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Losing out on consistency

LAW - A recent judgement on losses and damages shows worrying inconsistency, writes Jeremy Winter

IT IS vital to the construction industry that the law is applied correctly and consistently, otherwise it is difficult to make proper risk assessments.For this reason, we must hope that the case of Earl's Terrace Properties v Nilsson is a one-off. It amounts to a weakening in the application of some of the best-established rules in English law.

The facts of the case are simple, although the legalities are complex.Earl's Terrace Properties Ltd was a company set up to develop houses in Kensington, London.

It was a subsidiary of Vastint Holdings, a company registered in the British Virgin Islands, and the funds for the project came in the form of loans from Vastint.

The total funding was over £50 million and, under the terms of the loan agreement, the first £20 million of loans were interest-free. Anything above £20 million was subject to an annual interest rate of 10 per cent.

ETPL engaged Nilsson Design as its architect and Charter Construction as its contractor. Nilsson designed, and Charter installed, a membrane that was supposed to provide waterproofing.

The membrane leaked. ETPL sued Nilsson, and Nilsson brought Charter in.The discovery, investigation and remedial work to the defective membrane took 15 months, thus delaying the project and resulting in funds being 'held in the project for a longer period than they would otherwise have been' During the period that the remedial works were being carried out, there was an increase in property prices so that, when they came to be sold, the houses had increased in value.

ETPL sued Nilsson for the remedial costs, plus 'holding costs' of £5.98 million.These holding costs were the biggest and most controversial element of the claim and were therefore dealt with by the court, under Judge Thornton, first. (There has yet to be a decision on the issue of the remedial costs).

ETPL made no attempt to show that the holding costs were any kind of actual loss (such as additional interest payable to Vastint) suffered as a result of the delayed completion. In fact there was no evidence of any actual loss by ETPL at all.The £5.98 million figure was arrived at by applying notional interest at the London Inter-bank Offered Rate plus 2 per cent on the funds invested in the project for the period of delay.

Judge Thornton had to decide two main issues. Firstly, were the holding costs recoverable as damages? And secondly, did credit have to be given for the increase in value of the houses during the period of delay?

The question of the holding costs raised a number of subsidiary questions. Did it matter that the losses were interest? Was it necessary for ETPL to show a loss? Did it matter if the losses were actually Vastint's?

And could ETPL recover this notional rate of interest?

Judge Thornton decided that, yes, the holding costs were recoverable as damages and, no, credit did not need to be given for the increase in value. I and, I'm sure, many other lawyers, would have expected exactly the opposite decisions. So why did the judge's reasoning differ from what one would expect?

The holding costs were plainly an interest cost of some kind and, as a general principle of law, interest in the form of loss of use of money is not readily recoverable as damages.There are exceptions in special circumstances, one of which is where a contractor is kept out of its money by an employer. Judge Thornton extended to ETPL (an employer) the exception to this rule, which applies to contractors, without any analysis other than reliance on one of his own previous decisions. On the questions of who has actually suffered the loss, the judge's principal finding was that ETPL could recover against Nilsson even if the loss was actually Vastint's.

This goes against a fundamental principle of English law: that the only losses a party may claim and be paid are its own.

Judge Thornton said that this principle was 'susceptible to so many exceptions that it is doubtful whether it is any longer supportable as representing a statement of the general law'Most lawyers would not agree with this sweeping statement.

The judge also held that ETPL could recover the notional rate of interest (LIBOR plus two per cent).Remember that the actual rates of interest payable by ETPL to Vastint were zero per cent on the first £20 million and 10 per cent on the excess.ETPL asserted that the 10 per cent was higher than would normally have been expected (and, as such, not recoverable as damages), and that was why the lesser notional rate was used.

It probably made sense not to deprive ETPL of all interest merely because the actual rate payable was unusually high. But what is controversial about the decision is that ETPL's apparent inability to prove that it had actually suffered any loss did not stop the judge awarding it damages.

On the issue of whether credit had to be given for the increased value of the properties, the judge decided that no credit need be given because any rise and fall in the value of the property was unconnected with Nilsson's alleged negligence, and was too remote from it.

Of course, it was not the problem with the membrane that caused the value of the property to increase.But the problem with the judge's conclusion is that it is very hard to reconcile his thinking with the House of Lords case law that he quotes in his judgment.

Here is a case in which the lines of legal responsibility have become blurred. But how can contractors and consultants avoid the consequences of such blurring? Ironically, one simple answer is to actually ask for collateral warranties (normally anathema to any contractor) to be put into place so that the legal responsibilities to third parties can be identified and defined.

The law is clear that if there is a collateral warranty it is taken to define fully the scope of legal responsibility.

And what about employers? Must they rely on being able to find a judge who is willing to take a liberal view of the law to recover losses? The answer lies in keeping good records - and not letting the important issue of tax efficiency override the need to put proper contracts in place.