Collateral Warranties and Third Party Rights

Collateral warranties and third party rights

2 December 2014

Claim without a warranty or third party rights?

• If the buyer is not entitled to a collateral warranty or third party rights, any claim in tort is unlikely to succeed

• The case law is complex

• Murphy v Brentwood District Council [1991] UKHL 2 restricts the buyer’s opportunity to bring a successful claim in tort if the defects cause the buyer pure economic loss

• This case law contributed to the use of collateral warranties

• You can mitigate the risk by including a developer’s warranty in the sale contract, e.g. the developer confirms that the property was properly designed and built

• However that is of limited value if the seller is an SPV

#Olswang construction

Claim without a warranty or third party rights?

• Can also mitigate the risk with a structural survey

• If a patent defect is identified by the surveyor, can negotiate the price

• If the surveyor negligently misses a patent defect which is later identified, claim against the surveyor

• Drawbacks

• no protection against risk of latent defects

• Any claim against the surveyor will be limited to their PI cover


Collateral Warranties

• Gives a right of action against the contractor and design team if you’re not party to a contract

• Popularity stems from the overriding principle of doctrine of privity of contract

• Came about because a number of cases about in 1980’s decided that outside of any contractual relationship between claimant and defendant, there is no general duty of care to avoid causing defects in buildings which could cause economic loss to persons who acquire or use them

• BUT, they impose a burden on the development industry through the time it takes to negotiate and deal with the administration of getting them signed and provided (often by a particular long-stop date)

#Olswang construction#Olswang construction www.constructiveblog.com

The primary covenant

• The Contractor covenants with the Beneficiary that he has performed and will continue to perform all its obligations under the Building Contract in accordance with the terms and conditions thereof

• Most important clause in the collateral warranty

• This allows the Beneficiary to sue the Contractor for a breach of the underlying Building Contract

• Subject to reasonable endeavours - not acceptable.

• Subject to exercising reasonable skill and care – not acceptable.


Duty of care

• 1.2 The Contractor further warrants and undertakes to the Beneficiary that he has exercised the standard of care required under the Building Contract in:

• 1.2.1 the design of the Works to the extent that the Contractor has been or will be responsible for such design; and

• 1.2.2 the selection of goods and materials for the Works to the extent that such goods and materials have been or will be selected by or on behalf of the Contractor.

• Without an express standard of care the obligation to perform the services in compliance with the Appointment imports a fitness for purpose obligation

• Fitness for purpose is generally uninsurable

• Therefore standard of care is very important for Beneficiaries

• Selection of materials constitutes design


Copyright licence

• 2. COPYRIGHT

• 2.1 Copyright in all plans drawings details calculations specifications schedules reports and other documents ("Documents") prepared and/or provided from time to time by or on behalf of the Contractor in connection with the Works shall be retained by the Contractor but the Contractor hereby grants to the Beneficiary a royalty-free irrevocable non-exclusive licence to copy and use all or any of the Documents and to reproduce the same for any purpose whatsoever relating to the Works and/or the Site. Such licence shall be assignable and shall include the right to grant sub-licences. The Contractor will not be liable for any use of the Documents for any purpose other than that for which the same are or were prepared and/or provided.

• Why might Beneficiaries need a copyright licence?


Provision of copies

• 2.2 The Contractor shall (if so requested at any time) give access to and/or provide copies of all or any of the Documents referred to in clause 2.1 (subject to reimbursement of the Contractor's reasonable copying costs).

• Contractor often asks that this is subject to payment of all fees

• Problematic for Beneficiary in circumstances of bona fide dispute or insolvency

• Need the documents for replacement Contractor

• Held to ransom


Copyright infringement

• 2.4 The Contractor warrants that it has copyright in the documents referred to in clause 2.1 and/or an irrevocable licence to use the copyright in the same (such licence including the right to grant sub-licences on the terms set out in clause 2.1) and that the use of such documents for the purposes of the Works will not infringe the rights of any third party.

• Protects Beneficiary from the Contractor’s copyright infringement

• Can include a corresponding indemnity, although PI insurers often resist that

• 2.5 Without prejudice to clause 2.4 if the Contractor does not have either copyright in such documents or an irrevocable licence to use such copyright in the form set out in clause 2.1 it shall use its best endeavours to obtain such copyright or copyright licence.

