Collateral warranties - just the ticket?
A lawyer's eye view - The background issues

By Simon Tolson
Lecture given to the Royal Institution of Chartered Surveyors
3 October 1997

The tort roller-coaster

It is the very essence of the construction process that by its inherent creativity it produces a built environment which will have an unavoidable effect on a class of future owners who had no involvement nor control over the original production but who have very real liabilities if the original constructors got it wrong.

For many years the tort of negligence was an easy resort to those stuck with defective buildings and offered a useful remedy to that class of future owners. It permitted what might be regarded as a fairer and perhaps more flexible apportionment of liability amongst the original parties.

We shall see that the importance of collateral warranties evolves from the erosion of tortious remedies in the law. It was however in the 1970s and early 80s that the Courts were set on a course leading to an almost hedonistic utopia that of universal, unlimited, timeless liability for all engaged in the construction process, especially the insured! The Zenith for all intents and purposes came in 1983⁽¹⁾. Having reached this summit, the Courts found they did not much like the long and winding road that had led them to this point. They spent the next 12 years or so in pursuit of a major U turn.

Along this journey the great British public became acclimatised to the idea you could sue almost anyone irrespective of the relationship to the potential Defendants and today's pre-occupation with collateral warranties derives from the realisation of this turning point away from the trigger happy days of tort.

Changing the metaphor it was at this turning point that in military terms, the orderly retreat taken by the law of negligence which began with Junior Books, turned into what has been described as a chaotic route.⁽²⁾

Any introduction to the law now pertaining to collateral warranties would be deficient without at least a cursory voyage through the relevant leading cases in the tort of negligence, for it was the tort of negligence that was king.

The traditional approach to defining the situations that give rise to a duty of care were based upon a process of piece meal extension. The first notable attempt to elicit a more principled approach came with the leading case of Donoghue v Stevenson⁽³⁾. This of course is a much known about case even outside the law. It was a decision of the House of Lords by a majority of 3:2. The case was about the supposed snail in the ginger beer bottle which was said to have caused the Scottish pursuer to reach and a lot worse. It was held in brief that the manufacturer of an article of food, medicine or the like, sold by him to a distributor in circumstances which prevent the distributor or the ultimate purchaser or consumer from discovering by inspection any defect, is under a legal duty to the ultimate purchaser or consumer to take reasonable care that the article is free from defect, likely to cause injury to health. Lord Atkin's famous passage says this:

At present, I content myself with pointing out in English law there must be, and is, some general conception of relations giving rise to a duty of care, of which the particular cases found in the books are but instances. The rule that you are to love your neighbour becomes in law, you must not injury your neighbour; and the lawyers' question who is my neighbour? receives a restrictive reply. You must take reasonable care to avoid acts or omissions which you can reasonably foresee would be likely to injure your neighbour. Who, then, in law is my neighbour? The answer seems to be: persons who are so closely and directly affected by my act that I ought reasonably to have them in contemplation as being so affected when I am directing my mind to acts or omissions which are called into question

1. Junior Books v Veitchi Company Ltd (1983) 1 AC 520

2. Rout = offence committed when an unlawful assembly makes some move towards execution of a common purpose eg. to attack or march.

3. 1932 AC 562

Lord Atkin went on to quote Lord Esher in Le Lievre v Gould (1883) where Lord Esher said that the case [Heaven v Pender⁽⁴⁾] established that, under certain circumstances, one man may owe a duty to another even though there is no contract between them. If one man is near to another, or is near to the property of another, a duty lies upon him not to do that which may cause a personal injury to the other or may injure his property.

In the same case of Le Lievre v Gould, Smith LJ had said:

The decision of Heaven v Pender was founded upon the principle that a duty to take care did arise when the person or property of one was in such proximity to the person or property of another that, if due care was not taken, damage might be done either one to the other.

This, continued Lord Atkin:

Sufficiently states the truth if proximity be not confined to mere physical proximity, but be used, as I think was intended, to extend to such close and direct relations that the act complained of directly affects a person whom the person alleged to be bound to take care would know would be directly affected by his careless act.

Interestingly, in Donoghue v Stevenson there were two dissenting opinions, of which one was that of Lord Buckmaster. He thought that Heaven v Pender should be buried so securely that their perturbed spirits shall no longer vex the law. He said:

If one step, why not 50? Yet if a house be, as it sometimes is, negligently built and in consequence of that negligence the ceiling falls and injures the occupier or anyone else, no action against the builder exists according to English law, although I believe that such a right did exist according to the laws of Babylon.

In this respect, the law of England may possibly have caught up with the laws of Babylon, but the passage is strangely prophetic of the difficulties encountered much later by the Claimant's in D&F Estates v Church Commissioners⁽⁵⁾ to which I shall refer later.

Lord Buckmaster went on to say the case was indistinguishable from another Scottish case called Mullen v Barr & Co [1929] "excepting upon the ground that a mouse is not a snail", indicating, so it seems, a fairly disturbing outbreak of contaminated ginger beer bottles in Scotland in the late 1920s! He went on to say:

in a case like the present, where the goods of the Defenders are widely distributed throughout Scotland, it would seem little short of outrageous to make them responsible to members of the public for conditions of the contents of every bottle which issues from their works. It is obvious that, if such responsibility, attached to the Defenders, they might be called on to meet claims for damages which they could not possibly investigate to answer.

4. (1883) 11 QBD 503

5. 1988 3 WLR 368

Yet in the case of Dutton v Bognor Regis UDC⁽⁶⁾ it was established that the rule of law that came from Donoghue v Stevenson was equally applicable to buildings. The law was taken further down the road of expansionist development in Anns v Merton London Borough Council⁽⁷⁾ marking an ambitious evolution of the general principle liability in negligence. This was based on a two stage test derived originally from the House of Lords decision of Dorset Yacht Co Ltd v Home Office⁽⁸⁾ but further developed in Anns. The first stage involved consideration as to whether there was a reasonable foreseeability of harm to the Plaintiffs. If so, there would be liability unless under the second stage, there was some public policy reason to negate it.

