Understanding risks in warranties is crucial before signing any contract

Warranties form part of nearly every construction contract yet they remain poorly understood by many stakeholders in the construction industry. Despite this lack of knowledge, courts have had little hesitation in enforcing warranties. As a result, understanding the risk inherent in providing a “warranty” is critical.

A recent decision highlights the risk posed by a contract warranty.  In Greater Vancouver Water District v. North American Steel and Pipe Ltd., the GVWD contracted with North American to supply steel pipe for a waterworks project. The GVWD and its consultants had prepared the design and specifications for the steel pipe that was to be supplied by North American.  In the contract, North American gave two relevant warranties to the GVWD with respect to the steel pipes.  First, North American warranted that the steel pipes would conform to the specifications; and second, that they would be “free from all defects arising at any time from faulty design in any part of the Goods.”  Unusual wording one would think given that the design had not been undertaken by North American.

The pipes supplied were defective even though they met the specifications and design provided by GVWD. In other words, the design was defective. Eventually, GVWD sued North American for damages and North American counterclaimed for nearly $3.5 million dollars owed on the contract. North American was successful at trial where it had persuasively argued that the warranties were mutually exclusive and the design warranty should be read out of the contract. GVWD successfully appealed the trial court decision.

The appeal court found that on a plain reading of the contract, North American had contracted with GVWD to deliver pipes that not only met GVWD’s specifications but had also “warranted and guaranteed that if it so supplied the pipe, it would be free of defects arising from faulty design.” The Court disagreed that these clauses were mutually exclusively and held that they were separate contractual obligations which reflected an agreed distribution of risk. Accordingly, in the Court’s view, North American was liable for any damages that resulted from the design defect and it simply did not matter whose design gave rise to the defects.

The Court further found that while such a clause could be considered to distribute risk unfairly, such unfairness was a matter for the marketplace, not for the courts to adjudicate on. The Court went on to comment that such a distribution of risk in a contract can be “dangerous” as  contractors may refuse to bid or, if they do so, may build in costly contingencies. The Court also advised that those who do not protect themselves from the potential risk posed by such a warranty “may pay dearly”.  In conclusion, the Court stated that owners were unlikely to benefit from a transfer of risk where contractors would be faced with the prospect of potentially disastrous consequences and that the parties to construction contracts should more practically address the assumption of design risk as the failure to do so creates the potential for protracted and costly litigation.

What makes this case particularly interesting or, perhaps alarming depending on your point of view, is that North American was found liable for supplying a pipe in accordance with the design and specifications supplied by GVWD even though that design was defective. In essence, North American agreed, perhaps unknowingly, in the warranty provisions to assume the design risk associated with the GVWD’s design.

Warranty clauses such as the one at issue in this decision are yet another means of distributing risk in a construction contract. The fact that they sometimes appear to do so unfairly will normally not matter if a court is called upon to interpret the clause later. Paying attention to contract drafting as it applies to warranties is another effective tool in managing risk as is defining and limiting the remedies available under the contract for a breach of the warranty. To paraphrase the Court of Appeal, those who do not spend the time to protect themselves from the potential risks posed by a contractual warranty may end up paying dearly.

This article by Chris Hirst and Norm Streu first appeared in the ‘Construction in Vancouver’ supplement of the 15th – 21st April 2014 issue of ‘Business in Vancouver’.