PLC: No loss argument in construction claims

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A note considering the “no loss” argument in the construction and engineering context, including whether a party’s
claims can disappear in a “black hole” (published by Practical Law Company).

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PLC: No loss argument in construction claims

  1. 1. Construction PLC No loss argument in construction claims: what it is and how to deal with it Resource type: Practice note Status: Maintained Jurisdictions: England, Wales A note considering the “no loss” argument in the construction and engineering context, including whether a party’s claims can disappear in a “black hole”. PLC Francis Ho, King & Spalding and PLC Construction Contents  What is the no loss argument?   Often impractical not to use an equivalent  When can the no loss argument arise? rights of defence or a no greater liability clause  No actual loss   Draft an equivalent rights of defence or a no greater liability clause to avoid a no loss  Is there a black hole? defence   Person suffering loss has no contractual   Does a no greater duty clause prevent a no loss relationship with the person responsible defence?   Weaknesses in equivalent rights of defence or   Is there really a problem with the no loss no greater liability clauses might prevent argument and equivalent rights of defence and recovery no greater liability clauses?   Assignment and the principle that an assignee   What to do now in collateral warranties and may not recover more than an assignor third party rights   Failure to properly transfer rights and  How to deal with the no loss argument on the obligations under a novation agreement assignment of construction contracts  A chain of contracts  How to deal with the no loss argument when  How to deal with the no loss argument in novating a construction document construction documents  How to deal with the no loss argument when facing  How to deal with the no loss argument when a chain of contracts negotiating an equivalent rights of defence or no What is the impact of the Contracts (Rights of Third greater liability clause Parties) Act 1999 on no loss? What is the no loss argument? The “no loss” argument (or “no loss” defence) is an expression used to describe a defence raised by the defendant in legal proceedings that, while it may be in breach of its legal obligations to the claimant, the claimant has not suffered a loss following that breach. Consequently, the defendant argues that even if the claimant is successful in proving the breach, the claimant should only be entitled to nominal damages. Register for a free trial: T: +44 (0)20 7202 1200 E: info@practicallaw.com W: www.practicallaw.com This document can be found at http://construction.practicallaw.com/0-385-2290 © Legal & Commercial Publishing Limited 2009 1
  2. 2. In English law, it is a fundamental principle that damages for breach of contract are intended to put the innocent party in the position that it would have been in had the other party complied with its contractual obligations (see Practice note, Remedies: damages and agreed remedies: Claims for breach of contract (www.practicallaw.com/8-107-4864)). The damages awarded should compensate the claimant for the loss incurred. Consequently, where breach of contract is established but loss or damage is not, it should receive only nominal damages by way of compensation (Surrey County Council and Another v Bredero Homes Ltd [1993] EWCA Civ 7). If a defendant shows that the claimant has not suffered a loss (or, perhaps more accurately, the claimant cannot prove, on the balance or probabilities, that it has suffered more than a nominal loss), then the defendant has operated the no loss defence. In construction claims, the no loss argument can become a problem (or can create a so-called “black hole”) if a defendant can seek to rely on that argument, even if its actions have led to the claimant suffering substantial loss. When can the no loss argument arise? There are two common situations in which a no loss argument can arise:  Where a party has actually suffered no loss (see note, No actual loss).  Where a party’s loss has fallen into a so-called “back hole” (see note, Is there a black hole?). A third circumstance could, arguably and from a defendant’s perspective, fall into either category. That is a circumstance where a chain of contracts has been created, where the party suffering a loss relies on an intermediate party to recover that loss. For example:  Andrew has suffered a loss, caused by Colin, but has no contract with Colin. (Andrew has no claim available in tort against Colin.)  Ben has a contract with Andrew and a contract with Colin. Under Ben’s contract with Andrew, Ben is liable to Andrew for Colin’s default, but Ben’s liability to Andrew is limited to the amount Ben recovers from Colin. Colin could argue that Ben can only claim nominal damages because, if Ben does not recover substantial damages from Colin, then Ben is not liable to Andrew (see note, A chain of contracts). No actual loss A “no actual loss” situation occurs where a claimant has contractual rights against the defendant but is not entitled to substantial damages because the contractual breach did not cause it to suffer any loss. This is consistent with the fundamental principle that the claimant should only be compensated for losses it has incurred. (See, for example, Birse Construction Ltd v Eastern Telegraph Company Ltd [2004] EWHC 2512 (TCC) or McGlinn v Waltham Contractors Ltd [2007] EWHC 149 (TCC).) Is there a black hole? The concept of a claim for damages disappearing or falling into a “black hole” was first mentioned in GUS Property Management Limited v Littlewoods Mail Order Services (1982) SLT 533, HL at 538, which concerned a claim in tort. In a “black hole” situation, the claimant has suffered loss as a consequence of the contractual breach but its ability to claim has fallen into a legal black hole. There are several circumstances where a black hole may exist in relation to a construction claim:  The person suffering loss has no contractual relationship with the person responsible.  Weaknesses in equivalent rights of defence or no greater liability clauses might prevent recovery. Register for a free trial: T: +44 (0)20 7202 1200 E: info@practicallaw.com W: www.practicallaw.com This document can be found at http://construction.practicallaw.com/0-385-2290 © Legal & Commercial Publishing Limited 2009 2