The "two stage test" was a very wide application of Lord Atkin's dicta and it was at first applied with enthusiasm by the courts. However, judicial folk increasingly appeared to take the view that it heralded an unwarranted potential extension of liability into situations previously not covered by the tort of negligence. As a result there has been a steady retreat from the acceptance of the general principle of liability back to the judicial emphasis on case analogy and the incremental approach to the extension of liability situation.⁽⁹⁾

The end? The era of cold feet.

The Anns two stage test was further undermined by Lord Keith in the most important tortious decision of this decade that of the House of Lords in Murphy v Brentwood District Council⁽¹⁰⁾ in relation to the consideration of the duty of care in novel situations, Lord Keith commented:

As regards the ingredients necessary to establish such a duty in novel situations I consider that an incremental approach….. is to be preferred to the two stage test

However, Murphy v Brentwood and most of the cases connected with this retreat from the recognition of a general principle of liability have been mainly concerned with the duty of care to avoid causing economic loss. Economic loss being a category of non-physical damage such as lost profits as opposed to personal injury or physical damage to property.

The twist to the Rule - negligent misstatement

Although there is no general liability for economic loss which is disassociated from physical damage, economic loss consequential to damage to property is treated separately and is recoverable. The distinction between such consequential economic loss and pure economic loss is not always clear however. The chief exception to the general rule of their being no duty to avoid pure economic loss was provided in the area of negligent misstatement and the line of cases following Hedley Byrne & Co Ltd v Heller & Partners⁽¹¹⁾. Essentially it stands as authority for the proposition that pure economic loss suffered as a consequence of reasonable reliance placed upon a negligent statement uttered by a professional person is recoverable, at least where there is a special relationship between the parties.

6. [1972] 1 QB 373

7. [1978] AC 728

8. [1970] AC 1004

9. However the H.L. in Henderson v Merrett Syndicates Ltd (1995) 2 AC 145 gave first rumblings that Hedley may be applied more liberally - See White v Jones (1995) 2 AC 707.

10. [1991] AC 398

Thus, in respect of non-economic loss situations, the Anns approach still provides a useful framework for the consideration of the existence of a legal duty of care such that there should be little difficulty in considering whether such a duty exists where either damage to the person or property has been occasioned.⁽¹²⁾

The Hedley Byrne principle was extended in Junior Books v Veitchi⁽¹³⁾. This was a Scottish case where the House of Lords held that the pursuers (owners and occupiers of the factory) were entitled to recover as damages the costs of relaying a defective floor and loss of profits while the floor was relayed, although the defects were not alleged to give rise, or to be likely to give rise, to any danger or physical injury or to property in the factory. Many would say this decision is wrong, others argue it turned on its very special facts - in truth the exception to the rule.

Throwing in the towel

The cases of D&F Estates & Ors v The Church Commissioners of England & Ors⁽¹⁴⁾ and Murphy v Brentwood District Council dramatically established the legal position relating to defective buildings and negligence so that a builder would not be liable in tort to successive owners of the building i.e. those with no contractual link to him for any defects in the building itself. It was held that the cost of rectifying defects was economic loss and as we have seen this type of loss was not ordinarily compensatable in the tort of negligence. The builder would only be liable to successive owners if any defect caused personal injury or damage to other property i.e. something other than the building.⁽¹⁵⁾ The decisions in D&F Estates and Murphy left third parties legally exposed. This was why collateral warranties became increasingly important as the only means of protecting third parties who were prevented by the doctrine of privity of contract from recovering losses suffered due to defective building works. It has now become common practice for employers, purchasers, tenants, funders and others to require contractors, subcontractors and professional consultants engaged in building and design work with whom they do not have a contractual link to provide collateral warranties to enable them to recover directly for any defects arising.

What is a collateral warranty?

A collateral warranty (often also described without regard to strict legal meaning as duty of care deeds, memoranda of agreement, deeds of responsibility) is a form of contract which runs alongside and is usually supplemental to another contract. It is a contractual vehicle extending the duties and obligations owed by e.g. a designer to his client, under his terms of appointment to another person. It may also be viewed as to that third party tantamount to a standing invitation to sue in contract.

It is important to note that a collateral warranty is additional to the duties and obligations which may continue to be owed to the original client under the terms of appointment. A warranty is not a substitute for obligations owed to the client. By its nature, it creates a liability in contract which may not otherwise exist.

Thus, collateral warranties take the form of a contract between one of the parties to the underlying contract and the third party who an interest in the performance of that contract.

To whom may a warranty be provided

Initially, collateral warranties was sought by parties providing finance for development, that is funders/purchasers of developments from the original client. Increasingly, they were demanded by parties having different interests in the development e.g. mortgagees, adjoining proprietors, subsequent tenants/purchasers, reversioners, non occupying freeholders etc. In addition, they sought frequently by tenants in multi-let situations eg. shopping centres.

Without collateral warranties or the assignment of contractual rights, a person who subsequently acquires an interest in a particular development has little or no protection in law if he subsequently discovers that one of the parties involved in the building venture has been negligent or has acted in breach of contract.

The purpose of collateral warranties is therefore the establishment of the contractual link between the giver of the warranty "the Warrantor" and "the Beneficiary" i.e. the person to whom it is given. Therefore, if a building surveyor enters into a collateral warranty with his client's bank, then this constitutes a contract. If the bank does not have the benefit of a collateral warranty and the developer goes into receivership or liquidation, the bank has very little remedy against the building surveyor responsible for preparation of the erroneous specification. It is now, therefore, common place, for banks to require collateral warranties prior to advancing any monies.

There have a plethora of collateral warranty agreements now sitting in filing cabinets across the country. We shall look at some of the standard forms later on.

Why are collateral warranties so important?

A basic rule of contract is the doctrine of privity of contract. Privity is that holy cow in the law which says only a person party to a contract may sue on it. This doctrine states, as a general rule, that only a party to a contract can take the benefits of that contract or be subject to its burdens or obligations. It can quickly be seen that whilst in the case of future owners, tort could give a remedy, contract could not as future owners are not party to the original contractual arrangements. A collateral warranty or contract is one of the ways to overcome this restriction on legal remedies created by the doctrine of privity.

