by Paul Kinsella
“Compensation” has been defined as a sum of money which fails to compensate — remaining without injury is much better than being entitled to sue after injury has occurred. Similarly, a warranty that your building is without fault adds little if it is true but will lead to long and ardous litigation if it is false. However, collateral warranties are in great demand and, if a building cannot be financed or let without them, they do have an important function. The limitations of their usefulness must, however, be recognised and there is a need to look for wider means of preventing defects. Establishing clearer lines of responsibility and recognised standards is one way of reducing the occurrence of defects while new insurances may give better solutions for the faults that do get through the net.
Warranties will only cover “defects” as opposed to problems attributable to the natural ageing of the building and its components or to a lack of proper maintenance. The public perception of a building “defect” is not necessarily a defect for which an architect or a contractor will be liable. The presence of flaking asbestos coatings on steelwork is sometimes viewed as a “defect”, but when first applied and sealed the asbestos performed an important safety function. Dangerous flaking may have arisen not from faulty design or workmanship but because vibration and the passage of time now necessitate removal or resealing. In considering whether there was negligence in preparing original specifications we may meet another defence, namely that what was put into a building represented the “state of the art” at the time.
Some costly problems with buildings arise from differentials in the life-span of building components, but collateral warranties will have no relevance unless the issue has been addressed in the design brief which forms part of the professional’s terms of engagement. In practice, few developers have sought to impose on architects and others a requirement that the design life of building components — and their long-term maintenance profile — should conform to certain minimum standards. This type of “value engineering” is not usually built into the contractual relationship between developers and their professional teams because limiting initial costs has usually been the developer’s predominant concern. In planning after the recession, the emphasis of contractual obligations on designers could well be changed.
As well as standards which developers may themselves dictate, statutes (especially EC driven) are imposing new standards, as recently exemplified by the Construction Products Regulations 1991. In terms of recommended codes, BS 5750 has introduced a standard of management for the construction industry though not a standard of design or workmanship.
An interesting insurance-led setting of standards appears in the Defect Avoidance Manual recently published by the Housing Association Property Mutual in connection with their revolutionary 35-year defects cover for housing associations. This has very limited application, but, as the experience of defective building litigation spreads in the wider property market, the search for preventive measures will increase and these are likely to include a wider use of design and specification standards.
Design co-ordination
Another instance in which collateral warranties may leave the developer without redress is in a management contracting project with a multiplicity of works packages which include a design element. Responsibility for design co-ordination as between the various packages and the central architect’s design is essential but difficult and often poorly defined in documents. The practical result is that one may find well-designed windows fixed into frames which are of standard design and yet the frames are wholly unsuitable for the windows supplied. Was the window manufacturer in breach of contract for failing to co-ordinate his designs with the walling contractor or vice versa?
It is vital that contract documentation should allocate responsibility for design co-ordination between works packages as well as for each individual package.
Professional indemnity insurance
Collateral warranties are of little value without professional indemnity insurance backing, unless the warrantor is of such financial standing that his available assets will cover any foreseeable claim.
The typical PI policy will exclude “any claim arising out of warranties” etc, with the result that only a warranty given with the insurer’s approval is of value. (Whatever the defects of the standard forms of warranty published by the British Property Federation, they have the advantage of automatic acceptance by certain PI insurers.) Even if liabilities under a warranty are prima facie covered, professional indemnity insurance is normally taken out as an annual policy and it will often be possible to claim on a policy only if the insured has disclosed to the insurer involved at the date of the claim the existence of the warranty, which may have been given several years earlier. Failing this, the plaintiff has only the private resources of the professional to meet the claim.
Insurance policies will normally cover only “design” and not execution, so that a contractor cannot insure against its own failure to build properly. Another problem is that, since the purpose of the insurance is to protect the insured party and not his client, a plaintiff may find that claims as between the professional and his insurers can be settled without reference to the plaintiff client. Thus, in Normid Housing Association Ltd v Ralphs [9] 1 Lloyd’s Rep 265, the plaintiff was unable to prevent its architects from setting with their PI insurers for £250,000 where the plaintiff’s claim was for £5.7m. It may, however, be possible to include in the professional’s terms of engagement an obligation (though probably not in absolute terms) to maintain insurance at an agreed level and a prohibition on settling claims with the insurers without the client’s approval.
