Developers and occupiers will both be interested in a recent Court of Session judgment that deals with the interpretation of a net contribution clause in a collateral warranty. The Inner House (acting as the Scottish civil appeal court) held that the reference to "costs" in the expression "The Consultant's liability for costs under this Agreement" was not a limitation on the category of loss that was recoverable under the warranty.

The moral of the story is to check whether your business interruption insurance covers losses arising from property defects and carefully consider the terms of net contribution clauses that might be included in any collateral warranties.

Glasgow Airport Limited v Kirkman & Bradford was the Scottish courts' first opportunity to consider the terms of a Collateral Warranty containing a net contribution clause. Contractors and consultants are keen to have these clauses in the warranties that they grant to purchasers & tenants, as they provide that someone who is negligent can have their liability reduced if there is another wrongdoer, leaving the person suffering the loss to claim any balance from the other guilty parties. This reverses the normal common law rules, which state that the innocent party can sue any one of several joint wrongdoers, leaving them to apportion liability between themselves, and recover contributions from one another.

The case arose out of a fairly typical development, and shows clearly the potential impact that net contribution clauses can have for occupiers and developers. Glasgow Airport Limited ("GAL") entered into an Agreement for Lease with UPS for the design, construction and lease of a new building in the Air Cargo Centre at Glasgow Airport. GAL (and an associated company, BAA Lynton) appointed a Design & Build Contractor who in turn appointed the engineers, Kirkman & Bradford ("K&B").

K&B granted a collateral warranty to GAL as the employer in fairly standard wording, containing a net contribution clause which stated that the Engineer's liability would be reduced on a just & equitable basis if there were others who were also responsible for defects. Significantly, this did not expressly restrict their liability to the costs of repairing or making good any defects for which the engineers were liable, as is sometimes the case with net contribution clauses.

Defects appeared in the floor slab, which were alleged to be due to the engineers' fault. UPS started a court action against GAL for breach of the Agreement for Lease, claiming a sum in excess of £2,000,000. Of that, c. £775K was for remedial works, and the balance was loss of profit and other costs arising from disruption to their business due to their inability to use the warehouse. GAL subsequently sued the engineers under the collateral warranty for that sum.

Counsel for GAL explained that the Contractor was not available to be sued as they were insolvent. So the engineers, backed by PI insurance, were an obvious target despite the terms of the net contribution clause. K&B did not in fact suggest that GAL should seek a contribution from any other party, and the case was not about the validity or effectiveness of the net contribution clause itself. They simply argued that the reference to "costs" in the expression "The Consultant's liability for costs under this Agreement" meant that they were only liable for costs of repair and reinstatement, as loss of profits etc could not be "costs". If that argument was correct, then the engineers' liability would be reduced from £2M to £775K - quite a saving.

The interpretation of the Collateral Warranty and the effect of the wording of the net contribution clause was initially debated before Lord Clarke in the Commercial Court of the Court of Session and, subsequently, on appeal by the Engineers, before the Inner House. The Court recognised that the net contribution clause sought to restrict the general undertakings about exercise of skill & care given by K&B in the collateral warranty by "having regard to the responsibility of others" and had no difficulty in principle with this variation of the normal common law rules about the extent of a party's liability. That might therefore make it difficult to challenge net contribution clauses on the grounds of first principles or public policy, although the point was not specifically debated.

Both at First Instance and on Appeal, the Court rejected the engineers' argument. The word "costs" in this context did not limit the types of loss for which the engineers might be liable under the Warranty, and could include loss of profits. If GAL were liable to UPS for loss of profits, GAL would be entitled to recover them from the engineers under the Collateral Warranty. They would of course still have to prove a breach of the Warranty in the usual way (whether or not there was a breach was not the issue in this case).

Developers and occupiers will be reasonably happy with this decision as the courts plainly got it right - and we say that not just because it meant our clients won (Brodies acted for GAL)! Many collateral warranties do however now expressly limit the granter's liability to responsibility for costs of repair or remedial works and such an express limitation is likely to be valid.

Developers and occupiers will therefore still need to assess whether that is an acceptable limitation, which is of course another matter entirely. This case shows the significant sums that could be excluded by such a limitation and occupiers in particular will wish to check if these sorts of losses are recoverable under their own business interruption insurance.
Since this is not merely the decision of a single judge, the case should be a suitable precedent to follow in England. As a side-note, critics of the Scottish judicial system might be surprised at the speed the courts dealt with the case. Lord Clarke's original decision was issued on 8th March 2007, the appeal was heard at the beginning of May and the Opinion of the Inner House was issued on 6th June.

Mark Finlay
Head of Construction & Engineering Group
Brodies LLP

For more information contact Mark Finlay at mark.finlay@brodies.com or on 0131 656 0101.