Lets look at an example under the JCT Standard Form of Building Contract. If no collateral warranty is proffered and the subcontractor is in breach of his subcontract, the employer will not be able to sue him for breach of contract as the employer is not a party to the subcontract. The employer would in these circumstances have to make his claim against the main contractor with whom he would have a contractual link. Problems arise most acutely where the subcontractor's default would not place the main contractor in breach of the main contract and one can think of a number of examples, such as where a nominated subcontractor provides late or incorrect design information. Even where such a difficulty does not arise, if the contractor has gone belly up, the employer will find himself unable to recover any of his losses.

We have seen already that decided cases over the last eight or nine years have made the position even more apparent, particularly the decisions in D&F Estates and Murphy which allied to the doctrine of privity prevent third parties recovering losses due to the defective building work. What is more, it has been suggested that following the House of Lords' decision in St Martin's Property Corporation v Sir Robert McAlpine⁽¹⁶⁾ it may be possible for contractual claims to be pursued on behalf of subsequent purchases of a defective building, even though the purchaser has no contractual link with the contractor. This is not safe. The extent of the comfort afforded by this decision, which is based on a quaint case from the 19^(th) century, is so imprecise that any humble lawyer must still protect his client and ask for collateral warranties from contractors, subcontractors on behalf of purchasers, tenants and funders.

11. [1963] AC 465

12. Spartan Steel & Alloys Ltd. v Martin & Co. (Contractors) Ltd. [1973] QB 27

13. [1983] 1 AC 520

14.[1988] 49 BLR 1

15. By way of aside, professional designers who give negligent advice could still be held liable for pure economic loss even to persons with whom they have no contract: Hedley Byrne & Co v Heller & Partners.

FROM WHOSE PERSPECTIVE

The Funder

The institutions that lie behind many property developments come in all shapes and sizes be they high street banks, merchant banks, insurance companies, pension funds, or large public corporations. Prior to entering into a funding arrangement, these funding institutions will naturally want to satisfy themselves that their involvement minimises speculative risk from a financial point of view so that, if things do not go according to plan, they are safe as can reasonably be achieved. The funding agreement between the developer and the fund will apportion risk between the two parties and set out their respective rights, duties and obligations. If the developer gets into difficulties, e.g. as a result of breach of its finance agreement in not meeting interest payments on the due date then the funding institution may wish to protect its investment. To do so, it will wish to have the right in collateral warranties with the professional team and the contractor to take over those contracts themselves (so called "step in rights"), so that they can secure completion of the project with minimum of extra expense, disruption and delay.

For this reason, a common requirement in Funding Agreements and Agreements for Lease is that there should be a right of novation if the developer should fail to perform his obligations, particularly where this is due to liquidation or receivership or the person giving the warranty is entitled and proposes to determine his employment by the developer.

The inclusion of such a provision tends not to be too controversial, but they can provide a trap for the unwary since with the assignment of the contract or appointment at the discretion of the fund or tenant, etc, the original developer may lose his right to seek recompense from a party who may have contributed substantially to the circumstances preventing performance by the developer of his obligations!

On the other hand, such rights may be quite illusory where the right of assignment is restricted as in the case of the JCT Standard Forms, Clause 19 of JCT'80.

The tenant beneficiary

Given that the law of landlord and tenant is a complex area, it is not surprising that there has been a great deal of litigation over the years in relation to the meaning of defective leases. In examining collateral warranties, the repairing covenant in the lease is likely to be the most important provision. Some repairing covenants can require the rebuilding of the premises irrespective of the cost or the reason for the works. At the other end of the scale, there can be a proviso in the repairing covenant excluding from the tenant's repairing obligations a liability to remedy latent defects in the building. However, a more usual simple form of repairing covenant goes as follows:

To repair the premises and keep them in repair

It is doubted whether such a covenant is sufficient to require a tenant to completely rebuild. What is clear is that if there is a deficiency of repair caused by a latent defect, then that lack of repair falls to be dealt with under the repairing covenant by the tenant. The more difficult question is whether the latent defect itself falls to be rectified by the poor tenant. If the only realistic way of carrying out the repairs is also to rectify the latent defect, then that is likely to fall within the repairing covenant⁽¹⁷⁾. On the other hand, in Ravenseft Properties Ltd v Davstone (Holdings) Ltd a tenant was required to lay out a substantial sum of money to remedy a latent defect, but the Court did so without stating as a principle that latent defects would always fall within the repairing covenant. Forbes J said:

16. [1994] AC 85

The true test is, as the cases show, that it is always a question of degree whether that which the tenant which is asked to do can properly be described as a repair or whether on the contrary it would involve giving back to the landlord a wholly different thing from that which was demised.

On the other side of the equation where the work required to make premises safe is more than repair, it may be held that it not within the repairing covenant. As authority for this, we have the cases of Brew Brothers Ltd v Snax (Ross) Ltd⁽¹⁸⁾.

In Post Office v Aquarius Properties Ltd, strangely, there was an inherent defect in the building that did not cause disrepair; defective retaining walls had allowed flooding of the basement, ankle deep, no damage had been caused to the building by the flooding and as the building was in the same condition as when it was completed and let, the Court of Appeal held the tenants were under no obligation to the landlord to remedy the defect.

This much is apparent, a tenant on a repairing covenant on a commercial lease is taking on a risk, the full extent of which may, of itself be the subject of some uncertainty. Not surprisingly the tenants look for a means of reallocating that risk to any member of the team who designed and constructed the development, that is why tenants yearn to have collateral warranties.