  3. 3.  Two parties have assigned the benefit of a construction contract from one to the other and in a subsequent claim, a defendant argues that the assignee may not recover more than the assignor would have done (see note, Assignment and the principle that an assignee may not recover more than an assignor).  A failure to properly transfer rights and obligations under a novation agreement. Person suffering loss has no contractual relationship with the person responsible Collateral warranties and third party rights A construction project typically involves a number of third parties who have an interest in the development, such as funders, purchasers and tenants. These parties may require construction security (such as a collateral warranty or third party rights) to ensure that they are able to claim against members of the construction team. In addition, a developer will require construction security from sub-contractors and sub-consultants, if it wishes to be able to claim against them. In the UK, construction security usually takes the form of collateral warranties or third party rights in favour of the third party (see Practice note: overview, Collateral warranties on construction projects (www.practicallaw.com/0-371- 6962) and Practice note: overview, Third party rights on construction projects (www.practicallaw.com/2-372- 2962)). The difficulties in claiming in tort for economic loss occurring from defective construction and the doctrine of privity of contract mean that, in the absence of direct contractual rights, it is difficult for a party to claim against the member of the construction team that has caused the loss (see Murphy v Brentwood District Council [1991] UKHL 2 and Practice note: overview, Collateral warranties on construction projects: A claim in tort? (www.practicallaw. com/0-371-6962)). As a result, without a contract, the claimant suffers from a potential black hole in its ability to claim. Assignment and novation A third party may obtain contractual rights through the assignment or novation of a construction contract (see Practice note, Assignment of construction documents (www.practicallaw.com/5-282-1952) and Practice note, Novation of construction documents (www.practicallaw.com/1-315-1953)). The transfer (whether a novation or an assignment) means that the assignor or novating party is no longer able to enforce the benefit of the assigned rights. From the assignor’s or novating party’s point of view, a black hole has therefore been created in its ability to claim against the other party to the contract. If the assignor or novating party wishes to retain the ability to claim, it should consider obtaining a collateral warranty or third party rights from the other party to the construction contract at the time of assignment or novation. (See, for example, Standard document, Professional appointment: 16. Collateral warranties (www. practicallaw.com/5-382-5666).) Novation: collateral warranties, third party rights, bonds and guarantees Since (on a conventional analysis of a novation) novation extinguishes the original contract and replaces it with a new one on the same terms (albeit with different parties), a novation of the building contract or professional appointment could, at least in theory, mean that any existing collateral warranties that link directly to the novated contract could be rendered valueless by the novation. Arguably, the collateral warranties would relate to a contract that had been extinguished. (This would also be true of any other agreements that directly linked to the novated contract, such as a parent company guarantee or performance bond.) The same issue may also arise if a beneficiary to third party rights or a collateral warranty exercises a right to step-in, as step-in provisions in third party rights or collateral warranties are often drafted to take effect as a novation (see Glossary term, Step-in rights (www.practicallaw.com/8-107-7320)). To address the theoretical risk that a collateral warranty, third party rights or (for example) a parent company guarantee may be extinguished by a novation, the parties may agree to:  Obtain a new post-novation collateral warranty in favour of third parties from the professional consultant. For example, in a situation involving a novated professional consultant in a design and build procurement route, it is common for collateral warranties or third party rights to be obtained from the professional consultant at the same time as or following novation to the design and build contractor. Register for a free trial: T: +44 (0)20 7202 1200 E: info@practicallaw.com W: www.practicallaw.com This document can be found at http://construction.practicallaw.com/0-385-2290 © Legal & Commercial Publishing Limited 2009
  4. 4.  If a collateral warranty is entered into before a novation, draft the recitals of (or include a boilerplate clause in) the collateral warranty in a way that confirms that the collateral warranty will link to the novated contract, in the event the contract is novated. See, for example, the reference to “novated” contracts in Standard document, Collateral warranty to be provided by a professional consultant: 1. Interpretation (www.practicallaw.com/3-382-9986). (This approach could, theoretically, still mean that any step-in right may not be carried forward so, if possible, the new (post-novation) employer should be a party to the collateral warranty to avoid any problems.)  