29.07.2021

Subcontractor entitled to raise set-off claim against principal’s warranty claim

A recent High Court case examined the all too common situation where a contractor goes into liquidation, but there are unresolved matters on a construction project affecting both the principal and subcontractor.  In Asphalt Supply Company Ltd v Cole John Ltd [2021] NZHC 1257 particular circumstances meant the principal was able to directly pursue the subcontractor for defective works, while the subcontractor equally could set-off amounts unpaid to it by the contractor.

Background

Cole John Ltd (CJL) engaged Complete Ltd (Complete) to undertake construction work.  In turn, Complete engaged Asphalt Supply Company Ltd (ASCO) as a subcontractor to complete certain asphalt work. 

Once ASCO had carried out its subcontracted work, Complete refused to pay the balance of the contract price (c $80K), on the basis it was payable upon ‘completion’, and because it alleged the work was defective it was not complete.  Complete promised to pay the balance upon receipt from ASCO of a six month warranty in favour of CJL.  Despite ASCO providing the warranty, Complete did not pay and promptly went into liquidation.

There was no direct contractual arrangement between ASCO and CJL, so ASCO was unable to recover the balance from CJL directly.  When CJL claimed against ASCO for a breach of the warranty and negligence in respect of the defective work, ASCO argued it was entitled to set off, against any damages in CJL’s favour, the balance left unpaid by Complete.  ASCO was unsuccessful in the District Court, and c $130K damages were awarded against it.

ASCO succeeds on appeal

On appeal, the High Court agreed that CJL was entitled to rely on the warranty, the work was indeed defective, and CJL’s loss was correctly quantified.  However, it allowed the appeal, finding the work was complete (albeit defective) and ASCO was therefore entitled to set-off the unpaid balance against CJL’s warranty claim.

The ability for ASCO to set-off the unpaid balance against the warranty claim was a result of s 18(2) of the Contract and Commercial Law Act 2017 (CCLA).  That section provides that a party in ASCO’s position has available, by way of a defence, set-off, or otherwise, any matter that would have been available to it:

  • if CJL had been a party to the contract in which the warranty was contained; or
  • if CJL was the promisee (ie Complete), the warranty had been made for the benefit of the promisee, and the proceeding had been brought against ASCO by the promisee.

Had Complete sued ASCO for the defective work, the measure of damages would have had to make an allowance for the balance of the contract price.  The normal measure of damages for incomplete or defective work under a construction contract is the cost of completing the work or remedying the defects, less any sum that would have been payable to the contractor had the work been properly carried out. Otherwise, the plaintiff would be overcompensated.

Under s 18(2) of the CCLA, the same allowance had to be made when CJL sued as the beneficiary of the warranty.  As a result, the unpaid balance was offset against CJL’s damages, which were reduced to c $50K.

Our comment 

The facts of this case will be familiar to many construction projects.  As with any project, there are a number of parties, not all of whom will have direct contractual relationships with each other.  Contractual arrangements must be carefully considered, particularly where solvency concerns arise.  Equally, the terms of any warranties and the specific wording of warranties should be carefully considered, including for whose benefit the warranty is provided.  Careful consideration, with legal input as appropriate, is required.

If you wish to discuss this case or any matters arising out of this decision or construction projects generally please contact our Construction Team or your usual contact at Hesketh Henry.

Disclaimer:  The information contained in this article is current at the date of publishing and is of a general nature.  It should be used as a guide only and not as a substitute for obtaining legal advice.  Specific legal advice should be sought where required.

 

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