by John Martin
In his lucid article entitled “Construction Law — Where are we now?” published in your issue of May 5 (p 28) John Murdoch expressly sought not to incorporate a critique of collateral warranties. However, in his analysis of the present position at law he made amply clear the reasons why, over the past decade, considerable time and energy has been spent in constructing contractual relationships between various parties involved in the design, construction and ultimate occupation of development projects.
The desire of financial institutions, purchasers and tenants to avoid reliance upon rights in tort alone is easily understood. It is equally well recognised, however, that an excessive number of hours frequently has to be invested in negotiating such contractual relationships (at what can often be one of the more crucial stages of the project of development) and that working relationships are often impaired at the outset as a result of failure to reach agreement on issues arising out of those negotiations.
For this and other reasons the British Property Federation are to be warmly congratulated for the initiative which they decided to take some time ago in preparing (in consultation with the Association of Consulting Engineers, the Royal Institute of British Architects and the Royal Institution of Chartered Surveyors) a standard form of Agreement for Collateral Warranty for use where a warranty is to be given to a company providing finance for a proposed development. That standard form, with brief guidance notes, has recently been published.
This short note is not intended to be a commentary on the detailed terms of that standard form but rather a summary of its immediately apparent shortcomings as seen from the point of view of one who commonly advises developer-clients in relation to collateral warranties.
(It will be appreciated that one of the specific concerns of a developer in negotiating the terms of appointment of the members of his professional team is to ensure that he can procure the execution of collateral warranties in favour of, for instance, a financial institution in a form which will be acceptable to that institution.)
The perceived shortcomings may conveniently be dealt with under the following headings:
Duty of care
The level of the contractual duty of care which is provided for in the standard form is, by virtue of the wording, limited to the level which applies under the terms of the appointment. Furthermore, the extent of that duty of care (in relation to the specific services to be provided) is similarly limited. While it has been argued that a consultant should not be required to assume obligations in a collateral warranty over and above those contained in his appointment, this may not always be satisfactory to a financial institution which appears on the scene after the appointment has been put in place.
It is further provided that the consultant is to have no greater liability to the financial institution (by virtue of the collateral warranty) than he would have had if the financial institution had been named as a joint client under the appointment. This effectively imposes upon the financial institution the burden of any set-off rights which the consultant may have against the developer, and similarly the limitation period which obtains under the terms of the appointment.
Proscribed materials
The standard form details five proscribed materials (which are not to be specified for use in the development) and leaves it open to the parties to add further specific materials by agreement. No attempt has been made to incorporate general wording to cover further substances which do not comply with the relevant British Standards and Codes of Practice in force at the time. Again, a financial institution is likely to seek this additional protection.
Taking over the appointment
Provisions are included within the standard form which would enable the financial institution, in the event of default by the developer, to take over the appointment of the consultant and so be in a position to build out the development. The exercise of such right is made conditional upon the termination of the relevant finance agreement by the financial institution; in most cases a financial institution might well wish to be able to implement such right prior to the stage of termination and simply upon a specified breach of that finance agreement. Since the consultant is entitled to rely upon a notice given by the financial institution alone of that right arising he is adequately protected.
Professional indemnity insurance
The standard form does not, in fact, specify the risks against which professional indemnity insurance is to be maintained. (This is usually the negligence, omission or default of the consultant.) It does not state where and with whom such insurance should be maintained. Financial institutions will frequently want to see that such an insurance is maintained with an insurance office or underwriters in the United Kingdom. The consultant is relieved of the obligation to insure whenever such insurance ceases to be available “at commercially reasonable rates”. That expression is insufficiently certain. The ensuing provision which refers to the consultant and the financial institution discussing means of best protecting their respective positions in the absence of such insurance must be of limited legal effect and practical consequence. Finally, the consultant is not required to accept any express obligation to disclose the terms of the warranty to his insurers. These must all be points of concern for a financial institution.
Assignment
The benefit of the warranty may be assigned only to another company providing finance or re-finance in connection with the development project. It is not clear from the wording whether this means one assignment only, and this would in any event prevent a financial institution which chose to exercise a power of sale (where, for instance, the developer became insolvent) from passing on the benefit of the collateral warranty to an outright purchaser. There is very little logic in restricting the right of assignment in this way, since the assignment of itself does not increase the liability assumed by the consultant under the collateral warranty.
Variation of terms of the appointment
Most financial institutions will wish to know (for reasons which will be apparent from what has been written above) that the terms of the consultant’s appointment can not be varied. It may be argued that this can be covered in the finance agreement between the developer and the financial institution, but there seems to be no reason why an appropriate warranty should not be given direct in this respect by the consultant.
Conclusion
The present state of affairs in relation to collateral warranties is lamentable, and any sensible attempt to produce a standard form of collateral warranty which is generally accepted must be supported. The British Property Federation has strived nobly in this regard, but the initial impression gleaned is that insufficient emphasis has been placed upon the quite usual requirements of financial institutions, despite (apparently) consultations with representatives of such institutions. This imbalance could easily be corrected in a further edition of the standard form. At the same time there would undoubtedly be support for separate forms providing contractual redress for purchasers and tenants. Perhaps we may expect to see them shortly.