Include a clause in the novation agreement confirming that any collateral warranty granted pre-novation is still effective, following the novation. One complication of this option is that a beneficiary of a collateral warranty may wish to receive third party rights under the novation agreement in order to be able to enforce that provision themselves. (See, for example, Standard document, Novation of professional appointment from employer to contractor: 12. Collateral warranties and third party rights (www.practicallaw.com/9-383-4541).) The situation should be more straightforward where third party rights (not collateral warranties) were granted to beneficiaries prior to the novation. This is because the third party rights derive from the fact that obligations under a contract are for the benefit of a third party. As a result, those obligations and the consequent third party rights will be automatically replicated in the novated contract. However, because most construction contracts that allow for third party rights are drafted so those rights only take effect upon serving a notice (rather than automatically upon execution of the contract), the parties may choose to issue new notices following any novation, to protect their position. Weaknesses in equivalent rights of defence or no greater liability clauses might prevent recovery Equivalent rights of defence or no greater liability clauses allow a contractor or professional consultant to use whatever exclusions or limitations of liability it may have under its contract with its employer in defence to a claim brought by a beneficiary of third party rights or a collateral warranty. If there is a cap on liability under the contract with the employer or if a contractual claim by the employer would have been time-barred under the Limitation Act 1980, the contractor or professional consultant may also operate these defences against the beneficiary. Some legal practitioners argue that the inclusion of such a clause in third party rights or collateral warranties could, unless carefully drafted, permit the possibility of a no loss defence. Are equivalent rights of defence or no greater liability clauses interchangeable? Many practitioners consider that no greater liability clauses and equivalent rights of defence clauses are interchangeable, because they seek to achieve the same outcome. A minority argue that the clauses are fundamentally different, because although they seek a similar outcome, they seek it by very different means. This note considers both types of clause together on the basis that, whichever analysis is correct, the outcome of a well-drafted or badly-drafted clause of either type would be the same. Examples of clauses that raise a concern about a black hole These are examples of wording in a collateral warranty dealing with equivalent rights of defence and no greater liability that, some argue, could inadvertently create a black hole in certain circumstances:  Equivalent rights of defence: “The Contractor may use any defence that it may have against the Employer under the Contract in defence of any claim by the Beneficiary under or in connection with this Collateral Warranty (save in respect of set-off and counterclaim).”  No greater liability: “The Contractor has no greater liability towards the Beneficiary under this Collateral Warranty than it has towards the Employer under the Contract (save in respect of set-off and counterclaim).” Register for a free trial: T: +44 (0)20 7202 1200 E: info@practicallaw.com W: www.practicallaw.com This document can be found at http://construction.practicallaw.com/0-385-2290 © Legal & Commercial Publishing Limited 2009
  5. 5. How does the black hole argument arise when using an equivalent rights of defence or no greater liability clause? Some practitioners argue that the fundamental difficulty with clauses similar to the examples above is that the wording suggests that the beneficiary should be treated as if it were the employer for the purposes of ascertaining its loss (see note, Examples of clauses that raise a concern about a black hole). If correct, this means that a black hole may arise where the employer has suffered no loss (or a lesser loss than that suffered by the beneficiary of the third party rights or collateral warranty), following the contractor or professional consultant’s contractual breach. If the employer has no proprietary interest in the project and no liability to anyone who does have a proprietary interest, the employer will suffer no loss in the event that defects in the completed project arise. (This assumes that the employer is not seeking to recover damages on behalf of, for example, a group company: see Practice note, No loss and assignment: the development of the common law in the construction context: The narrow ground in St. Martin’s (www.practicallaw.com/4-385-6875). Separately, losses may accrue to other persons who have a proprietary interest and the benefit of third party rights or a collateral warranty.) Nevertheless, to illustrate, the no loss issue could arise if an employer:  Has disposed of its interest in the project to a buyer and the terms of the sale provide that it has no liability towards the buyer for defects in the project.  Is forward selling the project and the beneficiary is taking a lease or purchasing by way of sub-sale from the buyer and the beneficiary is liable for defects in the demised premises.  Has leased the project to a tenant on a standard full repairing and insuring lease (see Glossary term, FRI Lease (www. practicallaw.com/6-107-6604)). (The tenant is responsible for repairing any defects in the premises under the terms of the lease.) In each of these circumstances, the contractor or professional consultant could argue that the employer has suffered no loss. For more information on how to deal with equivalent rights of defence and no greater liability clauses, see note, How to deal with the no loss argument when negotiating an equivalent rights of defence or no greater liability clause. Assignment and the principle that an assignee may not recover more than an assignor The principle that an assignee may not recover more than an assignor would have recovered can lead to a concern that an assignment can create a no loss argument. The principle arose in Dawson v Great Northern and City Railway Company [1905] 1 KB 260 (CA) (see Practice note, No loss and assignment: the development of the common law in the construction context: The beginnings of the rule that an assignee may not recover more than an assignor (www. practicallaw.com/4-385-6875)). Generally, an employer may assign any, or all, of its rights and benefits under a contract to another party, subject to any contractual prohibition or restriction. In some circumstances (for example, some sales of a completed commercial property development), the parties may choose to assign the benefit of a contract rather than procuring a collateral warranty or third party rights. (For more information on the assignment of the benefit of a construction contract, see Practice note, Assignment of construction documents (www.practicallaw.com/3-314-7960).) Some practitioners express the concern that the assignee of the benefit of a building contract or professional appointment may only be able to recover nominal damages for a breach of contract by the contractor or professional consultant in situations where the assignor has suffered no loss or a loss different to that suffered by the assignee. This could occur on a sale, a forward sale with a pre-let or where the parties have entered into an FRI lease (see note, How does the black hole argument arise when using an equivalent rights of defence or no greater liability clause?). The courts have sought to avoid a wrongdoer benefiting from the principle that an assignee may not recover more than an assignor in a series of judgments, including: Register for a free trial: T: +44 (0)20 7202 1200 E: info@practicallaw.com W: www.practicallaw.com This document can be found at http://construction.practicallaw.com/0-385-2290 © Legal & Commercial Publishing Limited 2009
