This case will be of keen interest to lawyers for the discussion of English law's approach to the award of damages for breach of contract and for the robust debate in the House on the hitherto commonly accepted principle in English law that a plaintiff may only recover damages for a loss which he himself has suffered.
Here is a cautionary tale for property developers and other employers in construction contracts. It is a story of interest to contractors as well because in Panatown Ltd v McAlpine Construction Ltd [2000] 4 All ER 97, the House of Lords found on a preliminary issue, that the contractor, McAlpine, had no liability to the employer under the building contract, Panatown, for defects to the building they were engaged to construct. In other words, irrespective of whether McAlpine had breached the contract, McAlpine had no liability to Panatown for the defects. Admittedly the facts in Panatown were somewhat unusual. They demonstrate how extreme care should be exercised when employers contemplate unorthodox development arrangements.
The Facts
Panatown was part of a group of companies based in England, the Unex Group. The Unex Group owned a piece of land in Cambridge, England, through another company in the group, Unex Investment Properties Ltd ('UIPL'). Unex wanted to develop this land. Instead of UIPL entering into the construction contract, Panatown entered into it with McAlpine to build an office building on UIPL's land. This is the root of Panatown's (and Unex's) problem.
Unex chose Panatown as the contracting party because the group avoided VAT (the English equivalent of GST) this way. It should be noted that none of the Law Lords saw this as objectionable. This was legitimate tax avoidance and not tax evasion. This fact had nothing to do with Panatown's woes.
The building contract was in a modified JCT standard form with contractor's design (1981 Ed) and the contract sum was a little under £10.5m. On the same day Panatown and McAlpine entered into the building contract, McAlpine, under an obligation in the building contract, executed a duty of care deed ('DCD') in favour of UIPL. Under the DCD, McAlpine assumed a duty of care to UIPL, and its assignees, in respect of the building contract. McAlpine undertook that they would exercise all reasonable care, skill and attention in respect of all matters which lay within the scope of their responsibilities under the building contract.
The purpose of the DCD was to give purchasers of the building from the Unex Group undoubted causes of action for latent defects to the building. The widespread use of DCDs, or collateral warranties, as they are usually called, derives from the change in the tort law which occurred in 1990 when the House of Lords departed from Anns v Merton London Borough [1977] 2 All ER 492 in Murphy v Brentwood DC [1990] 2 All ER 908. In Murphy, the House of Lords held that a contractor has no liability in tort to subsequent purchasers for latent defects. The DCD was therefore designed to reclaim, for subsequent purchasers in contract, rights which had previously been accorded in tort.
Both Panatown and McAlpine agreed that there were significant defects in the foundations and steel frame of the building. The defects were serious and the building may have had to be demolished and rebuilt. The damages claimed by Panatown ran into many millions of pounds.
McAlpine denied any breach of contract and under the arbitration clause in the construction contract, arbitration proceedings were commenced. In the arbitration McAlpine sought a preliminary award that Panatown was not entitled to recover substantial damages under the building contract on the ground that Panatown did not own the building and hence did not suffer any loss. (McAlpine's argument was that UIPL may have suffered loss as the building owner but Panatown did not. The loss Panatown was claiming in the arbitration was UIPL's loss.) The arbitrator heard this as a preliminary issue and found in Panatown's favour. McAlpine appealed to the High Court which found in favour of McAlpine. The Court of Appeal reversed the High Court and the House of Lords reversed the Court of Appeal giving McAlpine the final victory.
The Narrow Road and the Broad Road
To understand the debate in the House of Lords, it is necessary to delve a little into English legal history. The debate in the House centred on the choice between a narrow ground and a broad ground justifying Panatown's claim.
First the Narrow Road
The narrow ground refers to an established exception to the rule that a plaintiff may only recover damages for loss which he himself suffered. This exception originated in carriage of goods by sea cases and was authoritatively stated in The Albazero, Albacruz (cargo owners) v Albazero (owners) [1976] 3 All ER 129. The Albazero referred to an even older case going back to the 19th century; Dunlop v Lambert (1839) 6 Cl & Fin 600, 7 ER 824, (1839) Macl & Rob 663, 9 ER 224, as the genesis of the exception.
