First Division of Court of Session reaffirms notion of equivalent rights in allowing appeal on interpretation of collateral warranties

The Lord Ordinary had held that, since the original building contract which was signed in 2008 and the warranty agreed in 2013 were separate contracts, the five-year prescriptive period started to run again from the date of execution of warranty.

However, the Inner House of the Court of Session allowed the appeal after ruling that the “fundamental purpose” of a collateral warranty is to place the beneficiary and the contractor in an “equivalent position” to the original developer and the contractor, not to extend the obligations of the contractor to the beneficiary of the warranty beyond those undertaken in favour of the original developer.

The Lord President, Lord Carloway, sitting with Lord Brodie and Lord Drummond Young, heard that in 2008 Northburn Developments Ltd entered into a building contract with the defender Stewart Milne Group to design and build retail units and other related works at a development in Inverurie.

The pursuers British Overseas Bank Nominees 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.

But the car park designed and constructed by the contractor suffered from flooding and following a report by consultancy firm Colliers International, dated May 2013, the pursuers raised an action for damages against the defender on 21 June 2013, seeking the cost of remedying alleged defects.

The defender tabled a plea of prescription, to the effect that under specific clauses of the collateral warranty, Clauses 2.3 and 3.1, any liability arising under the duties in the building contract had been extinguished by operation of prescription by the time that the action was raised.

Clause 2.3 provided that “The Contractor (Stewart Milne) shall have no greater duty to the Beneficiary (the Bank) under this Agreement than it would have had if the Beneficiary had been named as the Employer (Northburn) under the Building Contract”, while 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”.

The bank argued that the warranty was a “separate contract” from the building contract.

Consequently, if the relevant prescriptive period ran from the date when the collateral warranty was granted, the present action was raised within the prescriptive period. 

In December 2018, the Lord Ordinary at decided that, 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.

However, the First Division judges considered that the notion of equivalence was “central” to the purpose of the warranty and ruled that the defender’s construction of the collateral warranty agreement was “correct”.

The appeal judges observed that the exercise of interpretation of the warranty had to be both “purposive and contextual”, having regard to “commercial common sense”.

Delivering the opinion of the court, the Lord President said: “Clause 2.3, particularly in juxtaposition with clause 2.2, is in our opinion important. It indicates that the defender’s duties to the pursuers as Beneficiary of the Collateral Warranty Agreement are to be restricted to the duties incumbent on the defender in terms of the building contract. 

“The clear intention is that the liabilities undertaken by the defender under the Warranty are to be equivalent to, but no greater than, the defender’s liabilities under the Building Contract. This is hardly surprising; indeed, for reasons discussed previously, it represents obvious commercial common sense. 

“The Collateral Warranty is designed to place the Beneficiary in the same position as if it were the employer under the building contract, and thus to avoid the risk that loss will fall into a ‘black hole’ because of the absence of any contractual relationship between the contractor and the beneficiary. It is not, however, intended to place the Beneficiary in a more favourable position than the original employer.”

Lord Carloway continued: “When the wording of clause 3.1 of the Collateral Warranty Agreement is read in the light of the context and the underlying purpose of a collateral warranty, it is clear in our opinion that it incorporates a conventional prescriptive period that corresponds to the statutory period of prescription that applied to Northburn in any claim under the original building contract. Clause 3.1 entitles the defender ‘to rely on any limitation in the Building Contract’ and ‘to raise the equivalent rights in defence of liability’ as it would have had under the building contract. 

“Those words must be given a purposive meaning. Their purpose is clearly to achieve equivalence between the obligations and liabilities undertaken by the defender under the building contract with Northburn and the obligations and liabilities undertaken under the collateral warranty. The right to plead that a claim has prescribed is plainly a right ‘in defence of liability’: that is the function of prescription.”

The court concluded: “For the foregoing reasons we are of opinion that the Collateral Warranty Agreement is intended to confer on the defender as Contractor the same defences against a Beneficiary as would be available against the original Employer, Northburn. 

“For the reasons already given, that means that any claim by the pursuers as Beneficiary under the Collateral Warranty Agreement must be subject to the same prescriptive period, with the same terminus, as would have applied to a claim made by Northburn. 

“That prescriptive period operates by virtue of the parties’ contract, as embodied in the Collateral Warranty Agreement, rather than the general statutory law of prescription, but as we have indicated that appears to be the clear meaning of the contract, properly construed.

“The defender’s liability to the original Employer, Northburn, was extinguished by prescription at latest five years after the report obtained from Colliers International, which described the drainage problems in the car park and attributed them to fault on the part of the defender as Contractor.

“The effect of clause 3.1 of the Collateral Warranty Agreement is therefore to extinguish any claim by the pursuers against the defender based on the drainage problem.”