  6. 6.  Dunlop v Lambert (1839) 7 ER 824 (HL).  The Albazero, Albacruz (cargo owners) v Albazero (owners) [1976] 3 All ER 129 (HL).  Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd [1993] UKHL 4 (which also determined St. Martin’s Property Corporation v Sir Robert McAlpine in a joined appeal).  Darlington Borough Council v Wiltshier Northern Ltd [1994] EWCA Civ 6.  Alfred McAlpine Construction Ltd v Panatown Ltd [2000] UKHL 43 (which was determined against the interests of the third party seeking to enforce the contract, but still offers some support to third parties seeking to avoid a no loss defence).  Technotrade Ltd v Larkstore Ltd [2006] EWCA Civ 1079 (CA) (see also Legal update, Assigned cause of action did not leave a gap in liability (www.practicallaw.com/5-203-9970)). For more information on:  The development of the common law in connection with the assignment of construction contracts and the no loss defence, see Practice note, No loss and assignment: the development of the common law in the construction context (www.practicallaw.com/4-385-6875).  The common reaction of parties to a construction contract to these cases, see note, How to deal with the no loss argument on the assignment of construction contracts. Failure to properly transfer rights and obligations under a novation agreement Novation may be used when one of the original parties to a construction contract wishes to transfer its rights and obligations under that contract to a third party. In the Scottish case of Blyth & Blyth Limited v Carillion Construction Limited (2001), 79 Con LR 142, Outer House, Court of Session the court held that a novation agreement that does not adequately transfer all of the novating party’s contractual rights and obligations to a third party may fail to take effect as a novation. This could mean, under English law, that the third party has no claim against that other party. That is, it could create a black hole (see Practice note, Novation of construction documents: Is there a “black hole” after novation? (www.practicallaw.com/1-315-1953)). A chain of contracts Under the management contracting procurement route, an employer employs a management contractor, who in turn employs works contractors to carry out the works on site. It is common for the management contractor to be liable for its own breach of contract or negligence and also liable, but only to the extent it can recover the losses from others, for breach of contract by the works contractors. This theoretically simple approach leads to detailed drafting and many practical problems. For example, it is made more complex by the fact that the employer will require collateral warranties (or third party rights) from the works contractors. For more information of the structure of a management contracting project, see Practice note: overview, Procurement route: management contracting (www.practicallaw.com/9-376- 3628). Management contracting is now a relatively rare form of procurement in practice, but in the context of the no loss argument, illustrates a potential problem. The employer and the management contractor agree, in theory, that the management contractor is liable for its own default and that it should take the lead, as it manages the project, in recovering losses caused to the employer by others: the works contractors. However, in order to manage risk appropriately, the management contractor cannot be held liable for all the defaults of the works contractors and cannot take the risk of a works contractor breaching its works contract and becoming insolvent, and unable to pay damages. So, the parties agree that the contractor will only be liable to the employer “to the extent it can recover from others”. Register for a free trial: T: +44 (0)20 7202 1200 E: info@practicallaw.com W: www.practicallaw.com This document can be found at http://construction.practicallaw.com/0-385-2290 © Legal & Commercial Publishing Limited 2009
  7. 7. If a works contractor breaches its works contract and this causes the employer a £1,000 loss (perhaps the employer has to pay another works contractor £1,000 more to do something the first works contractor was contractually obliged to do), the employer would like the management contractor to recover that £1,000 from the works contractor. However, the works contractor may argue that, if it pays the management contractor nothing, the management contractor will have suffered no loss: the management contractor’s only liability to the employer is for the sums it has recovered from the works contractor. As the management contractor has not suffered a loss, the works contractor should be liable to pay only nominal damages. In practice, this risk is usually addressed in an “employer/works contractor agreement” (see note, How to deal with the no loss argument when facing a chain of contracts). Nevertheless, the example of management contracting illustrates how a no loss argument can arise if it is not adequately addressed in the contract documents. How to deal with the no loss argument in construction documents? How to deal with the no loss argument when negotiating an equivalent rights of defence or no greater liability clause Parties negotiating a collateral warranty or third party rights can avoid the no loss argument by:  Ensuring that the contract does not contain an equivalent rights of defence or a no greater liability clause (see note, Often impractical not to use an equivalent rights of defence or a no greater liability clause).  