Novation agreements and no loss arguments

A recent decision of the Scottish Court of Session has considered “no loss” arguments made by a consultant arising from the novation of an upstream construction contract. In rejecting the consultant’s arguments, the Court appears to have extended principles developed in cases dealing with assignments in connection with the sale of defective buildings. The Court’s decision highlights the complex issues which can arise in relation to novation agreements and should encourage parties to address these issues directly through careful drafting and well structured transactions.

“No loss” arguments and assignments

The right to claim damages for breach of contract is ordinarily assignable under English and Scots law – subject to any provisions in the contract to the contrary. It is a generally accepted principle that pursuant to such assignments (or “assignations” in terms of Scots law) the assignee takes the claim subject to any defences that exist as between the assignor and the contract-breaker and, as such, the assignee is unable to claim for more than the original assignor could have claimed for. The assignee cannot, for example, claim extra losses which arise from its own circumstances and which would not have been suffered by the assignor. We refer to this as the “no greater loss rule”.

In a construction context, the no greater loss rule has caused difficulties where a defective building is sold to a third-party for full market value with an assignment of rights under the building contract agreed either before or after the discovery of defects by the purchaser. In such cases, it was argued that the assignee purchaser could not claim against the contractor for the defects because the original employer had received full market value and had therefore suffered no loss (the assignee being limited to the amount claimable by the assignor). As a result of these arguments, a slightly modified form of the no greater loss rule has been adopted in building cases: that the assignee can recover no more damages than the assignor could have recovered if there had been no assignment and if the building had not been transferred to the assignee: Technotrade Ltd v Larkstore Ltd.

The “black hole” in Blyth & Blyth

The application of the above principles to novation scenarios was highlighted in a Scottish case decided in 2001, Blyth & Blyth Ltd v Carillion Construction Ltd. Carillion was the design and build contractor for a leisure development and agreed to accept a novation of an engineer’s appointment between the employer and Blyth & Blyth. Carillion subsequently claimed against Blyth & Blyth in relation to tender documentation the latter had prepared for the employer prior to Carillion’s involvement. Carillion claimed that the tender documentation had underestimated the scope and quantity of the work required and had caused Carillion to undervalue the works.

Carillion relied on broad wording in the novation agreement which stated that Blyth & Blyth’s liability under its appointment “whether accruing before or after the date of this Novation shall be to [Carillion]” and that any services performed by Blyth & Blyth prior to the novation, “will be treated as services performed for … [Carillion] and [Blyth & Blyth] agrees to be liable to [Carillion] in respect of all such services and in respect of any breach of the Appointment occurring before the date of this Novation as if the [Carillion] had always been named as a party to the Appointment in place of the Employer.”

The Court of Session considered this wording to be insufficient to give Carillion a claim against Blyth & Blyth for its own losses in relation to pre-novation breaches of the appointment. In the Court’s opinion, the novation operated in a similar way to an assignment so that the no greater loss rule applied and Blyth & Blyth’s liability in relation to pre-novation breaches was limited by the amount of loss suffered by the employer. As the employer had not suffered any loss as a result of the alleged breaches – indeed, it could only have benefited from Carillion’s undervaluation of the works – Carillion was unable to make good its claim.

The decision in Blyth & Blyth has been criticised by legal commentators, but has largely been addressed through improvements to the drafting of novation agreements to make clear that the contractor is entitled to recover its own losses in respect of pre-novation breaches by the consultant (see, for example, the CLLS Standard Form of Novation Agreement).

SRB Civil Engineering UK Ltd v Ramboll UK Ltd

In this most recent case, the no greater loss rule has been further tested and potentially extended to allow for the impact of a novated building contract on downstream appointments entered into by the original contractor.

SRB Civil Engineering Limited (“SRB”) entered into a Design and Build Agreement (the “DBA”) with the Scottish Ministers in July 2011 for the design and construction of upgrade works to Junction 1A of the M9. SRB appointed Ramboll to provide design services in relation to the DBA (the “Ramboll Contract”). Pursuant to a company reorganisation, it was determined that a related company (“SRB UK”) should take over SRB’s role as contractor under the DBA. A Novation Agreement was entered into on 12 July and 7 November 2013 by SRB, SRB UK and the Scottish Ministers. As part of this agreement, the Scottish Ministers released SRB from any further performance of the DBA. The Novation Agreement also absolved SRB from liability for prior breaches in the following terms:

“All rights of action and remedies under or pursuant to the [DBA] vested in [Scottish Ministers] will from the last date of execution of this novation agreement lie against [SRB UK] and not [SRB].”