• Catch all if the Contractor does not have the copyright required


Professional indemnity insurance

• 3.1 The Contractor confirms that it maintains and shall maintain professional indemnity insurance with an insurer or underwriter of good repute covering the Contractor's obligations under this Deed on the basis of and with an indemnity limit of not less than [……………..] [each and every claim] [in annual aggregate] [with [unlimited] automatic reinstatements] until 12 years from the date of Practical Completion (as defined in the Building Contract) (or 12 years from the date of termination of the Building Contract if earlier) provided that such insurance remains generally available to contractors in the EU insurance market at commercially reasonable rates and terms.

• Subject to reasonable endeavours? Very few consultants will get away with that

• Each and every claim/aggregate

• 12 years from end of Services/Practical Completion


Professional indemnity insurance

• 3.2 The Contractor shall notify the Beneficiary immediately if such insurance ceases to be available and shall co-operate with the Beneficiary to discuss the best means of protecting their respective interests in such circumstances and shall at the Beneficiary's option maintain such insurance above commercially reasonably rates if the Beneficiary undertakes in writing to reimburse the Contractor in respect of the net cost of such insurance above commercially reasonable rates or again at the Beneficiary's option the Contractor shall obtain in respect of any relevant period such reduced cover (if any) as is available and as would be fair and reasonable in the circumstances for the Contractor to obtain.

• Allows Beneficiary to procure latent defects cover if necessary


Assignment

• 4.1 The Beneficiary (which for the purposes only of this clause 4.1 shall mean the person named as the first party to this Deed only) may assign the benefit of this Deed and such assignee may then assign the benefit of this Deed to any person acquiring an interest in the Works and/or the Site without the consent of the Contractor being required. Subject to clause 4.2 any assignments additional to those provided by this clause shall only be permitted with the consent of the Contractor (which consent shall not be unreasonably withheld or delayed).

• Generally we will notify the Contractor notwithstanding that consent is not required

• Contractor’s/their PI insurers will tend to resist “(which consent shall not be unreasonable withheld or delayed)” as this increases their obligations


Assignment – standard carve out

• 4.2 Notwithstanding clause 4.1 the benefit of this Deed may be assigned:

• 4.2.1 by way of security and/or by way of re-assignment on redemption by or to the Beneficiary; and/or

• 4.2.2 to any company which is a member of the same group of companies as the Beneficiary

• which assignment(s) shall not count as an assignment for the purposes of clause 4.1.

• Invaluable for inter group transfers


Limitations on liability

• 7. CONTRACTOR'S LIABILITY

• 7.1 No proceedings in respect of the Contractor's liability under this Deed may be commenced more than 12 years after the date of Practical Completion of the Works under the Building Contract.

• Generally acceptable

• Some might try to reduce to 6 years, but 12 years is the most common



• 7.2 Subject to clause 7.3 below the Contractor shall:

• 7.2.1 owe the same but no greater duties to the Beneficiary than it would owe to the Beneficiary if the Beneficiary was jointly named as employer under the Building Contract; and

• 7.2.2 be entitled in any action or proceedings by the Beneficiary under this Deed to rely on any limitation in the Building Contract and to raise the equivalent rights in defence of liability (except set-off and counter claim for fees) as it would have against the Beneficiary if the Beneficiary was jointly named as employer under the Building Contract.

• 7.3 Nothing in clause 7.2 shall entitle the Contractor to contend in any action or proceedings that the Beneficiary can only recover reduced or nominal damages because the Employer has suffered no loss or a loss that is less than that actually suffered by the Beneficiary.



• 7.4 The Consultant’s liability under or in connection with this Deed shall be limited to [£5,000,000 (five million pounds sterling) each and every claim (but in the aggregate in respect of pollution and asbestos claims)]. This limit shall apply however that liability arises, including a liability arising by breach of contract, arising by tort, or arising by breach of statutory duty. Provided that this clause 7.4 shall not exclude or limit the Consultant’s liability for death or personal injury caused by the Consultant’s negligence, or fraud, or fraudulent misrepresentation.

