Within the negotiation of a construction contractual package there will always be arguments on the requirement of a collateral warranty or the style document itself but recently there was a case which determined the time period within which a collateral warranty can be requested, irrespective of the contractual obligations drafted.
Over the years many a “discussion” has been had over the contractual limitation period in construction contracts. In my career lifetime there have been three different periods, firstly there was five years, which is still seen in many standard form contracts, then this increased to ten years and now more commonly twelve years. To be clear this contractual limitation period is different from the limitation periods contained within the Prescription and Limitation (Scotland) Act 1973 (as amended) (the “Act”), those limitations contained within the Act cannot be contracted out of. Contractual limitations simply mean that, that the terms of the contract fall away after the specified time period and can no longer be relied upon in the event of a claim.
The Act sets out that certain obligations are extinguished if no relevant claim has been made within a period of five years (negative prescription). This is where the five-year period I mentioned in the pervious paragraph comes from. The current standard of twelve years for contractual limitation periods brings construction contracts, under which the Law of Scotland applies, in line with the English provisions and signing documents as deeds. I have often thought that the twelve-year limitation period was a tick box exercise for Insurance providers as it has no real relevance to Scots Law.
Looking at collateral warranty agreements, it needs to be remembered that providing a collateral warranty agreement potentially increases the financial exposure to the construction professional or entity granting it. The recent decision in the Engine Yard Edinburgh Limited and Allenbuild Limited v Bayne Stevenson Associates Limited [2024] CSOH 13 (“the Case”) effectively reduces that risk but the decision itself creates a double-edged sword with both positive and negative consequences for the industry.
Facts of the Case were as follows.
Allenbuild limited (the “Contractor”) was the design and build contractor for a development in Edinburgh known as the Engine Yard. The employer under that contract was the Engine Yard Edinburgh limited (the “Employer”).
The Contractor appointed Bayne Stevenson Associates (the “Engineer”) as the structural engineer. A bespoke letter of appointment (the “Appointment”) was executed on the 14 of April and 22 May 2017. Within the Appointment, under clause 6.1, there was a provision to provide further collateral warranty agreements upon written request. The wording was fairly industry standard which as a construction solicitor I would have expected to see in an appointment drafted at that time:
“The Engineer shall promptly execute in a self-proving manner and deliver a Collateral Warranty in the form annexed or in such other form as the Contractor reasonably requires within 7 days of written request in favour of the Employer and/or any lessee and/or purchaser and/or provider of finance for the Project acquiring from the Employer an interest in or charge over the Project Development or any part of the Project”.
On the 25th of August 2022, the Contractor made a written request to the Engineer for the provision of a collateral warranty in favour of the Employer. The request for the collateral warranty was only made after certain defects were discovered for which, it was thought by the Contractor, that the Engineer was responsible.
The Engineer did not provide the requested warranty to either the Contractor or the Employer and the Contractor and the Employer proceeded to raise an action against the Engineer seeking damages for the remedial works to be carried out.
The Engineer’s argument for not providing the warranty agreement was that the right to request the warranty agreement had in fact prescribed since no relevant claim (court action) had been made within five years of the execution of the Appointment. The Contractor argued that the obligation to provide the warranty only started running when the written request was made for the warranty to be provided. Thrown into the mix were arguments put forward by the Employer that, in any event, regardless of the warranty being provided, they as the Employer had acquired third party rights under ius quaesitum tertio (third party rights) and sought a declarator that the terms of the Appointment intended to confer benefits upon them in respect of provision of a collateral warranty thus allowing them the right to sue the Engineer for specific implement and execution and delivery of the collateral warranty agreement.
The court found that the Contractor had no right to demand the delivery of an executed collateral warranty, and that the obligation had indeed prescribed. The court indicated that the obligation existed at the point of execution of the contract and that the clock had started to run at that point in time and that as five years had passed, legal actions based on the right were now prescribed. The contractual provisions with the Appointment did not suggest that the obligation became enforceable at the point of the making of a written request, the requirement in Clause 6 of the Appointment that the warranty be provided within 7 days of a written request was held to be a stipulation concerned with the performance of the obligation, rather than about its subsistence. In terms of the claim made by the Employer that they had acquired third party rights, the court took what would appear to be a common-sense approach and rejected the position that was put forward by the Employer. There was a provision within the Appointment to provide a collateral warranty agreement to the Employer, this pointed away from an intention to provide any third-party rights to the Employer and this was also evident in other contracts in relation to the Project which explicitly excluded third party rights. It is also worth noting on this point that contractual third-party rights are now governed by the Contract (Third Party Rights) (Scotland) Act 2017. The Appointment in this case was concluded before that Act came into force.
Commentary:
Collateral warranty agreements are important in any construction project, they provide a contractual link to parties who are not party to the contract but are taking on liabilities in terms of the build. That contractual link allows them to make a claim in the worst-case scenario. Collateral warranties are relied upon by funders, employers, purchasers, and tenants to protect their interests.
There are countless developments that are either still under construction or are multi-let buildings which are now post 5 years from execution of the contractual documents. This decision will be causing issues in the obtaining of warranty agreements that have already been contractually obliged to be provided. Solicitors who are negotiating development agreements will need to ensure that if they are agreeing to provide warranty agreements that these agreements can indeed be provided or make alternative provisions.
I am wondering how insurance providers are going to react to this decision, I have not seen many comments being made from providers or brokers on this point to date in comments received back on client documents issued to them to review. Will insurance providers oblige their policy holders to refuse to provide warranty agreements? If a construction professional were to take a commercial view to provide a warranty to ensure future work from a client instead of refusing to provide a warranty could this have an adverse effect on their insurance coverage?
Categories of potential beneficiaries and those that act for them need to be vigilant in examining exactly when the expiry of the right to request warranties crystalises. Solicitors acting for commercial property transactions such as leases, sales, fresh funding will require to ensure diligence is carried out on what construction package is available to their client. They will need to be careful they do not conclude missives containing obligations which cannot be contractually complied with or worse still are of no effect in law following the decision in the Case. On the other hand, those parties who are being asked to provide warranties should be diligent and be prepared to resist any requests to provide a fresh warranty when it is no longer obliged to do so.
I suspect it will become more commonplace for assignations of the construction packages of either the main document or the warranties in older developments where the right to request warranties has crystallised. We could therefore see an attempt to increase the number of assignations being requested within the drafting, which will have the potential for affecting insurance coverage. Whilst not all PII polices have a specific limitation on the number of assignations that are permitted, some do and this needs to be remembered. There is no point drafting provisions that have the potential to remove the benefit of insurance coverage, this type of drafting benefits no one.
Will this be the death nell for the collateral warranty agreements and will there now be an increase in latent defects insurance policies being provided? The Case combined with the Act; will perhaps make the insurance route look more favourable. To be honest, I am not sure where this will lead. In the time I have been practising I have only had two developments where no warranty agreements were offered at all and instead utilised latent defects insurance. To date I have not seen any drafting to try and counteract the effect of this Case. I await with bated breath as to how this is going to be dealt with.
This briefing note does not constitute legal advice: individuals should seek professional advice, specific to their own circumstances, in relation to any matters raised.