From the tenant's prospective, he or she is looking for the designers to assume an obligation to him or her in respect of design; that deleterious materials have not been specified for use in the building; that the designers have professional indemnity cover in place and will maintain it during the limitation periods applicable; and that they can assign the benefit of the collateral warranty to third parties when they themselves come to dispose of the lease. From a contractor, the tenant will be looking for a warranty that the contractor has executed the work in compliance with his contract with the developer; that he has not incorporated in the works certain specified materials and that the benefit of the collateral warranty can be assigned to third parties. From a design and build contractor, the tenant will want, in addition to the above, a warranty in relation to design and that the contractor has and will maintain his PI cover. From subcontractors and trade contractors, the tenant may look for similar warranties. I would however mention that in the case of detailed design by subcontractors the tenant will be particularly be looking for a warranty where the main contractor would not otherwise be on risk as to design, e.g. because of a nominated package.

The Purchaser Beneficiary

The greatest problem facing a purchaser of freehold property is the principle of caveat emptor: let the buyer beware. At its simplest on the disposal of freehold land and premises, it is up to the purchaser to find out whether or not the building has been built correctly and designed competently and whether or not it contained any latent or patent defects. It is not possible simply to imply terms into a contract for sale of property to the effect that the property is free from defects.

Consequently different factors come into play depending on whether the purchaser is completing his purchase before or after completion of the building project. It is quite common for freehold commercial developments to be sold during the currency of the works by one party to another, for example between pension funds. Depending on the circumstances, the transfer of the project in progress is usually dealt with by way of novation agreements with all the members of the professional team and the contractor whereby the purchaser stands in the shoes of the vendor, the project otherwise continuing without interruption.

After completion, purchasers of the building will be looking for much the same things referred to above in relation to tenants. Additionally, they are likely to be looking for the right to obtain copies of plans, drawings, specifications, calculations and similar documents that will involve issues of copyright.

The insurer's view

As many of you will know, professional indemnity insurance is a contract between insurer and insured which provides protection to the insured for his negligent acts, errors and omissions and for his liabilities at law as a result of those. The policy is written on an annual basis and the concept was devised at a time when additional contractual obligations entered into between the insured and third parties were not contemplated. Indeed, professional indemnity insurance was not established and set up to extend cover to additional contractual obligations such as collateral warranties. There are may reasons why the cover provided by professional indemnity insurance is incompatible with covering collateral warranties in general, although the insurance industry has of course adapted to the requirements of the professions. That said, the following is trite:

1. They may be viewed as a voluntary assumption of contractual liability beyond that which the law would otherwise impose.
2. The insurer is unable to control the risk which he underwrites as new and potentially greater liability may be created.
3. The difficulties in administering the cover in those circumstances.
4. Insufficient premium to cover potentially unknown risks.
5. The nature of the annually renewable claims made policy.
6. Warranties have been forced upon unwilling insurers.

Some PI insurers have reluctantly acknowledged a willingness to extend cover to collateral warranties entered into by their insured in certain cases and on terms which the insurer considers reasonable, particularly where the forms of warranty are standard forms such as the BPF Form CoWa/F to funding institutions and the BPF Form CoWa/P&T to purchasers and tenants. Whilst the cover offered proves less than the beneficiary of the warranty would have preferred, one can question the advisability of insisting that insureds enter into forms of warranty which would patently be unacceptable to insurers either at the time of the warranty getting signed or at any subsequent date should a claim arise. For this reason some parties choose to take a middle ground which may be acceptable to all sides where others have sought to enforce extremely onerous provisions. Lets look at some examples:

1. In so far as the project has been or will be designed by the Consultant any work designed by him shall with respect to his design be fit for its purpose.
2. The Consultant agrees to fully indemnify the tenant for all claims, proceedings, costs, damages, fees and other expenses which may be brought against or claimed against the tenant by reason of any act or alleged act of the Consultant.
3. The covenantor has exercised and will continue to exercise all proper skill and care.
4. The consultant warrants that none of the following materials have been or will be used in the construction of any part of the development.
5. Nothing contained in the appointment and no approval, instruction or other communication at any time given by or on behalf of the client shall operate to exclude or limit the consultant's liabilities for any breach of his obligations hereunder.
6. His designs and specifications for the project be sound, accurate and practicable and capable of implementation without undue cost complexity or delay by a reasonably competent contractor and shall be capable of integration without undue cost, complexity or delay within the project.
7. The architect acknowledges that he will be requested to perform certain functions under the Agreement for Lease and agrees that he will carry out these functions and in so doing he will use all reasonable skill and care.
8. The tenant shall be deemed to have relied exclusively upon the architect's professional skill and judgment in respect of such matters.
9. The designer shall not without the prior written consent of the beneficiary settle, waive or otherwise compromise any claim, whether actual, potential or anticipated it may have against the insurers or underwriters or its professional indemnity insurance.

Claims made basis

I mentioned earlier that all professional indemnity insurance is written on an annual claims made basis. This means each year constitutes a separate contract of insurance. It is the insurer with whom you contract when a claim is made against you whom you notify who will accept or reject the claim, not the insurer who is putting cover up at the time you entered the collateral warranty! This is a very important factor because provision of cover (if it is available at all) at the time of signing a collateral warranty is no guarantee of future cover for a claim that may consequently arise from the warranty. Policy considerations may well change over time especially where the insurance market is soft or alternatively hard. An insurer is at liberty at the expiry of a policy year to alter the parameters of cover which he will provide in the next and totally separate policy year. Thus, there is no certainty of cover for future claims arising from collateral warranties. Much will inevitably depend upon the state of the insurance market itself and more importantly whether the market is hard or soft with particular reference to claims experience which that insurer has suffered. Thus, documents which you signed today under the impression that they have attracted PI cover, may well be uninsurable in the future.

THE FORM - IT IS TO BE STANDARD OR A BESPOKE DOCUMENT

There are in truth, even today only a handful of standard form warranties in print, predominantly in the BFP/JCT family, lawyers have been weaving away for over ten years developing warranties, many of which have developed a fine art of appearing apparently innocuous, when deadly or indeed downright deceptive. In the early 1990s a lot of legal hay was made from producing ever more inventive warranties, arguably to the disservice of the construction community.

Most of the warranties that come to my purview in the profession are variations on a theme which we will look at more detail below.