Procuring warranties for tenants
When the developer first engages his professional team he may have neither long-term funding nor a prospective tenant signed up. Nevertheless he will need to look ahead when settling terms of engagement and building contracts. Since funding is likely to be unavailable in the absence of a tenant, the developer’s first objective will be to seek accord with a tenant. Sometimes contractors and others will give direct warranties to an original tenant taking the entire building, but where several tenants are involved another approach must be found.
The tenant may suggest that the landlord should be liable in the lease for all defects in the design and construction of the building. This is seldom appealing to the developer but, if it were conceded, it is the landlord and not the tenant who may need the benefit of warranties.
In all probability the developer would be prepared to offer the “benefit” of collateral warranties in return for the tenant accepting the liability to make good defects. It is unwise to assign the benefit of warranties outright to a tenant since the developer would have nothing left to offer a fund or any later tenant. The original tenant might go into liquidation leaving other parties without rights when defects appeared.
Is the benefit assignable?
Quite apart from the desirability of the assigning the benefit of an appointment, building contract or warranty, there is the question of whether it is assignable at all and in many cases the consent of the professional or contractor will be required. Two recent cases decided together, Linden Gardens v Lenesta Sludge Disposals Ltd and St Martin’s Property Corporation Ltd v Sir Robert McAlpine & Sons Ltd [2] CILL 731 have emphasised how fraught with problems this whole area is, especially in relation to the type and extent of damages which may be recovered by an assignee. (One of the issues at stake was whether prohibition on assignment excludes assignment of a contract only while it is being performed and does not exclude the assignment of rights to sue for the results of defective performance. Another issue was whether an assignee can obtain nominal damages only if the assignor had disposed of the property before suffering any loss.) In both cases the Court of Appeal has reversed the decision at first instance and leave has been granted for an appeal to the House of Lords.
Partial assignments or trusts
As mentioned above, where a direct warranty is not available to tenants and where a prudent developer or landlord would decline to assign the benefit of warranties or other contracts outright, the developer or landlord may declare that he holds rights in respect of defects in trust for himself and the tenant, or will otherwise enforce them for the tenant’s benefit. Trust law is full of problems when it comes to enforcement and the drafting needs to be undertaken with care. If the substance of the “trust document” is an assignment then, no matter what it is called, it may fall foul of any prohibitions on assignment and lead to difficulties in determining what damages are recoverable.
Latent defects insurance
Given the complex problems of professional indemnity insurance supporting collateral warranties and the difficulty of assigning warranties and other contracts, what other comfort may be available?
One desirable solution is a single-premium non-cancellable policy, which is transferable so that owners and occupiers of the relevant building can enjoy the benefit and be able to pass it on to the prospective purchasers, thereby maintaining the capital value of the building.
Following a NEDO Report in 1988 which recommended the use of BUILD (an acronym for building users’ insurance against latent defects), the market is continuing to expand for insurance giving 10 years’ cover against major defects in the structure. Although this insurance, also referred to as “decennial insurance”, offers advantages, there are drawbacks. It adds between 1% and 3% to construction costs, there is a restricted definition of “defects”, often involving actual damage or imminent threat of collapse, additional monitoring may be required through the project, there are high deductibles and limited cover for loss of rent or other consequential loss and an additional premium is required if the insurer is to waive subrogation rights. We have more recently seen a contractor offering its own building guarantee scheme, with insurance backing, but, while the initiative is clearly positive in principle, there are always many detailed terms and conditions to consider.
Conclusion
All the techniques for dealing with the risk of latent defects have a greater or lesser degree of imperfection. This is perhaps inevitable when allocating the risk of a potentially expensive contingency. Although defects will never be wholly eliminated, effort at the beginning of a project in terms of quality assurance provisions in contracts, and clarification of design responsibility, should pay dividends. If developer/landlords have faith in their own buildings, there may be a case for returning to internal repairing leases, which would remove an obstacle to letting and enhance initial rent and rent reviews. This would leave the problem of disposal, which admittedly might necessitate a fairly radical change in the concept of the “institutionally acceptable” lease. If better control at the front-end of projects can be established, we may see further improvements in the insurance products available to a worried industry.