Meanwhile, in August 2013, defects were found in the pavement of the motorway which formed part of the works and which SRB/SRB UK attributed to breaches by Ramboll of the Ramboll Contract. SRB assigned its rights under the Ramboll Contract to SRB UK in July 2018 so that SRB UK could be compensated by Ramboll in relation to its liability to the Scottish Ministers in respect of these defects.

SRB UK subsequently brought proceedings against Ramboll for alleged breaches of the Ramboll Contract and breaches of delictual duty (known as tortious duty in England). Ramboll submitted that the action should be dismissed. It claimed that SRB’s obligations under the DBA had been extinguished as a result of the Novation Agreement – therefore any loss which SRB may have suffered was avoided and as assignee SRB UK could not recover any greater loss than SRB could recover.

The Court did not accept the legal effect of the Novation Agreement was merely to extinguish the obligations and liabilities of SRB to the Scottish Ministers but instead held that such obligations and liabilities were “transferred” to SRB UK.  Had SRB’s liability merely been extinguished by the Novation Agreement, the Court considered that Ramboll’s “no loss” arguments would have had force. However:

“That is not what happened here. … [SRB’s] obligations to Scottish Ministers were replaced by [SRB UK’s] obligations to Scottish Ministers. The effect of the Novation Agreement is that [SRB UK] became liable to the Scottish Ministers to make good the Scottish Minister's loss from the start of Design and Build Agreement.”

Conclusions and implications

The arguments made by Ramboll in this case bear some similarity to those made in the sale of property cases noted in the introduction, where the seller/assignor had received full market value for the property and was therefore said to have suffered no loss. In the present case, it is a building contract which has been transferred by way of a novation agreement and the releases given to the assignor as part of that novation agreement have resulted in it being absolved from liability and no longer having a loss to pass down to Ramboll. Broadly speaking, therefore, it is the overall transaction which in both scenarios result in the removal of the assignor’s loss. It appears that the Court has sought to achieve the same result which applies in the sale of property cases, effectively by asking whether SRB as assignor would have suffered the loss claimed for had it not assigned its claim to SRB UK and had it not entered into the Novation Agreement.

Despite these similarities in outcome, the approach in the present case marks a significant extension of the no greater loss rule established in previous cases. As Ramboll noted, SRB and SRB UK had voluntarily entered into the novation agreement with a view to absolving SRB of liability under the DBA. Ramboll had not been consulted in relation to the novation agreement and had not agreed to be liable to SRB UK. Whether these objections are properly overcome by the Court’s more transactional approach to the no greater loss rule remains to be seen.

The present case also highlights the importance of properly considering the impact of a novation on associated contracts and liabilities. Based on the facts of the case there appear to be some practical steps the parties could have taken to avoid argument:

• The Ramboll Contract could have been novated to SRB UK at the same time as the novation of the DBA. This would have ensured there was no question as to whom Ramboll owed their obligations under the Ramboll Contract to.
   
• Contemporaneously with the novation of the DBA, SRB UK could have requested Ramboll provide them with a collateral warranty for their services under the Ramboll Contract. This would have established a clear contractual link between SRB UK and Ramboll.
   
• It may also have been helpful for the assignation of SRB’s rights under the Ramboll Contract to have been made at the same time as the novation of the DBA. Although this would not necessarily have changed Ramboll’s position in terms of its response to the proceedings, the timing gap in this case between novation and assignation would not be considered standard practice in analogous circumstances and is more likely to provoke a challenge.

References:

Blyth & Blyth Ltd v Carillion Construction Ltd 2002 SLT 961

Technotrade Ltd v Larkstore Ltd [2006] EWCA Civ 1079

SRB Civil Engineering UK Limited v Ramboll UK Limited [2022] (CSOH) 93