REUTERS | Jason Lee

Collateral damage

New builds for sale?

I think that it is inevitable that a number of relatively new buildings will have to be disposed of by the present or intended occupants. Those buildings will end up in the hands of a bunch of new people ranging from purchasers or occupiers (who have acquired them at a knock-down price) to insolvency practitioners, on behalf of insolvent companies (who would probably rather not have them at all but can’t sell them).

Defects

In some of those cases the recipients may be less than delighted with the build quality and may well end up dusting off any available collateral warranties.

If the potential claim is against a contractor, the first job (given the flurry of consolidations and acquisitions over the last few years, to say nothing of recent financial difficulties) may well be to work out the present whereabouts and status of the contractor who gave the collateral warranty. If the contractor has been sold, check whether the shares have been sold or whether it was the business that was sold (including the right to use the company name). It is important in this context to look at a company number as well as a name: the name might change but the number stays the same.

Double jeopardy

There is a scenario that worries me. Imagine you are a contractor who constructed a building a few years ago. You signed a design and build contract with a developer and then gave a collateral warranty to a prospective tenant who was to take possession under a full repairing lease. (The original tenant may have now assigned the lease and the benefit of its collateral warranty, but let’s stick with the original tenant for the moment.)

Along comes the tenant who is less than delighted with the build quality (see Defects above). The tenant says that the building is defective and says that the defects will cost £250,000 to remedy.  You have a look at the building and find that, although there are defects, there is no way that they will cost that much to fix.  You negotiate and come up with a value of £100,000.

A little while after you pay the money the developer contacts you:

Remember me?  Remember that building you built?  Yes?  Well the tenant has gone bust and I’ve had to forfeit the lease.  I can’t re-let it so I’ve exercised the break clause on my own offices and I’m moving in.

You sympathise.

Well the problem is that I’ve found a number of defects in the building.  And, of course, you are still liable under the building contract so could you come and fix them please?

You tell him that you paid the tenant £100,000 for the defects.

He tells you that the tenant never spent the money on fixing the defects.

You look at the contract documentation.  The collateral warranty says (in effect) that any defence available under the building contract (e.g. I’ve paid) is available to the contractor under the collateral warranty (see clause 2.2 of PLC’s contractor collateral warranty).  But the same wording doesn’t appear in the building contract.  In other words the fact that there would be a defence to any claim under the warranty (e.g. I’ve paid) won’t help you in relation to a claim under the building contract.  Most developers won’t agree to that kind of wording.

A further twist: no right to repair

This problem becomes more “interesting” if the phone call from the developer comes before you’ve paid the money to the tenant.  In this scenario the developer says that there is a rumour that the tenant is about to go bust and in that case the lease would be forfeited, etc.  You try to get a promise from the tenant that the money will be spent on the defects – perhaps put into a joint account and not released until the defects are completed.  The tenant says no and that you must pay or get sued. Is there a way not to pay?

Apart from the obvious option of prevaricating until events overtake the dilemma, an attractive course of action would seem to be to insist on carrying out the repairs.  But the case law will not support you.  Generally speaking, the developer will always have a claim in damages.  It has always been said that a defects liability provision will (conceptually) give the contractor the right to carry out repairs during a defects liability period. This point has been considered in a number of cases including Tombs v Wilson Connolly Ltd at paragraphs 92-95, where the Judge decided that it was wrong to suggest that the existence of a right to carry out remedial work operated as a complete defence to an alternative claim for damages. He said that the authorities make plain that, at most, the denial of a right to make good defects affects the measure of the loss and nothing else: see Pearce and High Ltd v Baxter and the earlier judgment of His Honour Judge Stannard in William Tomkinson v Parochial Church Council of St Michael [1990] CLJ 319.

Can contract terms protect you?

Ultimately the answer may be (at contract negotiation stage) to expressly limit the remedy in respect of defects under the building contract to the making good of defects by the contractor.  In that instance the right to damages would only arise after a failure to repair.

Not sure how many developers would agree to that…

2 thoughts on “Collateral damage

  1. It seems to us that there is no “one size fits all” answer to the questions Edward has posed.

    However, the problems discussed are a stark reminder, on any multi-party dispute or project, to always involve in any settlement talks:
    – your insurers; and
    – as many of the other parties as possible.

    Whilst that may be commercially difficult, in some cases a settlement agreement with a tenant could include the developer as a party (to tie up claims under the building contract too).

    The more you involve the other parties, the less likely they will be to make the “same” claim against you with a clear conscience.

  2. Our experience is that on the sale of a construction business (as opposed to a share sale) there may well be a “pick n mix” approach to potential liabilities arising out of completed projects (and current projects). It would be usual for the initial legal liability to remain with the old company but there may be an agreement for the new business to contribute to the cost of any claims which crop up on completed jobs. This would (hopefully) put the old company in funds to settle any claims or get repairs done. However in an insolvency situation it is by no means certain that money recovered from the buyer will get passed on to the claimant. It would be unusual for a claim on a completed project to be secured or for the money recoverable from the buyer to attract trust status.

    Where there is a share sale it is unusual for the seller to retain any liability except where there are known but unresolved claims pending at the time of the sale.

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