New warranty gives added protection

WHO carries the can when defects are found in new commercial buildings? That is the issue lying behind the emergence of a new provision, called a collateral warranty, in the Irish construction industry.

Put simply, this is a contract between the contractor and the designers (including architects and engineers) of a new development, on the one hand, and those who will have an interest in the completed development, on the other. This interest is separate from the interest of the developer of the project who has employed the contractor and the designers.

A properly drafted collateral warranty should give its beneficiary the same contractual protection and remedies against the contractor and the designer as are enjoyed by the developer.

Individuals who should seek collateral warranties include funding institutions, investors, mortgagees, purchasers and tenants who have an interest in a new development, but have no relationship with the contractor or designers.

Tenants of new developments who enter into full-repairing leases may have to contribute towards the repair of any defects in a building caused by the negligence of the professional team or contractor who designed and constructed the building. In the case of a multi-tenanted building, the cost of remedying defects will usually be collected from the tenant by way of service charge.

A collateral warranty, however, would provide tenants with contractual redress in addition to any redress they might have under common law against those responsible for such defects. Effectively, it provides a tenant with the same remedies that the developer has against the contractor and design team for breach of contract.

Collateral warranties started in the UK due to the uncertain state of the common law. The House of Lords, in a number of recent decisions, has held that pure economic loss is not recoverable in civil actions.

In a case of a defective building, pure economic loss would include the cost of repairs to the building; the cost of providing alternative accommodation; the cost of interruption to business; damage to plant, machinery, or stock; and loss of profit.

As a result of uncertainty, it was felt prudent in the UK for an end-user or an owner of a new building to establish a direct contractual link with the contractor and design team to enable them to recover contractual damages (including economic loss).

Recovering pure economic loss in civil actions in Ireland is somewhat uncertain. There has been a number of recent Supreme Court decisions which seem to indicate the courts will follow the example of the House of Lords.

As a result, collateral warranties are now becoming widely used in this jurisdiction to protect the interests of future owners, or users, of new buildings.

Many different warranties have evolved in Ireland and the UK. The professional bodies representing the principal designers involved in construction projects, including the Royal Institute of Architects of Ireland and the Institution of Engineers of Ireland, have produced a warranty, which they recommend their members to use when requested to give a warranty.

However, these bodies have serious reservations about collateral warranties.

A properly drafted warranty should include, at a minimum, the following provisions:

(1) A general warranty on the part of the contractor, and each member of the design team, to exercise reasonable skill and care in the performance of their duties. In no ease should the contractor or designers be required to afford more protection to a beneficiary under the warranty than they are providing to their employer. Ideally, from the beneficiary's point of view, the warranty should not impose a restriction on the nature of damages recoverable. Frequently, collateral warranties will exclude liability for economic or consequential loss, thus defeating the purpose for which they have been developed. It should also be pointed out that some warranties include liability for economic loss, but exclude liability for consequential loss. The commonly held view is that economic loss includes costs incurred in remedying any defects which may arise due to the negligence of the warrantor. Any other losses as a consequence of the negligence are considered consequential loss.

(2) The liability period of the contractor and/or design team, under the warranty, should run for the same period as their liability to the developer under their various contracts. An attempt to reduce the period of liability under the collateral warranty should be resisted.

(3) Where the warrantor is involved in design, they should be obliged to maintain professional indemnity insurance for the period of the warranty, and to renew such a policy on an annual basis. It is essential, prior to entering into the warranty, that the beneficiary vet the professional indemnity cover arranged by the warrant or, and seek confirmation from the insurer concerned that the warranty is not in breach of any of the terms of such a policy.

(4) Collateral warranties should be freely assignable, and any restrictions on assignment should be resisted. Obviously, a tenant may wish to assign a lease and any prudent assignee should always seek to have the benefit of any relevant collateral warranties assigned to it also.

While these comments focus on a prospective tenant of a new commercial building, the same principles apply to any person with an interest in a development project, including funding institutions, investors, mortgagees and purchasers.

It is essential that people with an interest in a construction project, other than the developer, should seek to establish a direct contractual relationship with the contractor and designers.

From the developer's point of view, it is essential that prior to committing to a particular contractor and design team, he should agree with them in advance that they will provide collateral warranties in a form acceptable to prospective tenants, funding institutions, investors, purchasers and mortgagees.

The various organisations and bodies representing contractors and designers have expressed a great deal of disquiet in relation to the use of collateral warranties. In particular, the professional bodies representing architects and engineers in Ireland have expressed considerable concern. They point to an ever-increasing cost of professional indemnity insurance (a phenomenon now experienced by all professions) and their exposure to an ever-growing number of potential claimants.

These are valid concerns. But the point must be made that the risk of defects appearing in a new building should not be borne only by the end-user or owner in the building.

Maybe the current debate within the construction industry on the use of collateral warranties will give us the opportunity to deal with a wider issue - namely, how best to protect all those concerned in the construction process (including end-users) against defects arising in the future.

One possible solution is the use of decennial insurance cover, which effectively amounts to insurance of a new building against latent defects. This type of insurance is uncommon in Ireland, mainly due to cost and the insurer's requirements regarding inspection during the construction process.

New house buyers enjoy protection provided by "HomeBond". Organised by the National House Building Guarantee Company, this protects new home owners against major structural defects for a period of 10 years. Why should owners and occupiers of new commercial buildings not enjoy similar protection?