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Collateral warranty no more extensive than original contract: Inner House

16 September 2019

Collateral warranties are intended to provide rights against a contractor that are equivalent to those enjoyed by the original employer, and should be read as subject to the same limitations, qualifications and defences as were available to the contractor in respect of the original contract, the Inner House has held.

Lord President Carloway, Lord Brodie and Lord Drummond Young allowed an appeal by Stewart Milne Group Ltd in an action brought by British Overseas Bank Nominees Ltd and others, purchasers of a site and development built by the defenders, who claimed that a flooding problem that affected part of the car park was due to the defenders' defective design and construction.

The problem was apparent by May 2013. The action was raised in June 2018 and the defenders pleaded prescription. The pursuers argued that the action was raised within five years of the defenders granting a collateral warranty. That warranty allowed the contractor in any action by the grantees "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". The commercial judge accepted the pursuers' argument that the general law of prescription operated in such a way that a new prescriptive period ran from the date when the collateral warranty was granted, on the basis that it was a new and distinct contract.

Lord Drummond Young, delivering the opinion of the court, said that the underlying commercial purpose of a collateral warranty was of importance in the present case. That purpose was "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. Details of the wording used should not obscure that basic objective".

The notion of equivalence was central, Lord Drummond Young observed. It would make no commercial sense to provide purchasers, tenants and security holders with rights greater than those held by the original employer. "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."

He added: "Because of the importance of time bar provisions to contractors and designers, we are of opinion that a collateral warranty should normally be subject to the same time bar as applied to the original building contract. By the 'same' time bar, we mean a time bar that has effect on the same date. We cannot conceive of any policy reason to the contrary... in construing contractual provisions the norm must, we think, be that the same time bar should apply to all the potential liabilities of the contractor and the design team."

In the present case the clear intention was that the liabilities undertaken by the defender under the warranty agreement were to be equivalent to, but no greater than, the defender’s liabilities under the building contract. In relation to the prescription clause, "As a matter of principle we are of opinion that parties should be at liberty to agree in their contract to impose a time limit on claims that is shorter than the statutory prescriptive period."

On a contextual and purposive interpretation, and having due regard to commercial common sense, the effect of the prescription clause was to incorporate the same prescriptive period, with the same terminus, as applied to any claim by the employer, albeit that that prescriptive period was created by the parties’ contractual arrangements rather than by the operation of statutory prescription under the Prescription and Limitation (Scotland) Act 1973, as amended. Stated exceptions to the clause only covered situations where there was no equivalence between the employer and the grantee of the warranty.

In conclusion, the defender’s liability to the original employer was extinguished by prescription at latest five years after May 2013, and the effect of the prescription clause "is therefore to extinguish any claim by the pursuers against the defender based on the drainage problem".

Click here to view the opinion of the court.

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