Collateral warranties

Limitations of liability

Those providing collateral warranties will often endeavour to limit their liabilities under the collateral warranty by including clauses such as net contribution; equivalent rights in defence/no greater liability; and cap on liability. Each such clause is discussed below in brief.

Net contribution

It is no defence to a claim that a third person contributed to damages for breach of duty. The claimant may choose whom to sue and if they obtain judgment against one or more defendants, in respect of the same loss. They may enforce the judgment for the full amount against any one or more of the defendants.

In the construction industry issues of joint liability and multi-party litigation are common as responsibility for the design and construction of a project is often fragmented. For example, an architect who produced a perfectly acceptable design may, nevertheless, be held liable for defects as a consequence of failing, when carrying out its inspection obligations under the appointment, to detect errors in the contractor's workmanship.  

A warrantor can seek a fair and reasonable contribution from another defaulting third party under the Civil Liability (Contribution) Act 1978 if they are expected to bear an unfair proportion of the loss suffered by a beneficiary, where they consider that a third party has also contributed to the beneficiary's loss. Any such claim would be conditional upon the warrantor proving that the person from whom the contribution is sought is also in breach to the beneficiary in respect of the same damage. 

Even where this can be proved, there is a risk that the warrantor may not be able to recover that contribution from the third party due to the third party's insolvency or a provision in their collateral warranty or underlying contract limiting their liability.

To limit its financial exposure, a warrantor, particularly if the warrantor is a 'designer', will argue for the inclusion of a net contribution clause in its collateral warranty, on the basis that they should only be liable for their proportion of the total loss suffered by the beneficiary (and not the total loss) and that they should not carry the risk of the insolvency of a fellow member of the construction team.

The reality of a net contribution clause is that it transfers from the warrantor to the beneficiary:

• the risk that other persons responsible for the same damage may be unable to pay or may have ceased to exist on the date the warrantor is judged liable; and
• the burden of pursuing such contribution from third parties as may be available; and
• the risk that a third party named in the net contribution clause and who contributed to the same loss is not liable to the beneficiary on the basis that there was no contract (i.e. collateral warranty) between the beneficiary and this named third party.

Put simply, a net contribution clause transfers the risks associated with pursuing a contribution from a third party from the warrantor to the beneficiary.

The effect of a net contribution clause is usually to limit the liability of the warrantor in respect of any loss or damage suffered by the beneficiary to such sum as it would be just and equitable for the warrantor to pay having regard to the extent of the warrantor's liability for any such loss or damage.

The terms of net contribution clauses are often hotly contested. A consultant's professional indemnity insurer will usually insist upon the inclusion of net contribution provisions in terms as proposed by ACE or RIBA in their standard form documents. Considering that most funders' starting point is that a net contribution clause shall not be included in a funder warranty at all, such far reaching wording as suggested by either ACE or RIBA is rarely acceptable to a funder.

If acting for an employer where net contribution clauses are being demanded by the design team, it is a fair question to ask why a warrantor, who is being paid in full for his services, should not also be liable in full if those services are inadequate. However, if a compromise is required, careful consideration should be given to the terms of a net contribution clause.

For example, while most employers and funders will want the contributing parties in a net contribution clause to be limited to the professional team, the ACE include in their group 'all other consultants, subcontractors, designers or other persons providing services for the project'. Extending the 'pool' of parties from whom a contribution can be sought beyond the professional team places greater risk on the beneficiary and makes the task of apportioning liability even more onerous given the potentially large number of parties involved. A fair compromise would be to identify the key members of the professional team from whom a contribution might reasonably be sought.

Net contribution clauses, in any form, in a design and build contractor's warranty or in a collateral warranty with reference to the liability of subcontractors should be avoided. The issue here is that the relevant third parties are also in a direct contractual relationship with the contractor, and are persons for whose work the contractor is responsible under the principal contract.

Net contribution clauses are yet to be fully tested by the courts of England and Wales. There are doubts as to whether a net contribution clause would be enforceable as the court may regard it as beyond its function to attempt to assess a fair and reasonable proportion of the loss payable by the warrantor, after allowing for a notional 'just and equitable' contribution from absent third parties (as in Manual of Construction Agreements Update 5, para 5[262]).

Although of persuasive value only, the Scottish case of Glasgow Airport Limited v Messrs Kirkman & Bradford [2007] CSOH 52 is worth considering.

In this case, Glasgow Airport Limited as landlord agreed with its tenant (UPS Supply Chain Solutions Inc.) to construct certain works. The landlord in turn entered into a building contract for the design and construction of the works. The contractor appointed Messrs Kirkman and Bradford as consulting engineers. They provided a collateral warranty to the Landlord.

