In a recent Scottish appeal case, the Inner House of the Court of Session has endorsed the earlier decision of the Outer House, and in so doing has given further support to the effectiveness of collateral warranties in commercial projects.

Background

The facts surrounding the case of Scottish Widows Services Ltd v. Kershaw Mechanical Services Ltd and Building Design Partnership Ltd are complicated as a result of complex contractual arrangements between the parties. In summary, the action concerned defects that were found in the design and construction of the head office of Scottish Widows at Fountainbridge, Edinburgh. Building Design Partnership (BDP) were engaged as architects for that project and agreed to give collateral warranties to certain third parties. Scottish Widows Services (SWS) occupied the building and were assignees of both the interest under a sub-lease and the full benefit of rights and interests under a collateral warranty granted to the original beneficiary by BDP. In this capacity, SWS raised claims for recovery of the costs of repairs.

Outer House

The original action heard arguments from Kershaw Mechanical Services (KMS) (and others) that SWS should not have raised the action, because the collateral warranties which had been granted were to subsidiaries of SWS and SWS had become beneficiaries of these collateral warranties through a number of assignations. Lord Drummond Young disagreed, stating that the "essential purpose" of a collateral warranty is to ensure that the beneficiary of the warranty who has carried out the repair work has a right of action against the party who is responsible for the defects, even where that beneficiary has received this right by virtue of an assignation.

Inner House

In the Inner House action, BDP disputed the Lord Ordinary's decision that it didn't matter that there was no contractual obligation on SWS to carry out the repairs, because SWS needed to do so to enjoy the use of the building. BDP raised a number of technical arguments and contended that the collateral warranty should be construed narrowly, thereby limiting SWS's scope to recover.

The Court disagreed and stated that if it could be shown that BDP were liable for the defects, it would not matter that the claim under the collateral warranty was based on SWS's need to remedy the defects for "practical reasons"; i.e. to make the building wind and water tight so as to be fit for occupation. This is in contrast to having a contractual obligation under the sub-lease to fix the defects. In these circumstances, it appears that occupiers can claim under collateral warranties even where they have no contractual obligation to repair the defects.

The Inner House reiterated the view of the Outer House that where physical loss is sustained by an owner or tenant because of defective work, and where a contractual relationship exists with the party at fault, the owner or tenant can sue for their loss. In this case, a relationship did exist between SWS and BDP (in the form of the collateral warranty), so SWS could recover the costs of carrying out the repairs.

Commentary

This case emphasises that collateral warranties should never be considered by purchasers and tenants to be mere 'nice-to-have' documents. They provide essential comfort to the beneficiaries. Careful consideration should be given to identify the parties who may have an interest in the project (including potential assignees) and who may require to enforce a collateral warranty from those involved in the design or construction of the project. Purchasers, tenants or occupiers (or their assignees) will wish to receive collateral warranties because collateral warranties may give them the right to claim against parties responsible for the defective works, whether or not they are themselves under a contractual obligation to remedy defects.

Equally, the grantors of collateral warranties should not view them as being mere paperwork. Collateral warranties do involve real liability and are now coming before the courts with increasing frequency.