The exception in The Albazero is as follows: in a commercial contract concerning goods where it is in the contemplation of the parties that the proprietary interest in the goods may be transferred from one owner to another after the contract has been entered into and before the breach which causes loss or damage to the goods, an original party to the contract, if such be the intention of them both, is to be treated in law as having entered into the contract for the benefit of all persons who have or may acquire an interest in the goods before they were lost or damaged, and is entitled to recover by way of damages for breach of contract, the actual loss sustained by those for whose benefit the contract was entered into.
The rule was developed to plug what has been called a legal black hole. In common commercial practice when a consignor delivers goods to a carrier for delivery to a consignee, the property in the goods passes immediately to the consignee. However the contract of carriage is entered into between the consignor and carrier. Should there be a loss at sea, the consignee cannot sue the carrier in contract because he is not party to the contract (this is known as the privity of contract rule). On the other hand, the consignor, who is a party to the contract, cannot recover any substantial damages because he suffers no loss, the property having already passed. There was therefore a legal black hole allowing the carrier to escape liability entirely and the law moved to plug this by The Albazero exception, giving the consignor a right to claim damages suffered by the consignee on the consignee's behalf. This exception quickly lost its relevance in carriage of goods by sea cases because the black hole was plugged by parliament in the Bills of Lading Act 1855 which gave the consignee the right to sue for his own loss by statute.
The Narrow Road in Building Contracts
This exception was however resurrected in more recent times and applied to building contract cases in Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd; St Martins Property Corp Ltd v Sir Robert McAlpine & Sons Ltd [1993] 3 All ER 417 (the St Martins case). In the St Martins case the employer entered into a building contract with the contractor which prohibited assignment without the contractor's consent. In the course of construction, the employer transferred the land to a sister company and purported to transfer the benefit of the building contract as well. It was held that the benefit of the building contract could not pass because of the prohibition against assignment. There were defects in the construction. The case is similar to Panatown in that after the transfer of the land, the employer no longer owned the building and therefore cannot be said to have personally suffered loss. There was again a legal black hole and the House of Lords plugged it by applying The Albazero exception. The House found that the contractor could have foreseen that the property would be transferred to a third party and that such third party would not acquire rights under the building contract because of the prohibition against assignment. Accordingly, the employer must be allowed to claim loss on behalf of the transferee.
The Albazero exception was next applied and further extended in another building contract case, Darlington BC v Wiltshire Northern Ltd [1995] 1 WLR 68. In Darlington, the problem arose not out of normal commercial factors but out of a local authority's (ie local government's) wish to evade government restrictions on its borrowing powers. The authority wanted to develop land it owned. The authority's financing bank entered into the building contract with the contractor. The bank then entered into a contract with the authority undertaking to procure the erection of the building and to assign all rights under the building contract to the authority. But under this contract, the bank did not accept any liability 'for any incompleteness or defect in the building work'. There were again defects in the construction. The bank assigned its rights under the building contract to the authority. However, in the law of assignment, the assignee can only claim what the assignor could have claimed. It was argued that the bank itself suffered no loss because it was not liable to the authority for any construction defects, therefore the contractor's breach caused it no loss. The Court of Appeal, however, applied The Albazero exception and held that because the bank was entitled to claim the authority's loss, as assignee, the authority could claim this loss.
It should be immediately obvious that this was a radical extension of The Albazero exception. There was no transfer of property envisaged. The authority was always the owner of the land and there was no transfer to it from the bank. The Albazero exception had hitherto been premised on the fact that property would be transferred in the course of commercial dealings. Indeed this was the raison d'être for the exception as it was developed in Dunlop v Lambert and had been integral in the formulation of the exception.
