Collateral Warranties – what limitation period applies?

13 February 2020, Construction, Newsletter, by Kwok Kit Cheung,

In British Overseas Bank Nominees Ltd v Stewart Milne Group Ltd[2019] CSIH 47, the Scottish courts had to decide whether purchasers of a development were out of time to bring a claim against a contractor under a collateral warranty. The Scottish Inner House overturned the decision of the Outer House and held that the prescriptive period (Scotland’s equivalent of a limitation period) in the underlying contract also applied to the collateral warranty and had therefore expired.

Background

Northburn, a developer, engaged Stewart Milne to design and build a retail development. The Contract was a SBCC Design and Build Contract for use in Scotland, 2005 Edition, October 2007 Revision, as amended.  It placed obligations on Stewart Milne to use proper skill and care in the design and construction of the works and to provide collateral warranties to any subsequent purchasers or tenants of the development. The development was completed in 2009 and in 2013 was sold by Northburn to British Overseas Bank Nominees Ltd (Bank), who was provided with a collateral warranty by Stewart Milne, dated 24 June and 28 August 2013.

The collateral warranty provided that Stewart Milne “shall have no greater duty [to the Bank] under this Agreement than it would have had if [the Bank] had been named as the employer under the Building Contract” and “shall be entitled in any action or proceedings by [the Bank] to rely on any limitation in the Building Contract and to raise the equivalent rights in defence of liability as it would have against the Employer under the Building Contract”.

It subsequently transpired that the car park designed and constructed by Stewart Milne suffered from flooding. An investigative report by Colliers International stated that the flooding was apparent by May 2013. The Bank commenced proceedings against Stewart Milne on 21 June 2018 (more than 5 years after Colliers’ report) for alleged breach of its obligations under the collateral warranty, on the basis that the flooding was due  to its defective design and construction.

Limitation

Stewart Milne argued that its obligations under the collateral warranty were subject to a contractual time limit rather than the general law and that the prescriptive period of 5 years for claiming under the contractual warranty in the building contract expired in June 2014 (5 years after practical completion) or, at latest, May 2018 (5 years after the date of Colliers’ report). The Bank argued that the collateral warranty granted to them when they purchased the development (dated 24 June and 28 August 2013) was a separate instrument to the Contract and that the limitation period ran from that collateral warranty and, accordingly, had not expired.  

Decision of Scottish Outer House

The Court at first instance agreed with the Bank and held that the prescriptive period had not expired. It held that the statutory prescriptive period prevailed and the wording of the collateral warranty did not mean that the Bank should be treated as “standing in the shoes” of the employer under the building contract. It meant “no more than the content and scope of [the contractor’s] duties were equivalent to those it owed to [the employer].”

Stewart Milne appealed to the Scottish Inner House.

Decision of Scottish Inner House

The appeal court held that the fundamental issue in this case turned on the construction of the collateral warranty. It allowed the appeal, holding:

(1) 

A collateral warranty is a contract in its own right, distinct from (although dependent on) the building contract to which it relates. Consequently, the terms of the collateral warranty should be construed in the same way as contracts generally i.e. construed in accordance with the objective intention of the parties: the intention that reasonable persons  would have  had in the parties’ position had they possessed the same background knowledge.

(2) 

It was also appropriate to rely on commercial common sense. The exercise of construction should be both purposive and contextual. Purposive interpretation means that the court should attempt to give effect to the primary purposes that, objectively, the parties intended at the time of the contract, which would turn on the wording used. Contextual construction means that the wording used in the contract must be construed against the background known to the parties at the time. With building projects, the roles of the various persons involved, in the totality of the contracts governing the project, including subcontractors, are an important component

(3) 

The fundamental purpose of the collateral warranty is to place the beneficiary and the contractor in an equivalent position to the original developer and the contractor, not to extend the obligations of the contractor to the beneficiary of the warranty beyond those undertaken in favour of the original developer.

(4) 

Collateral warranties are now widely used in all major construction projects and their purpose is to create an express contractual provision whereby the contractor or a subcontractor or a member of the design team undertakes a duty of care to persons such as a purchaser of an interest in the development from the original employer, or a person who has obtained a tenancy or security right in the development from the employer. It is an independent contractual undertaking between on one hand a contractor or subcontractor or member of the design team and on the other hand persons who acquire an interest in the property from the original developer, who will normally have been the employer in the main building contract or in contracts for architectural and engineering services.

(5) 

An important feature of the purpose of collateral warranties is to provide persons such as a purchaser or tenant or security holder with rights against the contractor, or a subcontractor or member of the design team, that are equivalent to the rights that were enjoyed by the original employer under the building contract and the ancillary contracts with architects, engineers, subcontractors and others. The notion of equivalence is central. The purpose of the warranty is not to provide purchasers, tenants and security holders with rights greater than those held by the original employer; to do so would make no commercial sense. Equivalence, accordingly, requires not merely that the beneficiary of the warranty should have the same affirmative rights of action as the original employer; it also requires that those rights of action should be subject to the same qualifications, limitations and defences as were available to the contractor in respect of the original building contract.

(6)

Construction contracts and contracts with professionals in the building industry are almost invariably governed by standard forms in which duties will invariably be qualified by a range of limitations or defences, such as express time-bar provisions. There are important reasons for imposing time bars on rights of action in construction contracts. First, with the passage of time, there is an obvious risk that evidence will be lost; the contractual documentation may have been destroyed or mislaid, and recollection of witnesses will inevitably deteriorate. Secondly, there must come a point when finality is achieved, so that the persons involved can move on without the risk of latent claims against them particularly where the liabilities are the subject of insurance. Thirdly, buildings typically have a long life, and there is therefore a significant risk that claims for negligence might be made in respect of latent defects that only appear many years after the work was carried out, by which time evidence may be lost and the risk to an insurer is also serious. 

(7) 

Given the importance of time-bar provisions to contractors and designers, a collateral warranty should normally be subject to the same time bar as applied to the original building contract. It is possible for the parties to a collateral warranty to agree on a different time bar from that under the building contract, subject to the mandatory nature of the statutory law of prescription, but in construing contractual provisions the norm must be that the same time bar should apply to all the potential liabilities of the contractor and the design team.

Comments

This case is a good reminder to purchasers of building projects that if a longer time bar than that under the building contract is intended, it must be expressly stated in the collateral warranty. On the part of the contractor or consultant who is giving the warranty, they should study the terms of the collateral warranty carefully to make sure its obligations under it are what they agreed.