Defects claims in developer-tenant cases

A recent TCC decision has considered an innovative attempt by a tenant to obtain guidance as to the nature of repairs needed to comply with a repairing covenant under its lease with a developer and a contractor’s liability for the same under a collateral warranty. The existence of the developer's own separate right to pursue the contractor in such circumstances can pose complex legal and practical issues. The tenant’s attempt to shortcut these issues in the present case failed.

A liability triangle

Developer-tenant scenarios are a common feature of the UK construction and real estate industry. Typically a developer will enter into an agreement for lease with a tenant supported by a building contract. Upon completion of the works, the tenant will enter into a lease, often for 20 or 30 years duration, and ordinarily including a full repairing covenant in favour of the landlord making the tenant responsible for keeping the property in repair. Such covenants will usually cover latent defects in the works, unless they are so fundamental as to involve changing the nature of the building.

A developer in such circumstances (or any subsequent owner / landlord to whom the developer’s rights have been assigned) will have two avenues to pursue in respect of defective work. It may sue the contractor under the building contract or it may insist that the tenant repair the defects under the terms of the lease. These rights need not be mutually exclusive. The fact that the developer / landlord has recovered sums from the contractor in respect of the defects will not necessarily release the tenant from its obligation to repair. The developer / landlord will often want to take action to preserve the value of its asset irrespective of whether the tenant is liable for repair.

A contractor is likely to be mindful of this prospect where it has given a collateral warranty in favour of a tenant. The settlement of a claim made by the developer / landlord will not necessarily prevent a similar claim being made by the tenant under the terms of the warranty. The contractor may therefore seek to include in any settlement with the developer / landlord an indemnity against claims by the tenant. The contractor may also seek to pre-empt such a situation by including “equivalent rights of defence” and / or “no greater liability” wording in any collateral warranties it provides to try and give it a defence to any claim under the warranty where it has already settled claims with the developer / landlord.

Any collateral warranty is also likely to have a limited lifespan, typically 12 years from practical completion. The term of the lease will often exceed this period meaning that tenants may face a situation where the precise extent of repairs required by the repairing covenant is not yet known, but their right of recourse against the contractor is shortly to expire. This was the position faced by the tenant in the present case.

Office Depot International (UK) Ltd v UBS Asset Management (UK) Ltd

Office Depot entered into an agreement for lease with UBS in relation to a warehouse to be constructed on UBS's behalf by Amec under the terms of a design and build contract. Amec (and its sub-contractor) also gave a collateral warranty to Office Depot warranting its performance of the design and build contract. Shortly after practical completion, Office Depot and UBS entered into a formal lease of the warehouse for 20 years with a repairing covenant in standard form requiring Office Depot to keep the warehouse "in good and substantial repair".

The roof to the warehouse suffered water ingress and UBS brought a claim against Amec alleging defects in the roof cladding and the structural steel frame. The claim was settled more than six years after practical completion by the payment of £2.8 million from Amec to UBS. UBS agreed to indemnify Amec against any costs, liabilities or losses incurred as a result of any action brought by UBS seeking recovery against any other party in relation to the dispute.

Many years later, and shortly before the expiry of the limitation period under the collateral warranty, Office Depot became concerned about its position and commenced proceedings against UBS, Amec and Amec’s sub-contractor. Office Depot was concerned that despite the settlement between UBS and Amec, it would be required to repair the warehouse pursuant to the terms of the lease and that its ability to recover the costs of doing so from Amec and/or its sub-contractor would shortly expire.

Office Depot formally denied that it was obliged to repair the warehouse pursuant to the lease, but nonetheless sought declarations against UBS as to “what works, if any” it was obliged to carry out "in order to comply with its repairing covenant”. It then sought a further declaration against Amec and its sub-contractor that any such works were required as a result of design or construction defects in breach of the terms of the collateral warranties.

An impermissible shortcut

The proposed declarations were struck out by the court as being too open ended. There was no dispute between Office Depot and UBS as to the appropriate remedial scheme. UBS considered the question to be one for Office Depot pursuant to its repairing covenant. Nor was there any positive case by Office Depot as to what it considered to be an appropriate remedial scheme. The effect of the declarations would be to require the court to carry out an inquisitorial process and determine for itself an appropriate remedial scheme without the benefit of the usual adversarial trial process.

Ultimately, it was not for the court to direct or supervise the performance of the repairing covenant. The court could determine any future dispute between Office Depot and UBS as to whether the covenant had been performed. To proceed as Office Depot had proposed, however, would be to “transfer the risk of the covenant in the lease from the tenant to the landlord”. The claim against UBS was therefore struck out in its entirety with permission for Office Depot to plead a more traditional defects claim against Amec and its sub-contractor.

Conclusions and implications

This decision highlights the legal complexities which can arise in construction cases involving developers / landlords and tenants. Although these relationships are commonplace, cases considering their impact on liability for defects are relatively rare. The present decision focuses on the position of the tenant in such circumstances and shows the active role that is needed in managing its repairing covenant and preserving rights of recourse against contractors. Complex issues also arise for developers / landlords and contractors in such circumstances and require careful consideration at an early stage.

* CMS acted for the successful party in this case.

References:

Office Depot International (UK) Ltd v UBS Asset Management (UK) Ltd [2018] EWHC 1494 (TCC).