Case Law Update: Time Bar and Rights of Action under Collateral Warranties
In the case of British Overseas Bank Nominees Ltd and Others v Stewart Milne Group Ltd  CSIH 47, in which Anderson Strathern LLP acted for the successful party, the question for the Inner House of the Court of Session was whether the time-bar period in a building contract was altered by a collateral warranty. The court issued its opinion here.
The action was an appeal of a decision from the Outer House from December 2018. It concerned a particular type of contract known as a collateral warranty. Collateral warranties are widely used in major construction projects. They are typically entered into between (as in this instance) a contractor on a development and a party other than the original “employer” (i.e. the party who commissions the development and typically the original owner of the site in question) in order to grant parties with an interest in the site, such as its eventual purchaser, the same contractual rights and protections against the contractor as those the employer had.
The purchaser of the site was the beneficiary under a collateral warranty (“the CW”) in this case, and tried to sue the contractor for flooding at the site. The beneficiary alleged that this flooding was the result of a breach of the contractor’s contractual obligation to (a) carry out in accordance with the Building Contract, i.e. to carry out the works with due skill and care and (b) to design the works and select materials in a manner which was expected of a prudent and experienced, properly qualified and competent designer.
However, the beneficiary raised the action more than five years after the flooding issues were brought to the attention of the developer. The contractor argued that as the employer’s right to sue for the same defect under the main contract had prescribed, so had the beneficiary’s. The beneficiary argued that the starting point was the date on which the CW was signed by the contractor. Prior to this date, the contractor owed no duties at all to the beneficiary. Whatever the original developer knew or didn’t know before this point was completely irrelevant. The first point at which the beneficiary could have been aware of a breach of contract by the contractor cannot pre-date the date on which the contractor owed duties to the beneficiary. The effect of the CW was to put the beneficiary in the shoes of the developer, and this happened for the first time when the CW was signed and delivered to them. The court action had been commenced within five years of the delivery of the CW.
The question for the court was whether the wording of the CW was such that the contractor’s obligations under it were subject to the same time limitations as its obligations to the employer under the main contract. At first instance, the Outer House held that the wording did not achieve this result, and that therefore the beneficiary’s claim was not time-barred. The contractor appealed to the Inner House.
Construction of contract – how to interpret the words used
The court’s decision confirmed that the following are principles of contractual interpretation:
- The courts must construe contractual provision in accordance with the objective intention of the parties, that it, the intention that a reasonable person in the parties’ position with the same background information would have had (para );
- The courts must also construe contracts in accordance with “commercial common sense”. This means that they must interpret the contract both purposively and contextually (para ):
- A purposive interpretation means that the court must give effect to the primary purposes of the contract, which the parties objectively intended at the time they entered into it (para );
- A contextual interpretation means that the court must consider the contract against the background known to the parties at the time. This includes looking at the contract as a whole and the general industry and legal contexts (para ).
Interpreting the contract in question
Applying the above test, the court analysed the collateral warranty as follows:
- The purpose of a collateral warranty is to create an express contractual provision whereby the contractor undertakes a duty of care to persons such as a purchaser of an interest in the development from the original employer (para );
- The purpose of a collateral warranty is not to provide purchasers, tenants and security holders with rights greater than those held by the original employer, absent of any express wording to the contrary. Accordingly, any rights of action that the purchaser or other beneficiary under the collateral warranty have against the contractor are subject to the same qualifications, limitations and defences as were available to the contractor in respect of the main contract (para ). This may include any contractual time limitation on the raising of proceedings;
- In the absence of express agreement to the contrary within a collateral warranty, the warranty will normally be subject of the same time bar as applied to the original building contract (para );
- Looking to the context, the Collateral Warranty in question contained clauses to the effect that the contractor had “no greater duty” to the beneficiary than it would have had if the beneficiary had been the employer in the main contract, and that the contractor would be entitled in any action raised by the beneficiary to raise “the equivalent rights in defence of liability” (clause 3.1.) as it would have had against the employer in an action raised under the main contract.
In those circumstances, the court considered that the Collateral Warranty was subject to the same prescriptive period as the main contract. This meant that the action had been raised too late and the contractor’s obligations had prescribed and were no longer actionable.
Prescription – looking ahead
The deadline for appealing the decision of the Inner House to the UK Supreme Court has now passed. That means that the decision stands, and that the position in Scotland is the same as in England and Wales. Most observers consider that the decision does accord with the principles of commercial common sense. There are likely to be a number of important decisions coming out of the courts in Scotland in the next 12 months or so, not least because of the seismic decision of Midlothian Council v Raeburn Drilling and Geotechnical Ltd and Another 2019 CSOH 29. The Prescription (Scotland) Act 2018 has also been passed by the Scottish Parliament with the aim of tidying up the rules on when the five-year clock begins to run, but no date has yet been fixed for the Act coming into force.