• Last sentence mitigates risk of clause 7.4 being struck out under UCTA


Net contribution clauses

• 7.4 Without prejudice to any other exclusion or limitation of liability, damages, loss, expense or costs the liability of the Consultant if any for any loss or damage ("the loss and damage") under this Deed shall not exceed such sum as it would be just and equitable for the Consultant to pay having regard to the extent of his responsibility for the loss or damage and on the assumptions that:

• 7.4.1 [list the Consultants and design sub-contractors by name] [and the contractor employed under the Building Contract] have provided the same contractual undertakings to the Beneficiary in respect of the carrying out of their obligations in connection with Works; and

• 7.4.2 there are no exclusions of or limitations of liability nor joint insurance or co-insurance provisions between the Beneficiary and the other parties referred to in this clause and any such other party who is responsible to any extent for the loss and damage is contractually liable to the Beneficiary for the loss and damage; and

• 7.4.3 all the parties referred to in this clause have paid to the Beneficiary such proportion of the loss and damage which it would be just and equitable for them to pay having regard to the extent of their responsibility for the loss and damage; and

• 7.4.4 the contractor's obligations to design and construct the whole Works, under the Building Contract and under the collateral warranty given by the contractor to the Beneficiary, do not mean that the Consultant has no liability or has only a nominal liability to the Beneficiary because of those obligations of the contractor.

• Clause 7.4.4 mitigates the risk of the Consultant arguing that their liability is reduced to zero because the contractor is 100% responsible for design


Step in rights

• Generally for purchasers and funders

• Tenants not interested in completing the development

• 12.1 The Consultant warrants to the Beneficiary that it shall not terminate or treat as terminated the Appointment or discontinue the performance of any of its services or obligations under the Appointment without first giving to the Beneficiary not less than 28 days' prior notice of the Consultant's intention to do so specifying the grounds for so doing. For the avoidance of doubt temporary suspension under Section 112 of the Housing Grants (Construction & Regeneration) Act 1996 or paragraph 7 of schedule 3 of the Appointment shall not constitute discontinuance but the Consultant shall notify the Beneficiary immediately such temporary suspension commences.


Step in rights

• 12.2 If the Beneficiary serves on the Consultant a notice in accordance with clause 12.3 the Consultant shall not terminate or treat as terminated the Appointment or discontinue the performance of any of its services or obligations under the Appointment but service of such notice shall not prejudice any other right or remedy the Consultant may have under or in connection with the Appointment.

• 12.3 Unless the employment of the Consultant shall have terminated previously (and whether or not the Consultant shall have served notice on the Beneficiary pursuant to clause 12.1) if the Beneficiary serves upon the Consultant a notice to do so the Consultant shall thereafter accept the instructions of the Beneficiary or its appointee to the exclusion of the Employer under and in connection with the Appointment.

• The Consultant is required to continue performing the services if the Beneficiary instructs


Step in rights

• The Consultant needs to be protected against the Employer arguing that it has repudiated the contract by accepting the Beneficiary’s instructions

• This is why collateral warranties which contain step in rights are tripartite agreements

• 12.4 As against the Employer and the Beneficiary the Consultant shall be entitled and obliged to rely upon and to comply with such notice served by the Beneficiary under clause 12.3 and shall not make any enquiry into the entitlement of the Beneficiary as against the Company to serve such notice.


Step in rights

• 12.5 As from the date of service of notice under clause 12.3 the Beneficiary or its appointee shall assume all the rights and perform all the obligations of the Employer under the Appointment provided that this shall not affect or derogate from any right of action the Employer may have against the Consultant in respect of any breach of duty of the Consultant under or in connection with the Appointment happening prior to the date of service of notice by the Beneficiary under clause 12.3.

• Protects the Employer from prior breach by the Consultant

• 12.6 Within 21 days after serving notice under clause 12.3 the Beneficiary shall pay to the Consultant an amount equal to the fees and disbursements then owing to the Consultant under the Appointment.

