As you were? An important decision from the Scottish Appeal Court on Scottish collateral warranties

At the end of last year, a judge in the Court of Session reached what many regarded as a controversial decision on the interpretation of a Scottish collateral warranty in the context of prescription (time bar) of a claim arising out of alleged defects in construction works - British Overseas Bank Nominees Limited (‘the Bank’) v Stewart Milne Group Limited (‘Stewart Milne’). This week, three judges in the Inner House of the Court of Session overturned that decision on appeal.

The background

In 2008, Stewart Milne entered into a contract with Northburn Developments Ltd (“Northburn”) to design and build retail units and other related works at a development in Inverurie (‘the Building Contract’). The Bank purchased the development from Northburn in June 2013 and thereafter, pursuant to its obligations under the Building Contract, Stewart Milne executed a collateral warranty in favour of the Bank dated 24 June and 28 August 2013 (‘the warranty’).

There had been flooding in the car park which was part of the development and a technical consultancy produced a report on this in May 2013 (“the Report”). The Bank then raised an action for damages against Stewart Milne on the basis that the flooding resulted from its defective design or construction of the works. The action was raised on 21 June 2018.

The arguments

In defending the claim Stewart Milne relied on two clauses from the warranty, clauses 2.3 and 3.1 which, it argued, gave the Bank only the equivalent rights enjoyed by the original employer, Northburn, but no more. 

Clause 3.1, provided that ‘ The Contractor ( Stewart Milne) will be entitled in any action or proceedings by the Beneficiary ( the Bank ) to rely on any limitation in the Building Contract and to raise the equivalent rights in defence of liability as it would have against the Employer ( Northburn) under the Building Contract.........’

Stewart Milne argued that as the Report was produced in May 2013, the prescriptive (five year) time limit for bringing a claim had expired by the time the Bank raised the court action.

The Bank argued that the warranty was a separate contract from the Building Contract. The Bank had only acquired rights under the warranty when it was executed by Stewart Milne in 2013. On a proper interpretation of the warranty the bank was not tied to the prescriptive period under the Building Contract and, accordingly, the five year prescriptive period had not expired when the action was raised.

In December 2018, the Lord Ordinary at first instance decided that Stewart Milne had entered into a contract with the Bank (the warranty) which was separate from the Building Contract. On a proper interpretation of the warranty in the context of the law of prescription and given the dates the warranty was signed, the claim had not prescribed as the claim had been brought within five years of the signing of the warranty.

The appeal court reasoning and decision

In delivering the decision of the three appeal court judges which overturned the decision of the Lord Ordinary, Lord Drummond Young said that the exercise of interpretation of the warranty had to be both purposive and contextual.

The fundamental purpose of the warranty was to place the Bank and Stewart Milne in an equivalent position to Northburn and Stewart Milne.

The context was the background known to the parties at the time the warranty was granted. The use of collateral warranties in the construction sector had arisen to prevent loss caused by the failure of a contractor (or a sub-contractor or designer) from falling into a so-called ‘black hole’ so that the person suffering the loss is unable to obtain compensation because it has no contract with the person responsible for the failure, no action based on breach of duty being available under our law.

The legal and commercial context in which collateral warranties have come to be used demonstrate an important feature of their purpose. They are to provide persons such as a purchaser or tenant or security holder with rights against the contractor or a sub- contractor or a member of the design team that are equivalent to the rights that were enjoyed by the original employer under the original building contract and the ancillary contracts with architects, engineers, subcontractors and others. The notion of equivalence is ‘essential’. The purpose of the warranty is not to provide purchasers, tenants and security holders with rights greater than those held by the original employer; to do so would make no commercial sense.

The appeal court decided that when the wording of Clause 3.1 of the warranty was read in light of the context and the underlying purpose of the warranty, it was clear that it incorporated a ‘conventional prescriptive period’ that corresponds to the statutory period of prescription that applied to Northburn in any claim under the Building Contract. The words were to achieve equivalence between the obligation and liabilities undertaken by Stewart Milne under the Building Contract with Northburn and the obligations and liabilities undertaken under the warranty. The appeal court considered that the right to plead that a claim has prescribed ‘’ is plainly a ‘right in defence of liability’: that is the function of prescription’’.

In the circumstances, the appeal court decided that the clauses within the warranty gave the Bank the equivalent rights enjoyed by the original employer, Northburn, no more and no less. As a result there was a valid contractual restriction on the claims that could be made by the Bank under the warranty. Should the prescriptive period have been found to run from the date of execution of the warranty that would have extended the obligations of Stewart Milne beyond those under the Building Contract.

Conclusion

The original decision of the Lord Ordinary in the Outer House in favour of the Bank made lawyers think again about the traditional wording of Scottish collateral warranties. That may still continue notwithstanding the decision of the appeal court in favour of Stewart Milne.

Many will argue with some force that the decision of the Inner House reflects what had been understood to be the correct interpretation of such provisions in Scottish collateral warranties. However, given recent decisions in the field of contractual interpretation and prescription, make sure to watch this space. This case may well go all the way to the Supreme Court!

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