Checking and, if necessary, re-drafting an equivalent rights of defence or a no greater liability clause so that it properly addresses the possibility of a no loss argument (see note, Draft an equivalent rights of defence or a no greater liability clause to avoid a no loss defence). Often impractical not to use an equivalent rights of defence or a no greater liability clause To avoid the no loss argument, the parties may exclude equivalent rights of defence or no greater liability clauses from the third party rights or collateral warranty altogether. However, this is often impractical, since most contractors and professional consultants (not to mention their professional indemnity insurers) will insist on including these clauses. This is because they want to avoid the possibility that other clauses in the third party rights or collateral warranty will mean that their liability to a beneficiary is wider or greater than it would be to their employer, if the employer was in the beneficiary’s position. Draft an equivalent rights of defence or a no greater liability clause to avoid a no loss defence An alternative, which is generally commercially acceptable to contractors and professional consultants (and their professional indemnity insurers), is for the parties to draft any equivalent rights of defence or no greater liability clause to exclude the possibility of the contractor or the professional consultant raising a no loss defence. One of the simplest ways of doing this is to treat the third party as if it was the employer, or a joint employer, under the contract when establishing its losses under the equivalent rights of defence or no greater liability clauses. Alternatively, a separate clause may expressly exclude the no loss defence. The parties may achieve this by incorporating similar wording to the following examples:  Amend the equivalent rights of defence or no greater liability clause.  Add an additional clause prohibiting the professional consultant or contractor from relying on a no loss defence. Register for a free trial: T: +44 (0)20 7202 1200 E: info@practicallaw.com W: www.practicallaw.com This document can be found at http://construction.practicallaw.com/0-385-2290 © Legal & Commercial Publishing Limited 2009
  8. 8. Amend the equivalent rights of defence or no greater liability clause The no loss argument may be avoided by amending the example clauses that were set out earlier in this note to add the words shown in bold (see note, Examples of clauses that raise a concern about a black hole):  Equivalent rights of defence: “The Contractor may use any defence that it would have had under the Contract if the Beneficiary had been named in the Contract as its joint employer in defence of any claim by the Beneficiary under this Collateral Warranty (save in respect of set-off and counterclaim).”  No greater liability: “The Contractor has no greater liability towards the Beneficiary under this Collateral Warranty than it would have had if the Beneficiary had been named in the Contract as its joint employer (save in respect of set-off and counterclaim).” Add an additional clause prohibiting the professional consultant or contractor from relying on a no loss defence Another possible solution is to leave the ambiguous wording as it stands but to include a further clause prohibiting the contractor or professional consultant from raising a no loss defence against the beneficiary. For example: “Exclusion of “no loss” defence Notwithstanding any other provision of this Collateral Warranty, the Contractor agrees that it shall not be entitled to contend in defence of proceedings under this Collateral Warranty or otherwise that its liability to the Beneficiary is reduced or affected by virtue of the fact that the Employer has suffered no loss or a different loss from the Beneficiary as a consequence of any breach by the Contractor.” Any such clause must make clear that it takes priority over other contract provisions. This avoids any argument that the equivalent rights of defence or no greater liability clause override it. In this example this is achieved by using the words “notwithstanding any other provision of this Collateral Warranty” at the start of the clause. Does a no greater duty clause prevent a no loss defence? There is some support for the theory that the risk of a no loss defence can be avoided by replacing the word “liability” in a no greater liability clause with the word “duty” or “duties”. The theory argues that this also removes the need to include wording preventing the contractor or professional consultant from raising a set-off or counterclaim defence. This argument appears to stem from the fact that “liability” (or “obligations”) implies that the loss suffered by the employer as a consequence of the contractor or professional consultant’s breach is relevant for assessing a beneficiary’s loss. The word “duty”, on the other hand, does not require the employer’s loss to be considered, thereby avoiding the no loss issue. A concern with this approach is that, while there is no legal guidance that confirms definitively how the words “liability”, “obligations” and “duty” would be construed in the context of such a clause, general case law indicates that there is some degree of overlap between the interpretations of these words. This could mean there is a risk that a court could find “duty” to have the same meaning as “liability”. A more conservative approach is to use the “joint employer” wording suggested above and to expressly exclude set-off and counterclaim defences (see note, Amend the equivalent rights of defence or no greater liability clause). For example, see Standard document, Collateral warranty to be provided by a contractor: Clause 2. Comply with Building Contract (www.practicallaw.com/3-381-2976) (clause 2.2 includes the joint employer wording). Register for a free trial: T: +44 (0)20 7202 1200 E: info@practicallaw.com W: www.practicallaw.com This document can be found at http://construction.practicallaw.com/0-385-2290 © Legal & Commercial Publishing Limited 2009