At the back of this paper are some specimen printed standard form warranties (CoWa/F - for use where a warranty is to be given to a company providing finance for a proposed development; CoWa/P&T for use where a warranty is to be given to a purchaser or tenant of premises in a commercial and/or industrial development; MCWa/P&T for use where a warranty is to be given to a purchaser or tenant by a main contractor; JCT Employer/Works Contract Agreement) and JCT Employer/Nominated Subcontractor Agreement NSC/W all copied with kind permission of the copyright owners of the British Property Federation and/or JCT respectively.

THE STRUCTURE OF THE WARRANTY

The parties

Legal convention requires that anyone who is to be privy to a warranty must be a party to it. Thus, the person giving the warranty, the "warrantor" and the person obtaining the benefit the "warrantee" must both be parties. If, for example, the developer is to be bound by the terms of the warranty also, he must be a party. For example, with a warranty to a funder, if the funder is given the right to take over the quantity surveyors appointment in certain circumstances, the developer should also be a party in order to acknowledge that right.

What the recitals do is paint the scene by setting out the relationship between the parties, their interests in the development and things like that. By legal convention, recitals usually commence with the word "Whereas". The recitals should be carefully drafted so that they describe the story which led to the warranty, since this can be relevant if a problem arises on the interpretation of the document. For this reason it is usual in the recitals to describe the property which is to be the subject of the warranty and a description of the parties who are going to be bound to it.

If the warranty is not to be in the form of a deed, i.e. by being drawn up and calling itself a deed, consideration is required for it to be enforceable. The most obvious form of consideration is the payment of a sum of money in exchange for a promise to supply or do something, but it can take other forms. A typical clause would be:-

In consideration of the payment of £1 by the fund to the quantity surveyor, the receipt of which is hereby acknowledged.

Since the intention of a warranty is to create a contractual bargain on the part, for example, of the consultant where otherwise none would exist, a typical clause would say something like the following:-

the quantity surveyor warrants [or undertakes or agrees] that he has exercised reasonable skill and care and that he will continue to exercise reasonable skill and care…

Sometimes this obligation is expressed in a tortuous way, rather than contractually, for example, "the quantity surveyor owes a duty of care to the purchaser to exercise reasonable skill and care". This, however, can be rather confusing, as the warranty is creating an obligation in contract not confirming a duty in tort. Sometimes both are expressed.

Further, the intention of the warranty is to entitle a third party to benefit from the obligations which the consultant owes his client under the terms of engagement. Thus, if the quantity surveyor is in breach of his responsibilities to his employer client under his contract of appointment, in a warranty to a purchaser, the purchaser could sue under the warranty, because the quantity surveyor will be in breach of the warranty also. Still further, the obligations under the warranty should reflect those that the quantity surveyor owes his client. For this reason, the warranty would probably refer to and reflect the terms of appointment by saying that it is in performance of his duties and obligations under the Appointment.

To try and minimise problems for the consultant, the terms of appointment should be clearly set down, preferably using the consultants professional body's own document, although these are becoming increasingly difficult to get signed up as standard terms of engagement are mostly unfairly balanced against the reasonable interests of the client.

It is easy to see how it is important that the terms of appointment are clear when a third party who is generally speaking a stranger to the dealings between the consultant and his client is given a warranty.

For this reason, the beneficiary of a warranty is well advised to ensure that he is given a copy for the consultant's appointment when the warranty is executed. Thus, if the consultant has undertaken a limited service, he will want the warrantee to be fully aware of this.

Again, another obvious point is that the consultant will not except the warranty to impose upon him duties or obligations which enhance those he owes to his client and for this reason it is important to state so expressly.

Similarly, the warranty should not set duties or obligations on the consultant which could conflict with his duties to his client. If it were to do so, it puts the consultant in a very difficult position.

A professional person giving a warranty is usually undertaking to a third party that he will not be negligent in undertaking his duties to his client. The effect of those famous words "the consultant warrants that he has exercised reasonable skill and care in the performance of his duties and obligations under the Appointment" is an undertaking not to be negligent. This terminology gives rise to standards of care being the same as would be in tort, assuming there would be liability in tort.

What the law requires of a professional person in tort is reasonable skill and care judged by the standards of a reasonably competent person of the same profession. The reasonable average. The law does not require a professional man to be a paragon, combining the qualities of polymath and prophet, as Lord Justice Bingham put it⁽¹⁹⁾.

17. Quick vTaffe Ely Borough Council

18. Brew Brothers Ltd v Snax (Ross) Ltd [1969] 3 WLR 657

Most often, there is an express stipulation in the consultant's appointment document setting out the standard of care. The word diligent is also often referred to and many non-standard warranties contain variants on the "reasonable skill and care" wording.

The expedient and simple way of avoiding increasing the standard of care advanced is by using the word "reasonable" i.e. "the reasonable skill and care to be expected or the skill and care to be reasonably expected of a chartered building surveyor". On the other hand, using the words "all the proper" i.e. "all the proper skill and care to be expected" enhance the standard required.

Another pet development of the reasonable skill and care duty is the use of expressions such as "to be expected of a properly qualified and competent member of the consultant's profession, experienced in carrying out projects of a similar size, complexity and scope as the development…". This usually will increase the standard of care, since the ordinary consultant would not necessarily have this level of experience.

In addition to the promise by the consultant to exercise reasonable skill and care in undertaking his duties, a warranty will often also include an undertaking on the part of the consultant that he will comply with the provisions of his contractual appointment. Whilst I do not want to spend too much time on this point, there can be conflicting aspects in the contract of appointment and general tortuous common law duties.

As we have seen above, the standard of care imputed in a contract for professional services is to use reasonable skill and care. Yet, fitness for purpose obligations are often referred to. These impose a greater standard because they impose a duty of result. If the standard is that of reasonable skill and care, the consultant would be judged according to the ordinary skill of the ordinarily competent member of his or her profession. If it is a fitness for purpose standard it imposes an obligation to achieve a given result, e.g. to build a tower block over a volcano that will provide the client with a service life of say 80 years.

An example shows the difference in the two standards and relates to what is called the 'state of art' defence. If the warranty imposes a duty to exercise reasonable skill and care, if the consultant can show that his or her services did not fall below the standard prevailing in his or her profession at the time the work was undertaken, this would be a good defence. This is not available where there is a fitness for purpose obligation!