The Albazero exception therefore was in recent times extended first to building contracts and then, as applying to building contract cases, extended to remove the requirement for transfer of property. An employer in a building contract who does not own the building being constructed is, on the authority of Darlington, entitled to claim against the contractor loss suffered by the owner of the building, irrespective of whether the property passed from the employer to the owner in the first place.
Three members of the five-member panel in the House in Panatown (Lords Clyde, Jauncey of Tullichettle and Browne-Wilkinson) approved the extension of The Albazero exception in Darlington and would have been prepared to find for Panatown on that basis had it not been for the DCD.
The Narrow Road is Blocked
There is an exception to The Albazero exception. The rule in The Albazero only applies where no other contractual arrangement has been entered into between the consignee and the carrier. This exception to the exception makes sense when we recall that the rule was developed to plug a legal black hole in the first place. This black hole (the fact that the person who truly suffered the loss cannot sue because of privity of contract) does not exist where the consignee has a separate contract with the carrier. There is therefore no need for this exception.
The House of Lords found that the DCD was just such a separate contract between UIPL and McAlpine. This separate contract displaced The Albazero exception. Panatown therefore could not bring any claim for UIPL's loss. UIPL had to bring a claim under the DCD itself. It should be immediately obvious that the rights under the building contract are not coterminous with the rights under the DCD. McAlpine had strict liability for defects under the building contract. Under the DCD, UIPL had first to prove that McAlpine had breached its duty of care. Not only did UIPL have to prove that there were defects attributable to McAlpine but that these defects were caused negligently. Certain defences may also have been open to McAlpine under the DCD which were not open under the building contract. For example, McAlpine might have argued that it had satisfied its duty of care under the DCD by subcontracting the work to a competent subcontractor. This line of defence under a tortious claim for building defects has not been conclusively established, but it is not definitely closed either. It was precisely for this reason the Unex Group chose to bring the claim through Panatown under the building contract instead of bringing the claim through UIPL under the DCD.
The cautionary note here for employers is this: beware of opening black holes when devising out of the ordinary contracting arrangements for developments. It would be wise to scrutinise these arrangements carefully to ensure that the contractor is not completely let off the hook inadvertently.
But Wait
The story does not end here. Two respected members of the House, Lords Goff and Millet, handed down well-reasoned and strong dissents which may well ensure that this issue will come before the Lords again in another case. This is the legal equivalent of a cliffhanger in a movie hinting at a sequel. To this we now turn.
Now the Broader Road
In the St Martins case, Lord Griffith gave an alternative ground for awarding damages to the non-owner employer. Lord Griffith was of the view that irrespective of ownership, an employer to a building contract, faced with a breach by the contractor to perform the contract with sound materials and all reasonable skill and care should be entitled to recover from the contractor the cost of remedying the defect in the work as the normal measure of damages. Lord Griffith's point is really quite a simple one. A person who contracts with another person to perform certain work is entitled to have this work done properly and if it is not, he is entitled to the cost of rectifying the defect.
Lord Griffith found it offensive to common sense that a person would be deprived of all damages in such a case simply because he was not the owner of the land and in a highly technical sense, could be said not to have suffered any loss. Lord Griffith pointed out that there were many circumstances in modern life where people contracted for work to be done on land owned by others (he gave the example of a husband contracting for repairs to be done on the matrimonial home which happened to be owned solely by his wife - there could be any number of reasons for this as we all know) and it would be absurd for the law not to afford any protection to these people.
Following the Broader Road
There is a lot of common sense in Lord Griffith's approach and it was adopted and endorsed by Lords Goff and Millet in Panatown. Lord Goff explained that The Albazero exception was designed to address the problem of privity of contract. The problem in a case like Panatown is not privity, since the employer has contractual relations with the contractor, but an overly narrow approach to compensatory loss in English law.
In Lord Goff's view, The Albazero exception was inapplicable and the extension of the exception in Darlington (and indeed in the Court of Appeal in Panatown - the Court of Appeal followed Darlington) was not justified. Lord Goff was firmly of the view that Panatown should be allowed to claim damages and this was best justified on the broader ground first expounded by Lord Griffith in the St Martins case.