  9. 9. Is there really a problem with the no loss argument and equivalent rights of defence and no greater liability clauses? Standard form collateral warranties and third party rights schedules include “problematic” wording There is a long-standing question as to whether the commonly used wording of equivalent rights of defence or no greater liability clauses needs to be clarified to avoid the possibility of a no loss defence. If there is a risk, then this is a significant issue, since the “problematic” no greater liability wording is used in a number of standard form collateral warranties and third party rights schedules, including those published by the British Property Federation (www.practicallaw.com/9- 106-4398), the Construction Industry Council (www.practicallaw.com/0-381-3864) and the Joint Contracts Tribunal (www.practicallaw.com/0-106-5180) (see Practice note, Joint Contracts Tribunal (JCT) forms of contractor collateral warranty (www.practicallaw.com/3-329-1311)). Case law and Safeway v Interserve There is no definitive case law that allows one to predict with certainty whether the no loss defence would succeed in each of the circumstances described in this note (see note, When can the no loss argument arise?). However, case law does show that equivalent rights of defence and no greater liability clauses should always be used with caution, as demonstrated by Safeway Stores Limited v Interserve Project Services Limited [2005] EWHC 3085 (TCC) (see Legal update, Equitable set-off as a defence to a warranty claim (www.practicallaw.com/9-202-0600)). In Safeway, the claimant had the benefit of a collateral warranty from the defendant (the contractor for the project). Although the claimant was successful in establishing losses of £413,000 resulting from defects caused by the contractor’s breach, the no greater liability clause enabled the contractor to set-off the claimant’s claim against the amounts owed to it by the employer (Chelverton Properties Limited), which was in liquidation. As the unpaid sum of £1.26 million was significantly in excess of the claimant’s losses, the Technology and Construction Court (TCC) held that the claim was reduced to nil. While it is by no means a definitive case on the issue of no loss (in relation to equivalent rights of defence and no greater liability clauses), the contractor in Safeway successfully relied upon a clause in a collateral warranty that was similar to the examples of “problematic” wording illustrated above (see note, Examples of clauses that raise a concern about a black hole). It read: “The Contractor shall owe no duty or have any liability under this deed which is greater or of longer duration than that which it owes to the Developer under the Building Contract.” Mr Justice Ramsey allowed Safeway’s claim in respect of the losses it had suffered as a result of the defects. It was the absence of an exclusion of the defence of set-off within the clause that enabled Interserve to avoid paying Safeway any money. Interserve did not raise a no loss defence at trial, so the judge did not have the opportunity to clarify the legal position on the issue. Is the “no loss” argument flawed? While the no loss argument (in the context of equivalent rights of defence or greater liability clauses) remains a legitimate concern for construction practitioners, it has fundamental weaknesses that could prevent it succeeding in court. The English courts are likely to carefully construe the purpose of equivalent rights of defence and no greater liability clauses with regard to the commercial intent of the parties. It is well-known that the intention of granting third party rights or a collateral warranty to a beneficiary is to enable the beneficiary to be able to recover its losses stemming from a contractor’s or professional consultant’s breach. (The third party rights or collateral warranty are granted to allow the beneficiary to avoid restrictions under the doctrine of privity of contract and the absence of an effective remedy in tort (see, for example, Practice note: overview, Collateral warranties on construction projects: A claim in tort (www. practicallaw.com/0-371-6962)).) It is equally common knowledge that beneficiaries often have different proprietary Register for a free trial: T: +44 (0)20 7202 1200 E: info@practicallaw.com W: www.practicallaw.com This document can be found at http://construction.practicallaw.com/0-385-2290 © Legal & Commercial Publishing Limited 2009
  10. 10. interests in relation to a project to the employer. Consequently, the parties to a collateral warranty or third party rights clause do not usually intend to restrict claims to nominal damages when they include equivalent rights of defence or no greater liability clauses. If a no loss defence from a contractor or professional consultant succeeded in such circumstances, it would effectively allow the contractor or professional consultant to avoid liability based on what is, essentially, a technicality. This would result in a black hole in the beneficiary’s claim, a notion that the courts have previously indicated that they are reluctant to entertain (see, for example, Legal update, Assigned cause of action did not leave a gap in liability (www.practicallaw.com/5-203- 9970)). Since the “problematic” wording is also used in many standard form collateral warranties, a decision by a higher court to allow a no loss defence in ordinary circumstances would potentially have a tremendous negative impact on the construction security held by a large number of purchasers, tenants and funders. This could in turn have a detrimental affect on the real estate market. What to do now in collateral warranties and third party rights “Joint employer” wording should, from a legal perspective, prevent a no loss claim and it is good practice to use that wording (see, for example, note, Draft an equivalent rights of defence or a no greater liability clause to avoid a no loss defence and Standard document, Collateral warranty to be provided by a contractor: Clause 2. Comply with Building Contract (www.practicallaw.com/3-381-2976): clause 2.2 includes the joint employer wording). However, it is doubtful whether the mere omission of “joint employer” wording would enable a contractor or professional consultant to successfully rely on a no loss defence to avoid liability under third party rights or a collateral warranty. Unless the position is clarified by a judgment from the TCC (or a higher court), joint employer wording remains necessary to help avoid argument, if nothing else. How to deal with the no loss argument on the assignment of construction contracts Although a professional consultant or contractor might seek to rely on a no loss argument if the benefit of their professional appointment or building contract has been assigned, the development of the common law makes it unlikely that such a defence