Scottish Appeal Court reverses decision on time-bar for collateral warranty claims

A decision of the Inner House of the Court of Session this month has reversed an earlier decision regarding the law of prescription (time bar) in Scotland and its effects on collateral warranties. The Court decided that, “no greater liability” and “equivalent right of defence” clauses included in a collateral warranty governed by Scots law impact on the prescriptive period for that collateral warranty; that the entering into of a collateral warranty did not create a new prescriptive period and that the prescriptive period under the original building contract was equally applicable to the beneficiary of the warranty. The decision closely aligns the Scottish position in relation to such clauses with that which presently applies in England and Wales, but poses unique challenges for projects in Scotland due to the way in which the law of prescription operates.

British Overseas Bank v Stewart Milne Group Limited: a recap

Stewart Milne Group Ltd (the “Contractor”) were employed by Northburn Developments Ltd to undertake the design and construction of a car park in Inverurie. British Overseas Bank (“BOB”) acquired the site on behalf of others in June 2013 and was granted a collateral warranty from the Contractor in August 2013.

The form of warranty within the building contract, and that provided to BOB, stipulated that the Contractor would have “no greater liability to the Beneficiary under this Agreement than it would have had if the Beneficiary had been named as the employer under the Building Contract”. The warranty also contained an “equivalent rights of defence” clause which entitled the Contractor to “rely on any limitation in the Building Contract and to raise the equivalent rights in defence of liability as it would have against the Employer under the Building Contract …”.

The car park suffered from ponding and flooding at the northern boundary and BOB brought proceedings against the Contractor in June 2018 for breach of the collateral warranty. The prescriptive period under the building contract (similar to a limitation period in England) expired on 19 June 2014, five years after practical completion. However, the proceedings were brought within five years from the granting of the collateral warranty.

The Outer House held that BOB’s rights under the warranty were subject to a fresh five year prescriptive period from the date of the warranty and its proceedings were brought in time. For a more detailed summary of the Outer House decision, please see our original Law-Now here.

The Appeal

The Contractor appealed the decision to the Inner House of the Court of Session where the original decision was reversed.

The Contractor successfully argued that the claim was time barred under the law of prescription, due to the existence of a no greater liability clause within the collateral warranty. It argued that although the collateral warranty had been granted less than five years previously, the time limit attaching to it was that attached to the original building contract.

When interpreting the terms of the collateral warranty, the Inner House focussed on what it believed to be the underlying commercial purpose of a collateral warranty. The Inner House stated that the objective of a collateral warranty is to put the beneficiary in the same position as the Employer under the original building contract. It stressed that the purpose of a collateral warranty was not to place the beneficiary in a more favourable position than the original employer. The Inner House found that the existence of both a “no greater liability” clause and an “equivalent rights of defence” clause within the warranty supported this approach and showed that that the objective intention of the parties was to restrict the prescriptive period to that contained in the building contract.

Parts of the Inner House’s decision to go beyond the specific terms of the warranty in the present case are likely to have significant ramifications for the interpretation of other collateral warranties under Scots law. For example, the court considered that due to the importance of time-bar provisions to contractors and designers, “a collateral warranty should normally be subject to the same time bar as applied to the original building contract.” In a similar vein the court noted that a collateral warranty which “which had the effect of conferring greater rights on the Beneficiary … could readily be regarded as unfair to the contractor who grants the Warranty.”

The court emphasised that the law of prescription is to act as a default position, which allows the parties to agree a shorter prescriptive period where desired. The court found that, in this instance, the parties had agreed shorter prescriptive periods in two ways:

• by capping the longstop prescriptive period to 12 years (rather than 20 years, as contained in section 7 of the Prescription and Limitation (Scotland) Act 1973 (the “1973 Act”)); and

• by agreeing “no greater liability” and “equivalent rights of defence” clauses within the warranty and therefore agreeing a prescriptive period in the warranty which was shorter than the statutory period of five years under section 6 of the 1973 Act.

The court found that it was clearly the parties’ intention for the Contractor to be barred from bringing a claim at the same point in time as the original Employer would have been and that as the prescriptive period under the building contract had expired, BOB was time-barred from bringing a claim under the collateral warranty.

Summary

The court clarified that “no greater liability” and “equivalent rights of defence” clauses apply to equivalence of content, scope and time – that there was no commercial reason for a beneficiary of a collateral warranty to be in a more favourable position than the employer under the building contract so the Contractor could rely on a defence to claims under a collateral warranty that its obligations under the building contract had prescribed.

Implications

The decision of the Inner House has several implications:

• “Commercial common sense”
  • The court relied on the principle of “commercial common sense” and looked at the intention of the parties in coming to the decision. This marks a difference in an approach from the Outer House’s decision which placed greater emphasis on the meaning of the words used in the “no greater liability” and “equivalent rights of defence” clauses. The Inner House’s approach can also be contrasted with recent Supreme Court decisions (including MT Højgaard v E.ON) which warn against placing undue emphasis on notions of commercial common sense at the expense of the literal meaning of the terms agreed between the parties.
• Statutory prescriptive period as a default.
  • The decision expressly provides that the statutory prescriptive period can be contracted out of where it is to further limit the prescriptive period available to the parties. The ability to contract out of the statutory prescriptive periods is to be updated by the Prescription (Scotland) Act 2018 when it comes into effect, but the court’s findings help to clarify the reach of the existing section 13 of the 1973 Act which expressly prohibits contracting out and provides that a provision in any agreement purporting to do so shall be null.
• English position
  • The decision is more aligned with the English position in Swansea Stadium Management Company Limited v City & County of Swansea in which the TCC held that a “no greater liability” clause supported an argument that the beneficiary of a collateral warranty was bound to the limitation period under the building contract.
• Purchaser/Tenants/Real Estate Investors
  • The decision means that parties who are buying, letting or entering into funding agreements in respect of properties which are more than 5 years old may not be able to rely on collateral warranties to make claims in respect of defects which are already known. It will put greater emphasis on technical reports and commercial agreement with the Vendor/Landlord/Developer.
  • Given the recent decision in Midlothian Council v Blyth and Blyth where the consultant successfully argued the 5 year prescriptive period had started from the date the Developer had spent money building a defective development this decision emphasises that the courts will not look to find a generous interpretation of a prescriptive period.
• Further appeal decisions and the coming into effect of the 2018 Act are looked forward to.

References:

MT Hojgaard AS v E.ON Climate and Renewables UK Robin Rigg East Ltd [2017] UKSC 59.

Swansea Stadium Management Company Ltd v City & County of Swansea [2018] EWHC 2192 (TCC).

Midlothian Council v Blyth and Blyth [2019] CSOH 29.

British Overseas Bank Nominees Limited v Stewart Milne Group Limited [2019] CSIH 47.