One is tending to find these days the word "reasonable" put in front of the words "fitness for purpose". Indeed, it is reasonable fitness for purpose that is imposed under the Sale of Goods Act 1979 and under the Supply of Goods and Services Act 1982!

It is accepted amongst most lawyers that unless a design and build contract expressly says so to the contrary, the standard required is that of reasonable fitness for purpose.

One can see easily problems that might arise where the architect has a reasonable skill and care obligation under his appointment with the client and a fitness for purpose obligation under a warranty to a tenant.

Not always the words "fitness for purpose" are used, other words which have the same effect are the words "warrants and undertakes" e.g. the consultant warrants and undertakes to the purchaser that the development when complete will be fit and suitable for its intended purpose. Alternatively, if the words used are "…will in all respects meet the stated requirements of the client" this has the same effect.

Surprising as it may be, a good deal of professional indemnity insurance policies do not cover liabilities arising from an indemnity.

It is, however, not always necessary to use the word "indemnity" or "indemnify" in a contractual provision to give effect to an indemnity. The sense and context of the provision may be sufficient to indicate the contractual intention to indemnify, so that, for example, an express guarantee given by a specialist subcontractor to an employer that his work will be satisfactory may be treated as an indemnity in the event that the work should not be satisfactory or should fail.

However, usually, the word indemnity is used e.g. "the consultant shall indemnify and hold harmless the tenant from and against any claims actions costs losses and expenses made or suffered by the tenant as a result of any breach by the consultant of its warranties and undertakings under this deed…" The most important thing to know about indemnities is that they drastically increase the scope of recoverable loss beyond what is usually the case in breach of contract. The law takes very strict interpretation of the precise words used and therefore, determines the damages recoverable. Perhaps the most important affect of indemnity clauses is that they extend the limitation period drastically⁽²⁰⁾. They do this because the clock does not start ticking from the date of the particular breach of contract against which remedy is sought, instead with an indemnity, the breach of contract does not occur until the beneficiary incurs the loss against which he is entitled to be indemnified i.e. liability is identified. Because the cause of action does not arise until the loss has been established. For example, if a subsequent purchaser under a warranty is entitled to an indemnity in respect of the cost of remedial works resultant upon say, an architect's negligence, the time limit runs from the date the remedial works were undertaken and quantified, not from the date when the architect was contractually negligent.

19. Eckersley v Binnie & Partners (1991) CA

Those of you involved with drafting warranties, if you want to make absolutely sure that the indemnity in a warranty applies both the breaches of contract and negligence and, in particular, perhaps to cover situations where arguably the tenant or beneficiary might have been negligent themselves, then the indemnity clause must expressly provide for this. This rule is usually known synonymously to lawyers as the Alderslade principle⁽²¹⁾.

A check should be put on the amount of damages recoverable. If it is left silent, the consultant may be taking on a greater risk than he would of have under the good old law of tort during its expansionist period.

The reason of this is that traditionally, at least, there were important differences between liability in contract and tort because of the different rules that applied to the recovery of damages. Essentially, in contract there is no limitation on the recovery of financial or economic loss per se although in the rule in Hadley v Baxendale sets the broad parameters. The Plaintiff is entitled to damages so that, insofar as money can do, he is placed in the same position that he would have been in had the contract been performed, subject to that nice little concept, foreseeability of loss⁽²²⁾. In tort, the position is different because the courts have historically drawn a distinction between damage to property and physical injury on the one hand (which is generally recoverable) and economic loss e.g. such things as lost profits on the other, which are usually not recoverable save where the former is involved.

Thus, one of the problems when granting warranties is that in furnishing contractual remedies rather than tortuous ones, the potential damages that could flow may be greater and therefore, a problem for insurers. If economic loss is stretched to its nth degree, the position would be quite horrendous.

For these reasons, warranties often limit the damages to say £5 million. Alternatively, there might be an outright bar to a commitment beyond direct losses by such words as "any liability for economic and consequential losses incurred by the purchaser, howsoever arising, are hereby expressly excluded".

As sure as eggs are eggs one of the ubiquitous features of warranties are a schedule of deleterious materials. Exactly why it has become necessary to spell out what materials should not be used in the works or specified is perhaps difficult to understand when there is a duty to take reasonable skill and care. It has nevertheless become the convention.

For example, one often sees the wording "the consultant further warrants that he or she has exercised and will continue to exercise reasonable skill and care to see that unless authorised by the client none of the following has been or will be specified by the consultant for use in the works to which this appointment relates". The benefit of this wording is that the consultant is not warranting that the deleterious materials have not actually been used simply that they will not be specified. However, it is often the case that the duty is expressed in absolute terms, for example, "the consultant undertakes that he has not and will not specify any of the following for use". It is much better to use the words "not knowingly to specify". Much more dangerous is the use of the words "…and will ensure that they are not used". If the consultant agrees to this he effectively becomes a policeman and forensic scientist!

As many of you will know, the British Council for Offices and the British Property Federation, whose members are at the receiving end of some of these often idiosyncratic lists, commissioned Ove Arup & Partners to produce a guidance report for clients and specifiers on how to apply good practice in the selection of materials in construction. As some of you know producers have in fact argued that there is a stigma attached to being named in the guide itself.

This guide refers to the background to the use of materials blacklists and mentions research by the Construction Industry Research and Information Association which has identified up to 70 different materials included in recent lists, the rational for their conclusion often being long forgotten. I am however, grateful for Tony Bingham pointing out that wood wall slabs that were for a long time a friendly and environmentally renewable source came to a sticky end in 1972 when an office block in Belfast which had used wood wall as a permanent framework for the ribbed concrete floors failed. And from that point on, doubts began.

As for calcium silicate bricks, these have been with us for over 103 years and generally it is understood their performance compares well with clay bricks. The one problem with them is that they should generally not be used underground because of their expansion and contraction characteristics. In the right context they are a wonderful brick. As with so many things, much depends on how and where such materials are used.

