All about timing for collateral warranty

Keith Emmerson

By Keith Emmerson, senior solicitor, dispute resolution (specialising in construction) at Gillespie Macandrew

COLLATERAL warranties are an integral part of the construction contract landscape, filling the ‘black hole’ where the beneficiary (usually a purchaser, tenant or funder) suffers loss due to the fault of the contractor and/or design professionals but where there is otherwise no direct contractual relationship between beneficiary and contractor.  

These losses cannot be pursued under the contract by the employer, as the employer would not be the party who suffered loss. The collateral warranty agreement therefore provides the beneficiary with rights against the granter equivalent to the rights of the employer under the contract.  

The issue of the time-limit for raising claims under collateral warranties (“prescription”) has recently been considered in the appeal case of British Overseas Bank Nominees Ltd (BOBN) v Stewart Milne Group Ltd (SMG). Northburn Developments Ltd employed SMG to design and construct eight retail units, garden centre and associated car parking.  Northburn subsequently sold the development to BOBN on 27 June 2013. One of the building contract conditions was that SMG would provide collateral warranties in favour of any buyer of the property.  Therefore, SMG granted a warranty in favour of BOBN, dated 24 June and 28 August 2013.

The car park at the site suffered from persistent flooding, allegedly due to defective design and/or construction of the car park.  

An investigative report into the flooding dated May 2013 was prepared by Colliers International. The flooding was an apparent issue from at least that date. BOBN raised an action in June 2018 against SMG for breach of the warranty to carry out the works with the reasonable skill and care expected of a prudent and experienced designer of the relevant discipline.

In Scots law, a claim will prescribe if not raised within five years of the date when the loss/injury/damage occurs. SMG claimed in their defence that the claim had prescribed.  

The damage (flooding of the car park) was evident at least from the date of the Colliers report in May 2013 – as the action was not raised until 21 June 2018, BOBN’s claim was out of time, having been raised more than five years after the fact.  

BOBN argued that the claim was in time as the obligation only became due to BOBN (as opposed to Northburn as employer) from the date of the collateral warranty, i.e. 24 June 2013 at the earliest. In that case, the action was raised within the five-year prescriptive period and could proceed. 

BOBN’s argument was successful when considered by the Outer House of the Court of Session. SMG then appealed that decision.

On appeal, the court considered the purpose of a collateral warranty.  Notwithstanding that it was a separate contract to the building contract, its purpose was to grant to the beneficiary equivalent rights as the employer would have under the building contract – no more, no less. 

The principal of equivalence was held to be key. The warranty provided that SMG could ‘raise the equivalent rights in defence of liability [as they would have under the building contract]’. 

Therefore, if SMG were able to raise a defence of prescription had the claim been raised under the building contract by Northburn, it could rely on the same defence under the collateral warranty. This meant the prescriptive period was the same, with the same expiry date, regardless of whether the claim was raised by Northburn under the building contract, or by BOBN under the warranty.

The court’s decision is entirely reasonable. The existence of the defect was apparent before the date of the collateral warranty. If the beneficiary could benefit from the prescriptive clock being reset simply because the warranty was granted at a later date, this would undoubtedly put the beneficiary in a better, not equivalent, position to the employer under the building contract. If SMG’s argument had succeeded then, taken to the extreme, an employer could effectively resurrect an otherwise time-barred claim by ‘selling’ its interest in the property to an associated party, who could then demand a collateral warranty from the contractor and restart the whole process. 

Depending on the number of required collateral warranties under the contract (e.g. for subsequent purchasers, tenants and/or funders), the contractor may be vulnerable to claims for considerably longer than the five year prescriptive period under the building contract. 

It is important that any beneficiary to a collateral warranty carefully considers the terms of the warranted appointment or contract, as the prescriptive period for any claim arising will be that under the building contract. Ultimately, a collateral warranty is only as good as the underlying contract.