REUTERS | Jose Miguel Gomez

Ask the team: novation due to administration: what about the collateral warranties?

This Ask the team considers some of the practical issues that arise where a solvent employer agrees that the administrators of a contractor may novate the building contract from the original contractor (now in administration) to a replacement contractor.

Assumed facts

A contractor and employer entered into a design and build contract (such as the JCT Design and Build Contract, 2005 edition). The works started and made significant progress, but the project is about 50% complete. The original contractor has run into significant financial difficulties and gone into administration.

The employer has agreed with the administrators that it will, in principle, consent to the novation of the building contract to a replacement contractor. The original contractor’s professional consultants provided the employer with collateral warranties. These refer to professional appointments between the professional consultants and the original contractor.

Questions

  • Given the novation of the building contract, will the professional appointments also have to be novated to the replacement contractor, simultaneously with the building contract novation?
  • Should the professional consultants acknowledge that the novations do not affect the enforceability of each of the existing collateral warranties?

Parties to a novation

A deed of novation will usually only affect the parties to that deed. As such, a professional consultant (appointed by the original contractor, who is now in administration) will not be affected by the deed of novation for the building contract. That is, the novation of the building contract will not somehow automatically novate the professional appointments from the original contractor to the replacement contractor.

Novation of professional appointments: employer prefers certainty

From the employer’s perspective, the professional appointments entered into between the original contractor and the professional consultants should be novated to the replacement contractor (in writing) at the same time as the building contract’s novation.

Although the parties could (and sometimes do) “muddle along”, arguably only express novation will give the employer legal certainty over how its project will progress. That certainty will usually benefit the replacement contractor and the professional consultants too.

Typically, the administrators will contract with the replacement contractor in terms that pass across the commercial responsibility for all liabilities arising under the building contract. That often takes the form of a purported assignment (entered into irrespective of whether permitted by the underlying contract) of the benefit of the contracts associated with the building contract, including the professional appointments, backed by an indemnity in favour of the administrators from the replacement contractor. Usually, the overarching contract between the administrators and the replacement contractor will contain some form of “further assurance” clause, allowing for the replacement contractor to require a novation (at the replacement contractor’s expense).

Collateral warranties should continue

Each collateral warranty will usually be a stand-alone contract in its own right. That is, what effect the administration has on each collateral warranty will depend on the terms of that collateral warranty. Often, it will be possible to argue that, following the original contractor’s administration and the novations of the building contract and professional appointments, the collateral warranties provided by the professional consultants will remain effective.

However, the key consideration is that a collateral warranty is there to protect the employer. It would be cold comfort for the employer to do nothing following the novations, then have to try to bring a claim against a professional consultant in future, only to have that professional consultant raise a defence or seek to avoid liability because of the fact of, or the circumstances surrounding, the administration. For example, if the professional consultant had not been paid by the original contractor and had suspended performance of its design services, a contractual warranty to exercise skill and care when carrying out that design may be undermined.

New collateral warranties or formal confirmation?

An employer usually aims to secure replacement collateral warranties on the same terms as the originals. It can do this by:

  • Asking the replacement contractor to obtain a fresh collateral warranty under the professional appointment. (This usually requires the co-operation of the professional consultant, as it has already provided a collateral warranty to the employer, before the novations.)
  • Novating the original collateral warranty, so the replacement contractor replaces the original contractor. (From a traditional legal perspective, the novation creates a new contract.) Ideally, the professional consultants’ collateral warranties could be novated in the same documents that novate the professional appointments, reducing the parties’ workload and costs.

If the employer cannot secure replacement collateral warranties, it may ask the professional consultants to confirm that the existing collateral warranties remain in full force and effect. It can do this by:

  • Including such a confirmation in the deed of novation of each professional appointment to the replacement contractor.
  • Using a side letter from the professional consultant to the employer. (The employer will prefer this to have contractual force.)

The employer may ask the replacement contractor for similar confirmation to protect the employer’s step-in rights under the collateral warranties (that is, the step-in rights that allow the employer to step-in to the professional appointments).

Administrators do not have unlimited time to deal with the administration

It is important to remember that in an insolvency situation, tying up all the legal loose ends may not be possible. The choice for the employer may be to either:

  • Do the best it can on the legal documents, and end up with uncertainties, but the possibility of a completed project; or
  • Require complete resolution of all “legal” issues at the risk that the project is not completed at all, because the replacement contractor (and the administrators) cannot deal with those demands.

Remember that administrators will require indemnities in their favour in agreements that they sign (in their capacity as administrators) and will not expect to pay any additional costs that are not part of the core costs of the administration. Typically, an administration must last no more than one year and often ends with the liquidation or dissolution of the original contractor.

Design sub-contractors and other beneficiaries

What goes for the professional consultants and their collateral warranties in favour of the employer will also apply to any design sub-contractors who have provided collateral warranties to an employer. However, with minor sub-contractors an employer may simply have to take a commercial view and muddle along, with the aim of achieving a completed project taking priority.

Finally, the employer should also ensure that any other beneficiaries of collateral warranties are kept abreast of developments. For example, a funder will have its own particular requirements, and an employer must ensure it continues to comply with its obligations to any party providing development or property finance.

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