‘Black holes’ on construction projects – The gravity of the situation
The TCC’s recent decision in Dr Jones Yeovil Limited v The Stepping Stone Group Limited is a useful reminder of the issues posed by legal “black holes”.
What is a “black hole” in contract law?
It is a fundamental principle of English law that damages for a breach of contract are to put the innocent party in the position that it would have been in had the other party complied with its obligations under the contract. Damages should compensate for loss incurred. So, if there is no loss, then the claimant should only receive nominal damages even if the defendant is in breach of their contractual obligations.
In construction projects, the no loss argument can lead to a contractual “black hole”, even if the defendant’s actions have caused the claimant to suffer serious losses.
One way a black holes may arise is where the developer is a separate legal entity to the owner of the land. In this case it may be argued that the developer (the entity with a contractual claim against the contractor/consultant responsible for the defect) has not suffered a loss, as it doesn’t own the works in question and isn’t under any obligations to repair. This risk can be mitigated by the developer entering into a development agreement which provides obligations to the owner of the land so that the loss incurred by the owner can then be passed to the developer. However, the developer may seek to restrict its liability period under such an agreement to only a limited period following practical completion. Another way to avoid such a black hole is to require all the relevant contractors and consultants to enter into collateral warranties with the owner of the land so that it can claim against the relevant contractor and/or consultant directly.
In order to avoid such situations where a ‘black hole’ may arise, the courts have developed a number of principles, including the principle of “transferred loss”. Transferred loss is a complicated area of evolving case law, but essentially it can be divided into a “narrow” and “broad” ground. The narrow ground enables an employer to claim on behalf of a third party purchaser where the purchases are foreseeable at the time of entering into the building contract. The broad ground applies where, at the time of entering into the contract, the parties have a common intention and/or a known objective to confer a benefit to an independent third party.
Dr Jones Yeovil Limited (DRJ) v The Stepping Stone Group Limited (Stepping Stone) - Background
DRJ was employed by Stepping Stone to carry out works on a number of assisted living units. The property on which the assisted living units were constructed was owned by NCL, a subsidiary of Stepping Stone and a separate legal entity. After practical completion NCL sold the properties on long leases and retained the freehold of the common parts.
A dispute regarding defective work arose after practical completion. The building contract specified the use of ground source heat pumps. DRJ had not complied with this specification and instead installed less efficient heat pumps. Stepping Stone claimed against DRJ for the increased energy costs incurred by the leaseholders of the units as a direct result of the less efficient heat pumps.
The court’s decision
DRJ contended that Stepping Stone had in fact suffered no loss, as it was neither the occupier nor owner of the assisted living units. Stepping Stone initially suggested that it had entered into a development agreement with NCL, which contained an obligation to indemnify for defective work. This argument was dismissed as there was no documentary evidence that this development agreement actually existed. Stepping Stone therefore attempted to rely on the broad ground of the transferred loss principle, arguing that at the time the building contracts were entered into, Stepping Stone and DRJ had intended to transfer the benefits under those contracts to both NCL and the purchasers of the assisted living units.
However, the court rejected Stepping Stone’s argument. The court noted that the broad ground of the transferred loss principle was good law, underpinned by the need to provide a remedy for a breach of contract in the interests of giving effect to the object of that contract. However, the court reasoned that, as the building contract contained a clause expressly dis-applying the effect of the Contracts (Rights of Third Parties) Act 1999 (pursuant to which contractual rights may be conferred on identifiable third parties), there was a positive disclaimer of the known third party benefit. Therefore, the broad ground of the transferred loss principle could not apply.
As ‘boilerplate’ clauses dis-applying the effect of the Contracts (Rights of Third Parties) Act 1999 are ubiquitous in UK construction contracts (and for good reason), the broad ground of the transferred loss principle is unlikely to assist parties in the future who find themselves in Stepping Stone’s position.
The court’s decision in this case demonstrates the importance of collateral warranties and third party rights agreements in construction projects where the loss may fall on a party with no contract with the defendant. Had NCL or the residents had the benefit of collateral warranties or third party rights from DRJ, they would have been able to recover their losses directly, rather than passing them on to Stepping Stone to pursue. As such, while the preparation, negotiation and execution of collateral warranties and third party rights agreements might seem a laborious exercise during a project, their worth should not be overlooked.
This article was written by Sam Johnson. Please do not hesitate to contact Sam, or your usual Charles Russell Speechlys contact if you have any queries.
Charity Training: Digital Transformation in the Charity Sector
We would be delighted if you could join us for the second session in our new series of bite-size webinars for charities.
Charity Training: Brand Protection
We would be delighted if you could join us for the first in our new series of bite-size webinars for charities.
The UK’s New Skilled Worker & Intra-Company Visa Routes: a closer look
Taking a closer look at the UK’s new visas to assist UK businesses.
Practicalities in Cladding Claims
Insight into Issues with Cladding Claims
EWS1 Forms - the latest episode
RICS have now published their highly anticipated guidance on when EWS1 forms will be required.
Q&A: Am I insured for COVID-19?
Laura Bushaway writes for Estates Gazette on a recent claim under the “disease clause” of business interruption policy.
The Purpose Podcast: Corporate purpose
Simon Ridpath discusses corporate purpose and the rise of environmental, social and governance (ESG) issues in “The Purpose Podcast”
Client alert: Construction under competition law spotlight
We outline the three investigations which have either recently concluded or are ongoing together with what this means for businesses.
Looking beyond the benefitted land: confirmation that an objector’s wider property may be considered in applications to discharge/modify restrictive covenants
Read our recent case study on applicants who were prevented from developing a new house due to a restrictive covenant covering their land.
Further extension of coronavirus restrictions affecting residential properties: Where are we now?
The extension will be implemented from and including 31 March 2021 by the Coronavirus Act 2020.
Knight Frank Wealth Report: The Global Perspective on Prime Property & Investment
Knight Frank partners joined Charles Russell Speechlys for a virtual panel-led discussion on the Knight Frank Wealth Report
Case Study: One Blackfriars Limited
An informative and positive judgment for administrators selling high-value property in distressed and complex scenarios.
Keeping Up With Construction: Handover at Practical Completion - Practical Pointers
Practical tips for the handover of a successful project.
Charles Russell Speechlys advises on Trident Royalties’ US$28m Placing
Trident Royalties plc is a growth-focused mining royalty and streaming company.
Temporary restrictions on winding-up petitions extended until 30 June 2021
As the restrictions are extended, read what it means for you here.
Steven Carey writes for Building on whether a company can provide expert services in claims for and against the same party
A recent appeal case looked at whether a company can provide expert services in claims for and against the same party.
InvestAfrica: Checking in or Checking out? Financing Africa’s Hotels in 2021
The discussion examined the strategies investors and financial institutions can implement to mitigate the effects of the pandemic.
Commercial rent arrears: what are the latest restrictions on landlords’ remedies this quarter day?
What you need to know for this Quarter Day.
Charles Russell Speechlys advises Avation plc on £7.5m secondary placing
Headquartered in Singapore, Avation plc manages a fleet of aircraft which it leases to airlines across the world.
To Promote or not to Promote, that is the Option: Top 10 Tips with Promotion Agreements
Providing you with the top ten tips with promotion agreements - what should you know?