Collateral warranties – just when you thought it was safe to go in the water again …

1 March, 2019

Let us imagine a pretty typical development project.  The scheme is a retail unit.  The developer engages a main contractor.  The unit is pre-let to a tenant on full repairing and insuring terms.  The developer sells the freehold of the complete project to an investor.  The contractor, and the consultants with design liability, provide collateral warranties to the tenant and to the investor.  The collateral warranties contain the usual limit on the liability of the contractor, or consultant, to that which it has under the underlying contract or appointment and leaving available as a defence the same defences as would have been available under the contract or appointment.

Sadly, defects in the unit subsequently emerge.  The investor pursues the contractor and professionals under the collateral warranties.  Liability is accepted and payment is made to the investor in settlement.  The investor, however, decides not to utilise the payment it has received to carry out the necessary remedial works.  That, it concludes, is the tenant’s problem as the tenant has signed up to a full repairing lease.  So the tenant, faced with a defective building and an obligation to the landlord to keep it in repair, pursues the contractor and the professionals under the collateral warranties that it has been given.

Here the contractor and professional could be liable again for something for which they had already paid.  On these facts, it would be difficult to avoid liability to the tenant, there has been a breach and the tenant has suffered loss.  The ‘usual’ liability provisions in the collateral warranties would not in themselves provide any protection to the contractor or consultant, as payment to a third party under a collateral warranty would not have been a defence available against the original employer under the contract or appointment.

So what might the contractor or consultant have done to avoid this potential double hit?  Some collateral warranties do contain provisions that say the warrantor will not be liable to more than one party for the same loss.  Beneficiaries of warranties will not however readily agree to such a provision as different beneficiaries may suffer different losses.

The facts are similar to those in the recent case of Office Depot International (UK) Limited v UBC Asset Management (UK) Limited and others [2018] EWHC 1494 (TCC).  The issues that have so far been litigated in that case do not provide any resolution to this potential problem but further proceedings are in train which, if heard, may point the way.