Collateral warranties and no greater liability

This article was co-authored by Emily Chetwood, Trainee Solicitor.

Typically, when signing a collateral warranty, it was often assumed that the party entering into the collateral warranty in favour of a beneficiary would have the same legal protections as were under the original contract. However, the recent decision in this landmark Scottish case confirms that this may not be the case.

This judgment is likely to be all the more significant to construction professionals whose professional indemnity policies often provide that collateral warranties are only insured if they do not create any greater liability than under the original underlying contract.

Before we summarise the case and consider impacts, here is a brief definition of a collateral warranty.

A collateral warranty in a construction project is a legal agreement where a party involved in delivering a project, like a contractor or consultant, grants contractual rights to a third party with an interest in the project, such as a funder, buyer, or tenant (a “beneficiary”). 

This creates a direct contractual link between the warrantor and the beneficiary, allowing the beneficiary to sue the party that provides the collateral warranty for losses caused by a breach of their obligations under the original underlying contract. It provides recourse to third parties who would not otherwise have a direct contractual relationship with the contractor or consultant.

The facts

Union Plaza is an office building in Aberdeen which completed in 2008. The original owner was Stewart Milne Central Ltd (‘SMC’), and the architects were Halliday Fraser Munro (‘HFM’). SMC then sold it to Union Plaza Limited Partnership (‘UPLP’) who then sold it to Legal and General Assurance (Pensions Management) Ltd (‘L&G’) in 2013 (the second purchasers).

In January 2014, HFM granted a collateral warranty in the favour of L&G which became central to the proceedings brought against the architecture firm. The Dispute

L&G subsequently discovered multiple significant defects including the design of the protective paint, insulation problems and the inspection of said works. L&G issued proceedings against HFM in December 2018 alleging they breached their duty and obligations to exercise reasonable skill and care.

HFM argued that the five-year prescriptive period under the Prescription and Limitation (Scotland) Act 1973 meant that L&G were out of time to bring the claim. Typically, time begins to run at practical completion and parties have often treated collateral warranties as ancillary extensions of the original contract. However, the ruling reached by the Inner House on an appeal brought by HFM, departs significantly from this.

Court Ruling

The main issue highlighted was whether the collateral warranty had the same prescriptive period as that of the original contract.

The court ruled that the purpose of a collateral warranty is to give subsequent purchasers, such as L&G, a direct contract with the architect so that if problems did arise, they would have a means of redress. By entering into the collateral warranty, HFM was essentially making the promise that they had carried out their work to a proper standard. This was a breach of contract, no matter the timing of the collateral warranty.

The court also held that, in this case, the collateral warranty did not contain any wording to import the same time limits as the original contract. ‘No greater duty’ clauses were interpreted as being about the scope of obligation, not about the prescriptive period.

The Inner House held that the collateral warranty was in fact a standalone contract which established a time period starting from the date it was signed. Therefore, the claim was valid as it fell within the five-year time period.

Key takeaways

• A collateral warranty can stand alone and doesn’t simply mirror the original contract.
• Unless express wording is used, collateral warranties do not automatically incorporate the same defences as the initial contract.
• In isolation, the “no greater duties clause” limits the scope of obligations but do not limit the duration of liability. No greater liabilities clauses (properly expressed as being in respect of all of quantum, scope, limitation and duration) however should do.
• In the absence of wording to the contrary, the limitation period may run from the date the warranty is signed and not the practical completion date.
• While this was not discussed , due to the wording of many Professional Indemnity policies, collateral warranties which do not contain “no greater liabilities/duties” clauses may not be covered by insurance.

Comment

Whilst governed by  Scots law, this ruling may be applied by the English courts.  We therefore recommend parties use clear wording to limit liability to the original underlying contract under a ‘no greater duties/liabilities’ clause.  Failing which, parties giving collateral warranties risk facing greater liability than under the original underlying contract.