• Ensures the Consultant is fully recompensed in accordance with the Appointment


Step in rights

• 12.7 If the employment of the Consultant under the Appointment is terminated before service of any notice under clause 12.3 then if required to do so by notice served by the Beneficiary not later than 12 weeks after the date of such termination the Consultant shall enter into a new agreement with the Beneficiary or its appointee on the same terms as the Appointment but with such revisions as the Beneficiary shall reasonably require and the Consultant may approve acting reasonably to reflect altered circumstances Forthwith upon the execution of such new agreement the Beneficiary shall pay to the Consultant an amount equal to the fees and disbursements (excluding cancellation fees) then owing to the Consultant under the Appointment.

• Very important clause for the Beneficiary as it protects the Beneficiary against the risk that the parties do not comply with their obligations under the collateral warranty


Further warranties

• The Consultant shall as the Beneficiary may at any time or times require (and whether before or after completion of the Services (as defined in the Appointment) or the termination of the Consultant's engagement under the Appointment) execute and deliver to the Beneficiary within 14 days of receipt of engrossments from the Beneficiary a deed or deeds of collateral warranty in favour of any party (excluding the Beneficiary) in whose favour the Consultant may have been required to execute a deed of warranty under the Appointment (save where such deed of warranty has already been requested and executed by the Consultant).


Third Party Rights – how did they come about?

• Contracts (Rights of Third Parties) Act 1999

• Provides that a person who is not a party to a contract may in his own right enforce a term of the contract if it expressly provides that he may, or purports to confer a benefit upon him

• Section 1:

• "Subject to the provisions of this Act, a person who is not a party to a contract (a "third party") may in his own right enforce a term of the contract if-

• (a) the contract expressly provides that he may, or

• (b) subject to subsection (2), the term purports to confer a benefit on him."


Why choose third party rights?

• Construction industry (and crucially funders) getting used to them

• As the rights are incorporated into the building contract or appointment, there is no need to finalise, print and sign multiple collateral warranties

• Preferable to assignment of the benefit of the building contract or appointment, which results in the assignor losing their own rights

• The assignment only benefits the first assignee and subsequent assignees

• Collateral warranties and third party rights can in contrast be granted to multiple parties


Why choose third party rights?

• Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd [2013] EQHC 2665 (TCC)

• Many forms of collateral warranty subject to the Housing Grants, Construction and Regeneration Act 1996

• The general consensus is that it is unlikely the court’s reasoning would be applied to third party rights

• Hurley Palmer Flatt Ltd v Barclays Bank plc [2014] EWHC 3042 (TCC) supports this view

• Therefore third party rights look preferable as could avoid multiple adjudication proceedings


Third Party Rights- why are people still reluctant to use them?

• They still haven’t been tested in court (although note the Contracts (Rights of Third Parties) Act 1999 expressly referred to construction contracts as being one of the beneficiaries of the act)

• Banks are generally wary of efficacy of step-in rights so if funding is being used on a development, the option of giving a bank a warranty has to be there.

• Our own precedents provide for both so that clients are not limited if they choose to refinance

• There is often a concern that they might unintentionally confer rights upon unintended beneficiaries

• Difficult to change traditions. Some people prefer a ‘tangible’ document rather than a notice.


Third Party Rights – why should they be used?

• The concern that they might unintentionally confer rights upon unintended beneficiaries can be easily overcome by specifying the number and identity beneficiaries to whom rights can be conferred

• Easier

• Quicker

• Cheaper!


Methods of drafting

1. Stand-alone schedule of third party rights annexed to the building contract or appointment

2. A schedule identifying the clauses in the underlying contract that a third party may enforce

• The first option is more common as it gives the beneficiary the comfort of seeing a tangible set of rights in a schedule

• Provide an operative clause in the building contract or appointment which gives a right to a list of third parties to enforce the terms of the stand alone schedule

• Annex a schedule setting out the terms.

• The schedule will contain the same clauses as a collateral warranty


Methods of drafting

• The second option:

• Provide an operative clause in the building contract or appointment which gives a right to a list of third parties to enforce the clauses listed in the schedule

• Annex a schedule listing the clauses that may be enforced

• Difficulty is that some of the underlying clauses in the building contract or appointment may have to be adapted so that they make sense when granted to such third parties

• This makes the familiar clauses negotiation points, which can make it difficult


Real Estate

Collateral Warranties and Third Party Rights