On occupation, the tenant found the floor slabs to be seriously defective, allegedly as a consequence of the engineer's breach of its duties as consulting engineers. The tenant incurred losses (the cost of repair and reinstatement of the works and consequential losses including loss of profit and loss due to disruption to business) in excess of £2 million and held the landlord responsible. As the contractor was insolvent, the landlord sought to recover these losses from the consulting engineers under the terms of the collateral warranty.

The collateral warranty contained a net contribution clause, in 'inelegant' terms. It read:

'(a) The sub-consultant's liability for costs under this agreement shall be limited to that proportion of such costs which it would be just and equitable to require the sub-consultant to pay having regard to the extent of the sub-consultant's responsibility for the same ...'

The consulting engineers argued that its liability was limited to the 'costs' of repair and reinstatement of the works and did not extend to cover consequential losses. The Landlord argued that the consulting engineer's liability was unlimited, subject only to the common law rules of remoteness. The Court agreed, Lord Kingarth stating that:

'... [t]he warranty is granted in general and unqualified terms and would, unless clearly restricted, entitle the pursuers to recover all losses directly cause by its breach, subject always to ordinary common law rules of remoteness of damage, as set out in Hadley v Baxendale and other cases ...'.

So, although this case was concerned with the types of losses recoverable rather than the issue of 'apportionment' of liability, the court did acknowledge that the liability of the consulting engineers would be apportioned having regard to the responsibility of others. Lord Clark said that:

'[t]he provisions of sub-paragraph (a) are, in my judgment, designed simply to provide for the allocation as between the defenders, and other parties, of sums due to be paid as a consequence of their respective liabilities to the pursuers'.

No greater liability/equivalent rights in defence

While a collateral warranty may contain either or both of these types of clause, where both concepts are acceptable, there is no reason why they cannot be presented as one clause.

Contractors and consultants alike will usually insist that their primary covenant under the warranty is qualified by the inclusion of a 'no greater liability/equivalent rights in defence' clause. The principle behind this is that provided that the warrantor performs its obligations in accordance with the underlying principal contract, it should have thereby also complied with the primary covenant under the collateral warranty. While this may appear fair, in practice such clauses (unless and even when carefully drafted) can have unintended consequences.

Such clauses are usually only acceptable to funders if the clause is drafted so that the warrantor cannot argue that the employer has not incurred the same sort of loss as the warrantor or in terms that allows the warrantor to rely in defence of any claim by the beneficiary on any right of set-off it may have against the employer.

The former is achieved by naming the beneficiary 'jointly' with the employer as 'Employer'. This should circumvent any argument that the employer may not have incurred the same sort of loss as the beneficiary in respect of a default upon the part of the warrantor.

The latter is achieved by excluding the warrantor's ability to rely on any right of 'set-off' and/or 'counterclaim' it may have against the underlying employer (whether a consultant or contractor) as a defence to a claim brought by the beneficiary.

Failure to do so could have dire consequences for the beneficiary. For example, in the absence of such wording, if a beneficiary were to bring a claim under the warranty against a contractor who in turn has a claim against its employer (e.g. loss and expense) the contractor could rely on the defence of set-off to the beneficiary's action under the warranty (see Safeway Stores Limited v Interserve Project Services Limited [2005] EWHC 3085 (TCC)).

As most warranties are a straight step down of the relevant obligations in the principal contract, and are subject to the same limitation periods, the reality is that the inclusion of a 'no greater liability clause' is, in such circumstances, superfluous.

Cap on liability

It is common for consultants in particular to try to cap their liability, usually at the level of their professional indemnity insurance. Naturally, a funder, in particular, will not want to accept a limitation of liability clause in its warranty.

The request is usually a commercial issue for the consultant company rather than being a requirement of their insurers as, ultimately, their insurers will only have to pay out as much as the consultant is insured for in any event. While a consultant may argue that they should not be exposed financially beyond the level of protection provided by their insurers, the beneficiary's position will be that the consultant should stand liable for the consequences of its failings.

In the event that such a clause is agreed, from the beneficiary's point of view, it should apply to each and every claim against the warrantor rather than be a capped sum in respect of all claims against the warrantor.

Adjudication

As with a PCG, it is worth noting that a collateral warranty is not a 'construction contract' for the purposes of the Housing Grants, Construction and Regeneration Act 1996 as a warranty is designed to extend rights arising under a principal contract without itself being an agreement for the carrying out of construction operations.