would succeed (see Practice note, No loss and assignment: the development of the common law in the construction context (www.practicallaw.com/4-385-6875)). Even though the risk of a professional consultant or contractor successfully relying on a no loss defence following an assignment is low, the parties to construction contracts commonly follow three drafting approaches, which help them address any residual concern about the no loss argument. These three approaches also have other benefits for the parties and so they are often adopted without the parties giving any consideration to no loss issues. However, that does not make them any less effective. The first two approaches arguably benefit only a professional consultant or contractor (or a party in an equivalent position) and are already common in some forms of construction and engineering documents:  Limits on the assignability of construction contracts: the courts have supported express contractual provisions or limitations on assigning the benefit of a contract. (The possible “exception” to this is a situation where one party wishes to claim damages on behalf of another: see, for example, Practice note, No loss and assignment: the development of the common law in the construction context: Exceptions to the rule that a party may only recover its own losses: the narrow ground and the broad ground (www.practicallaw.com/4-385-6875).) A limit on rights of assignment is common in construction and engineering contracts, although details vary between different contracts and different sectors.  Limits on liability to third parties: the parties could agree a clause that expressly lists who may claim what types of loss from the professional consultant or contractor. (Such a clause would be in addition to any exclusion of the rights Register for a free trial: T: +44 (0)20 7202 1200 E: info@practicallaw.com W: www.practicallaw.com This document can be found at http://construction.practicallaw.com/0-385-2290 © Legal & Commercial Publishing Limited 2009
  11. 11. of third parties under the Contracts (Rights of Third Parties) Act 1999.) For example, a clause could state that a party would be liable for only the reasonable costs of repair, renewal and/or reinstatement of a property, plus the employer’s other losses of up to £1,000,000 only. In those circumstances, even if the employer did have the right to recover damages on behalf of another, if the clause was carefully drafted, the employer would only be able to recover the reasonable costs of repair, renewal and reinstatement, plus its own other losses. This example is based on a clause common in some forms of commercial property development collateral warranty, see, for example, Practice note, Joint Contracts Tribunal (JCT) forms of contractor collateral warranty: CWa/P&T: clause 1.1: carry out Works and repair, renewal and/or reinstatement (www.practicallaw.com/3-329-1311). The third approach, on the face of it, does not benefit the professional consultant or contractor, but is equally common in the fields of construction and engineering:  Provide for collateral warranties or third party rights: if an intended assignee (whether they are a purchaser, tenant, funder or group company) has the benefit of an effective collateral warranty or effective third party rights, they may not need the benefit of an assignment and would hopefully not need to grapple with the exclusions to the no loss defence. In Panatown, one of the reasons why the House of Lords did not allow the claim to succeed was that the third party in question (Unex) had the benefit of a “duty of care deed” (in theory, equivalent to a collateral warranty), under which it might have claimed (see Practice note, No loss and assignment: the development of the common law in the construction context: Alfred McAlpine v Panatown (www.practicallaw.com/4-385-6875)). (It appears that Unex did not make a claim under the duty of care deed because the terms of the deed would not have allowed it to make full recovery, in the circumstances.) If there is a benefit to the professional consultant or contractor in agreeing to a collateral warranty or third party rights clause in this context, it is that there is a greater chance of certainty if express contractual provisions govern third parties’ rights. How to deal with the no loss argument when novating a construction document To help avoid a no loss argument affecting a novation, follow best practice in any novation agreement. The City of London Law Society (CLLS) publishes guidance in connection with its form of novation agreement: for more information, see Practice note, Novation of construction documents: The CLLS Standard Form Novation Agreement and Notes (www. practicallaw.com/1-315-1953). The Standard document, Novation of professional appointment from employer to contractor: clause 5. Binding of Consultant to Contractor (www.practicallaw.com/9-383-4541), includes an express term, similar in effect to clause 1.4 of the CLLS form, designed to expressly address the no loss concern raised by the Scottish decision in Blyth & Blyth v Carillion (2001), 79 Con LR 142, Outer House, Court of Session (see Practice note, Novation of construction documents: There is a “black hole”: Blyth & Blyth v Carillion (www.practicallaw.com/1-315-1953)). How to deal with the no loss argument when facing a chain of contracts The contract structure used in the management contracting procurement route illustrates the problem of using a chain of contracts to pass losses “up and down” as they occur (see note, A chain of contracts). Under management contracting, the employer wants to both ensure that it can use its management contractor to effectively manage the project and that it can recover any losses caused to it by a breach of contract by an individual works contractor, even though the management contractor appoints those individual works contractors. However, from the management contractor’s perspective, it cannot accept open-ended liability, and so it restricts its liability to the employer to losses arising out of its own breach of contract and sums it can recover from the works contractors. In practice, the “employer/works contractor agreement” (as the separate contract between the employer and an individual works contractor is known) should allow the employer to recover its losses. If the management contractor cannot recover the losses suffered by the employer and caused by an individual works contractor under the works Register for a free trial: T: +44 (0)20 7202 1200 E: info@practicallaw.com W: www.practicallaw.com This document can be found at http://construction.practicallaw.com/0-385-2290 © Legal & Commercial Publishing Limited 2009