The lists themselves vary enormously and it is the job of the professionals to make sure these lists are intelligently prepared.

Particular care should be focused on any general sweep up clauses, for example, "any materials generally known to be deleterious". This is a pretty common wording.

The Operative Clause

It must be stressed that the purpose of professional indemnity insurance is to give a warranty to the insured in respect of his loss - no more, no less. This is achieved in the insurance policy through what is known as the "operative clause". This clause is of the most importance in deciding whether or not particular losses are covered by a policy. Having examined that clause to see if cover is provided, it is then necessary to look at the other terms of the policy to see whether there are any particular exclusions.

It is essential to determine that the operative clause will provide cover in respect of breaches of contract - for that is what a claim under the collateral warranty will be. Fairly typical policy wording is:

the insurer agrees to indemnify the insured up to the limits specified in the Schedule in respect of any sum or sums which the insured may become legally liable to pay as damages for breach of professional duty as a result of any claim or claims made upon the insured during the period of insurance arising out of the conduct of the practice described in the Schedule as a direct result of any negligent acts, error or omission committed by the insured in the said practice or business".

The most important words in the context of collateral warranties are "…..as a direct result of any negligent act, error or omission". Those words have given rise to much bun fighting in the courts. One must ask, for example, do they provide cover in respect of a claim arising under a contract as well as a claim for negligence as a tort? Experience shows, insurers usually accept that a breach of duty under a contract, whether express or implied, to exercise reasonable skill and care will fall within the matters giving rise to indemnity under the operative clause. Some support for the view that the word negligent does not also conditions "error or omission" was given by Webster J in Wimpey Construction (UK) Limited v DV Poole.

You should be aware however that there are policies in currency where the operative clause gives an indemnity against "liability at law for damages". Using very similar words, arguments have been advanced in the past that those words did not cover claims arising from breach of an obligation to exercise reasonable skill and care under a contract. If that argument were right, there would be no cover for collateral warranties! It has been held the courts should not strain to put an artificial construction on the phrase. The meaning is plain. It covers tort and contract.

Another point to be aware of is that there are policies around, particularly for design and build contractors where the operative clause appears to limit cover expressly to negligence, for example:

We agree to indemnify the assured for any sum or sums which the assured may become legally liable to pay…… as a result of negligence of or on the part of the assured in the conduct and execution of the professional activities and duties as herein defined".

The word "negligence" in that clause is in fact capable of having a particular meaning in law limited to claims in tort. If the word "negligence" were to have that meaning in its operative clause then the consequences for the insured would be very serious indeed, he would have no cover in respect of claims arising out of breach of duty under contract, either under a collateral warranty or the terms of his appointment unless of course they were also negligence as a tort. Such a policy is dangerous and either the words negligence should be defined as the purpose of the policy so as to include breach of any common law duty to take reasonable care or exercise reasonable skill and/or breach of any obligation whether arising from express or implied terms of the contract or statute or otherwise to take reasonable care or exercise reasonable skill, or the policy wording should be changed.

We have already considered above the insurer's viewpoint as to warranties but what about the beneficiaries? The beneficiary would generally be relying on the consultant having PI cover in the event that a significant claim is made. For this reason, to protect the warrantee's position it is common for an insurance clause to be included e.g.

The consultant shall maintain professional indemnity insurance in the amount of not less than £2 million for any one occurrence or series of occurrences arising out of any one event for a period of 10 years from the date of practical completion of the development for the purposes of the Building Contract provided always that such insurance is available in the market at commercially reasonable rates. The consultant is to immediately inform the Company if such insurance ceases to be available at commercially reasonable rates. As and when he/she is reasonably requested by the Company, the consultant shall produce for inspection documentary evidence of his or her professional indemnity insurance being maintained.

It does not take the brains of Einstein to appreciate that it may be difficult to enforce this provision because the remedy in damages could be difficult to pursue save possibly for a claim based on loss of chance in that if insurance had been procured, and was procurable, the beneficiary would have recovered.

Nearly all consultants will clearly have upper most in their mind, the cost that might be involved in future years maintaining insurance, which can become prohibitively expensive or simply not procurable. Hence, the use of the words "reasonable commercial rates" although sometimes one sees the words "will make reasonable endeavours to maintain" or "best endeavours".

As we have seen, PI insurance is invariably "claims made" and since these are annually renewable contracts, once one policy has elapsed, it is by no means certain that in the following years similar insurance can be procured, e.g. say for example that a building surveyor is engaged by his client in 1990 and carries out an inspection of a development over the next 3 years. In 1997 the client discovers hairline cracks in the external masonry and he writes to the building surveyor blaming him and demanding that he do something about it. The building surveyor should, of course, inform his insurers straight away and the relevant policy will be the one current when the notification is made, in 1997, not the one current when the mistake was made, say in 1992. If the building surveyor had retired in 1994 and decided not to renew his policy, he could have no cover at all. It is easy to see the problems.

When a warranty is being provided to a funder or funding institution it is common for the warranty to contain "step-in rights". For example, clauses 4 to 6 of MCWa/F enable the funder to step into the employer's shoes, (hence clog hopping), should the employer behave in such a manner as would enable the contractor to determine his employment. This is most likely to occur if the employer encounters financial difficulties and is unable to pay the contractor or, in the right circumstance, the consultant. Step-in provisions such as these permit the fund actually to take on the duties, rights and responsibilities of the employer.

Of course, one of the most important things any consultant would be concerned about is not the legal niceties but that when the project is taken over by the funder, the transition goes smoothly and he gets his unpaid fees settled.

Sometimes these step-in rights are expressed to be in the form of novation. A Novation is a completely new contract between the new parties. The original contract between the developer and the consultant falling to the wayside and in its place a new contract between the developer, the consultant and the funder, usually on the same terms as the original appointment.

This is to be contrasted with assignment where only the benefits may be passed on to the assignee.

When developments are sold or some other change of ownership takes place, it is common for the potential purchaser to request that the existing warranties are assigned to him. Under the common law of this country, the benefits of a contract can be assigned unless there is an express prohibition against an assignment in the contract.

