the works to protect your self from contractor's insolvency, sadly a not uncommon event in recent years.

So the next time you are in negotiations over heads of terms and the seller/borrower/landlord attempts to skate over the question of collateral warranties on the grounds that they're not worth the paper they're written on and no-one ever relies on them anyway, think back to Scottish Widows and their leaky roof and walls and don't be fooled. Get them, and get good ones.

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.