  12. 12. contract, perhaps because the works contractor argues that the management contractor has not suffered a loss, then the employer may use the employer/works contractor agreement to ensure that it can make a claim under a contract with the works contractor. In the employer/works contractor agreement the works contractor typically warrants to the employer that it has complied with the terms of the works contract, allowing the employer to recover damages arising out of that breach. Nevertheless, the parties will always take a degree of risk if they pass contractual losses up and down a chain of contracts, where that chain includes limitations on recovery to protect the interests of intermediate parties, because this can allow a “no loss” argument to arise. Other examples of a chain of contracts could include:  An agreement by a property owner, who has employed a developer to develop its property, that it will only claim delay damages from the developer to the extent that the developer successfully claims them from the contractor. This gives rise to the risk that the contractor could argue that the liquidated damages clause is a penalty. This is because (if the contractor paid the developer nothing) the developer would not suffer a loss, as the property owner would not be able to recover delay damages from the developer. On current case law, the contractor’s argument is unlikely to succeed, provided that all other aspects of the relevant delay damages have been properly addressed. For more information see Practice note, Liquidated damages in construction contracts (www.practicallaw.com/9- 383-6757).  An agreement between an architect and its client that the architect will employ a specialist asbestos consultant to survey a building for the client, on the condition that if that survey is carried out negligently, the client will only be able to recover any losses from the architect that the architect recovers from the asbestos consultant. Two possible solutions in that situation could be:  a collateral warranty or other agreement between the client and the asbestos consultant, allowing the client to make a claim direct against the asbestos consultant, if the sub-consultant raised a “no loss” argument against the architect; or  the client appointing the asbestos consultant itself, rather than the architect appointing it as a sub-consultant, even if the architect then gave the day-to-day instructions to the asbestos consultant on behalf of the client. Avoiding arrangements that pass losses up and down a chain of contracts, or creating stand-alone contract rights between the relevant parties (such as a collateral warranty), is good practice in any situation where a party causing a loss could argue that the party that it is in contract with has not, itself, suffered a loss. In addition, if you find yourself in a situation where there is a chain of contracts and no direct contractual right for you (or your client) to claim against the party responsible for a loss, consider whether the exceptions to the no loss rule, in the leading authorities related to assignment, apply in your (or your client’s) circumstances: see Practice note, No loss and assignment: the development of the common law in the construction context (www.practicallaw.com/4-385-6875). The intermediate party in the chain of contracts may be able to claim damages on your behalf and defeat a no loss argument. What is the impact of the contracts (Rights of Third Parties) Act 1999 on no loss? The Contracts (Rights of Third parties) Act 1999 (Third Party Rights Act 1999), which came into force on 11 November 1999, is an exception to the doctrine of privity of contract and may give third party contractual rights against a contract party where these would not otherwise exist. This could avoid a black hole situation where a party suffering loss has no contractual remedy against the party in breach of contract. Until the JCT’s adoption of third party rights schedules in June 2005, it was common for construction parties to seek to exclude the operation of the Third Party Rights Act 1999 and to use collateral warranties instead. Register for a free trial: T: +44 (0)20 7202 1200 E: info@practicallaw.com W: www.practicallaw.com This document can be found at http://construction.practicallaw.com/0-385-2290 © Legal & Commercial Publishing Limited 2009
  13. 13. Third party rights in construction are generally used as an alternative to collateral warranties. In terms of the impact of the Third Party Rights Act 1999 on the black hole issue concerning assignment, if a party has the benefit of third party rights from a contractor or professional consultant then the end result should essentially be as if it had a collateral warranty (see Practice note, No loss and assignment: the development of the common law in the construction context: Alfred McAlpine v Panatown (www.practicallaw.com/4-385-6875)). That is, if a party has the benefit of third party rights, it should use those rights and (unless it can also procure the assignment of the benefit of the contract in its favour) the existence of the third party rights claim may preclude that party from relying on the exceptions to the no loss arguments referred to in St. Martin’s (see Practice note, No loss and assignment: the development of the common law in the construction context: Exceptions to the rule that a party may only recover its own losses: the narrow ground and the broad ground (www.practicallaw.com/4-385-6875)). For more information on third party rights, see Practice note, Third party rights on construction projects (www. practicallaw.com/2-372-2962). Register for a free trial: T: +44 (0)20 7202 1200 E: info@practicallaw.com W: www.practicallaw.com This document can be found at http://construction.practicallaw.com/0-385-2290 © Legal & Commercial Publishing Limited 2009
  14. 14. Register for a free trial: T: +44 (0)20 7202 1200 E: info@practicallaw.com W: www.practicallaw.com This document can be found at http://construction.practicallaw.com/0-385-2290 © Legal & Commercial Publishing Limited 2009

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