Prospective purchasers or tenants are prepared to incur legal and other fees to ensure they have good title to any property that they are seeking to buy or rent. Often, however, there is less focus on what other comfort is available in relation to recently constructed or refurbished properties.

It is strange that this should be so - you wouldn't buy a new or nearly new car without ensuring that a warranty is in place, so why would you take less care when the far more costly commodity of a property is concerned?  What would happen if a day after buying the property it collapses due to a structural defect, or the day after a tenant opens a new shop the roof begins to leak? Property insurance may not be sufficient to cover any losses that are suffered. For these reasons it is important to undertake construction due diligence to ascertain what comfort is available in relation to newly built or recently constructed projects as part of the overall due diligence process.

What is meant by 'recent'?

While many believe that most defects appear within the first five years following completion of a project, we have seen a number of cases where defects have appeared after this period. Under Scots Law there is often no prohibition on claims being raised in the seventh or eighth year following completion of the project, or even in year 11 or 12. We would advise that as a general rule of thumb it is worth undertaking thorough construction due diligence for any buildings that are in the first 10 years of their lifespan following completion.

What is a purchaser or tenant looking for?

In effect, a purchaser or tenant is looking for recourse against a third party to recover any costs incurred as a result of a defect that materialises as a result of the construction works. This recourse may be against the original team (contractor, consultants and sub-contractors) via collateral warranty agreements, or to an insurer through a specialist insurance policy, for example a latent and inherent defects policy.

What if nothing is available?

In addition to not having recourse, the following issues may be faced by the purchaser or tenant:

  • Absence of a Copyright Licence: without a collateral warranty agreement a purchaser or tenant will not have a copyright licence to use and reproduce drawings and other documentation produced by the designers in relation to the original development of the property. As a result, this may prohibit the use of the original drawings, specifications or reports for the purpose of maintaining, cleaning or even marketing or extending the property.  The purchaser or tenant will also have no ability to request copies of such materials.
  • Marketability: while a purchaser or tenant may be happy to accept that no comfort is availaable in relation to the construction of the property on the basis of a building survey, there is no guarantee that its successors (or in the case of a purchaser any future tenants with whom it seeks to enter into a lease) will also accept such a view. Foreign investors, for example, often have stringent requirements. Any subsequent purchaser or tenant may use the lack of an "acceptable" construction package as an argument for seeking commercial concessions, for example a reduction in price or the dilution of repairing obligations under a lease.

Other tips for successful construction diligence

Due diligence on construction documentation should consist of a combination of legal and technical diligence. As construction contracts are a mixture of both legal and technical elements, it is important that these are checked from both a legal and technical perspective. We would recommend a purchaser/tenant putting an onus on both its legal and technical advisers to communicate with each other and to ensure that any construction reports produced are integrated and co-ordinated.

It is also important that any diligence pack exhibited comprises the full suite of documentation available and that this is issued as one package. A common reason for diligence costs spiralling is when documentation is "drip-fed", or different versions of documents are exhibited, resulting in these having to be reviewed more than once.

It is important that the review of any collateral warranty package is undertaken concurrently with a review of the Building Contracts or Appointments as the value of any collateral warranty will largely depend on the underlying document. Indeed, collateral warranties often include a provision that the granter will owe no greater duty or liability to the beneficiary under the collateral warranty than it would do to the employer under the Building Contract/Appointment.

It is also important that technical appendices (e.g. preliminaries, specifications, drawings, etc) are exhibited in full as these may contain further limitations or exclusions of liability.  Indeed, these documents would be critical for any claim as they defined the extent of the contractor's actual obligations and so, if they are not correct or comprehensive, this can undermine the extent of the legal obligations in the Building Contract. The onus should therefore be on the Seller or Landlord to provide a full diligence pack.

Finally, there is no point in simply reviewing the collateral warranty package and underlying documentation as part of an academic or "tick-box" exercise in isolation from the project to which they relate. It is important to confirm that there are no ongoing disputes in relation to the project and that no settlements have been reached that undermine the comfort afforded to any purchaser or tenant by the collateral warranty package on offer. Collateral warranties in excellent terms may be provided to a purchaser, but in practice these may provide no comfort - for example if the collateral warranties include the provision outlined in the paragraph above (that the contractor will be under no greater liability to the beneficiary under the warranty than it would be to the employer) and a settlement agreement had been concluded between the contractor and the employer in full and final settlement of all claims in relation to the development, then the contractor's collateral warranty may be worthless.

In Scotland there are now standard diligence questionnaires (such as that produced by the Property Standardisation Group) that list the key questions that should be confirmed by any seller or landlord.

Conclusion

There is caselaw to the effect that the value of a property can be diminished by the lack of an acceptable collateral warranty package (including sub-contractor collateral warranties). Furthermore, we are aware of many examples where the absence of a marketable construction package has resulted in commercial concessions having to be offered to make up for any shortfall. It is therefore not surprising, given the current commercial landscape, that there is a greater focus on the acceptability of construction packages available - seemingly innocuous gaps in the comfort available can result in tangible consequences for sellers and landlords.

The Due Diligence Questionnaire produced by the Property Standardisation Group is available at www.psglegal.co.uk.