Lord Goff opined that hitherto not enough emphasis had been given to protecting a contracting party's performance or expectation interest. Not getting what one contracted for is itself a loss and the law should accordingly award damages for this. In building contract cases, the normal measure of such damages would be the cost of rectification although it need not be invariably so (East Ham BC v Bernard Sunley & Sons Ltd [1965] 3 All ER 619 is cited as authority).
Lord Goff further pointed out that there are ample examples of cases where the courts have awarded damages to protect a party's expectation interest. Ruxley Electronics and Construction Ltd v Forsyth; Laddingford Enclosures Ltd v Forsyth [1995] 3 All ER 268 and Radford v De Froberville [1978] 1 All ER 33 were among the more well-known cases cited.
In Ruxley Electronics, the House of Lords awarded substantial damages to the plaintiff because the swimming pool he had ordered was only some 6-feet deep instead of the contracted 7 ft 6 in. The House found that there was no loss in value caused by the shortness in depth. The House also found that there was no loss of amenity since a 6-foot pool was perfectly safe to dive into (Forsyth, the plaintiff, alleged that he had specially specified the depth because he wanted to dive into the pool). The House declined to award the cost of rectification because it felt this was unreasonable and entirely out of proportion to the loss caused. Since there was no difference in value, damages could not be awarded on a diminution in value basis. But the House did not leave Mr Forsyth completely bereft of remedy. It awarded him a substantial sum for what it described as 'loss of amenity'. In reality (since there was in fact no loss of amenity) it was for disappointment of his expectation/performance interest.
In Radford v De Froberville, the owner of a block of flats sold part of the land on which the flats stood to another party. It was a condition of the contract of sale that the purchaser erected a wall on the land he purchased to demarcate the boundary between that land and the land on which the flats stood. The purchaser failed to erect the wall. The owner of the flats was awarded the costs of building a wall on his own land even though it was found that the wall made no difference to the value of his property and, since this was investment property and he did not live there, he suffered no loss of amenity for lack of the wall. In other words he suffered no loss. However, the court found he wanted to erect the wall for the benefit of his tenants and on this basis was satisfied that costs of rectification were reasonable. This is an example of the court protecting expectation/performance interests by awarding the cost of rectification.
Lord Goff argued that protection of expectation/performance interest was well supported by authority and by academics who have examined the implications of awarding damages in such cases and found no detrimental effect on the general body of law. Lord Goff was even prepared to award damages for delay to Panatown on the basis that this also was a loss to the expectation/performance interest.
Lord Millet concurred with Lord Goff and filed an even more trenchant dissent charging the majority with wrongly adopting a '[p]rocrustean approach which leaves parties without a remedy for breach of contract because their arrangements do not fit neatly into some pre-cast contractual formula'.
Both Lords Goff and Millet did not think the DCD deprived Panatown of recovery on the broader ground since the parties clearly did not intend the DCD to replace Panatown's rights under the construction contract.
The End?
The debate in the House on this vexed issue was more wide-ranging and vehement than disclosed in this note. The judgments took up cudgels on almost all points and along the way there were also a few twists and turns to plot. Regrettably, this is not the place to engage in a wider and more in depth discussion of all these points.
The decision in Panatown as it stands, should be of interest to employers as warning of the dire consequences that may befall the unwary when treading into unfamiliar territory.
The decision should also be of interest to contractors as a possible escape hatch when the building contract and the relationship with the employer turns sour.
The case is definitely of interest to lawyers for the debate amongst the Law Lords on a basic principle of law which hitherto had been accepted as a tenet of the faith. It is often said that hard cases make bad law. It is also true that hard cases magnify the cracks and fissures in the law requiring re-examination of principles which might previously have been held sacred.
The debate is far from over. This round goes to the majority but the minority is by no means vanquished and can be expected to rebound when an appropriate case comes next before the Lords.
Steven Lim
Rajah & Tann