Sometimes the warrantor may require the assignment to be permissible only with consent, which shall not be unreasonably withheld. Alternatively, the warrantor may only allow assignment of the warranty a limited number of times, for example, or to purchasers or tenants of the specified part of the development. These are all matters which need to be discussed and considered, depending on which party and which perspective.

MUST I ENTER INTO A COLLATERAL WARRANTY?

Except for commercial pressure, which none of us can ignore, there is no obligation on anyone to enter into a collateral warranty unless there is a binding obligation contained in another contract; for example the quantity surveyors' conditions of engagement could contain a clause requiring the quantity surveyor to give collateral warranties to certain parties in accordance with a draft attached. Provided the obligations in the draft are certain, this is likely to be a binding obligation. Such a well drafted clause is likely to be effective in law, even though the name of the tenant/purchaser is not known at the outset, provided the clause is drafted on the basis that the name of the tenant/purchaser can be fixed by determination by one party and which determination does not depend upon agreement between the parties (see May & Butcher Ltd v The King).

WILL I BE PAID FOR IT?

That the warrantor is to be rewarded or paid for the warranty is, of course, in my opinion, a very important point. Given how valuable in legal terms a warranty can be and should be, and the additional risks that the warrantor is taking on in giving a warranty it is obvious that in the overall scheme of things the warrantor should receive remuneration adequate to compensate. The time to negotiate this is at the time the contract is being negotiated. If, for example, the warranty is coming from a consultant and the employers terms of engagement come up for discussion, then factored into the equation must be the run on insurance premium, the additional potential liability to beneficiaries for heartache and the uneconomic time expended in dealing with what might well be potential claims in future years.

If a warranty is sought after a contract of engagement, this may well be the time the putative warrantor can extract a reasonable pound of flesh. There have been many occasions over the last 5 or so years where I have negotiated rather nice terms for specialist subcontractors, main contractors and consultants who have had warranties sought belatedly.

Perhaps the most pleasant luxury is the opportunity to turn down a warranty in certain cases.

At the end of the day, it is down to commercial bargaining power.

WHERE IS THIS ALL TAKING US TO?

20. County & District Properties Ltd v Jenner C & Son Ltd (1976) 2 Lloyds Reports 728 - an indemnity does not give rise to a cause of action until the consequences are ascertained.

21. Taken from the case of Alderslade v Hendon Laundry (1945) QB 189 and approved subsequently in Smith v South Wales (Switch Gear) Limited (1978) 1WLR165

22. Robson v Harman (1848) 1 Exch 850

As we saw at the beginning of this lecture, warranties were the legal community's knee jerk reaction to the swingingly tortuous pendulum. There have been momentarily palpitations in the old pendulum over the last few years, particularly in relation to a decision in Linden Gardens v Linester Sludge Disposal and St. Martin's Property Corporation v Sir Alfred McAlpine⁽²³⁾ where the House of Lords on a unique ruling allowed an employer to recover losses suffered by a third party and in Darlington Borough Council v Wiltshier Northern⁽²⁴⁾ where the Court of Appeal allowed an employer who never had a proprietary interest in a site to recover substantial damages for breach of contract in respect of loses of the owner of the site. In all these actions there was no longer a direct contractual link between the two parties litigating and yet the courts found a remedy. These cases cannot, however, be relied upon for safety and turn on their very special facts. For the time being warranties are still a very important staple of ensuring a link between parties that would not otherwise have a contractual nexus. The greatest problem with warranties is the concept of joint and several liability which has preoccupied some great legal minds of late.

An example will help. Let say an architect, a consulting engineer and a contractor are all partly to blame but say, in truth, in the proportions respectively of 10%, 20% and 70% if, however, it turns out that the consulting engineer is insolvent and has no insurance and the same applies to the main contractor, the architect could cop the lot if pursued by a beneficiary. Hardy a fair result, and hence one of the reasons why insurers have had a few nightmares.

Despite a Law Commission Report, the law in relation to joint and several liability and particularly its relationship with privity of contract has yet to be modernised.

Lawyers have come to a number of possible solutions to crack the problem. One solution is the use of a condition precedent clause, for instance, "this agreement shall only take effect where all the other consultants and contractors employed by the client have given warranties to the purchaser and tenant in connection with the development". What this means is that there is no liability on the part of the consultant at all unless other warranties have been obtained.

An alternative solution is for the consultant to obtain a contractual commitment that other warranties will be obtained, although I have to doubt what claim the consultant could make if the employer did not obtain other warranties, save possibly for the argument that the consultant can show that liability also lay elsewhere and a contribution might have been sought under the Civil Liability (Contribution) Act 1978.

Another possible solution to the problem of joint liability is to limit the Consultant's liability to those cases where the others jointly liable have given effective warranties. This is less drastic than the condition precedent clause because if there is no joint liability, the architect's liability is unaffected by the existence or otherwise of other warranties. It does mean, though, that where there is joint liability the architect pays nothing if the others jointly liable have not given effective warranties.

Perhaps the most fair solution is the net contribution clause. The intention being that whether other warranties are given are not, and sometimes whether the others jointly liable can pay their share or not, the consultant pays his net contribution, that is the proportion that the architect would pay if he were able to obtain a contribution under the Civil Liability (Contribution) Act 1978 from all relevant parties. Many of you will recognise this from warranties that you have seen. It is also a feature of a number of the standard appointment documents such as the Architects SFA'92.

But net contribution clauses are not perhaps the only other alternative to warranties. A true alternative to warranties would be a stance by the legislature to actually create something far wider in scope than the Defective Premises Act which sadly only applies to those capably involved with providing a dwelling and then only if it is not habitable. Such an Act would have a statutory cut off period in which claims can be pursued against wrong doers even though there may be no contractual link.

Another alternative which has been much debated over the last ten years is latent defects insurance of the type common in France and other European countries. To date whilst various schemes have been played with nothing really satisfactory has come forward and do not mention the NHBC!

23. (1993) 3 ALL ER 417 and (1993) 3 ALL ER 497

24. (1995) 3 ALL ER 895