08 November 2005
Key Points:
There are various legal options available to purchasers of commercial property to protect their rights if the property has a latent defect. There is some legal uncertainty associated with each option, and each option holds different advantages and disadvantages for the vendor and the purchaser.
The High Court decision in Woolcock Street Investments Pty Ltd v CDG Pty Ltd [2004] HCA that a subsequent purchaser of a commercial property was not entitled to relief against the original builder in an action in negligence, squarely raises the question of what legal steps a purchaser can take at the time of purchase of a commercial property to protect its rights if the property does turn out to be defective in any way.
There are at least three classes of contractual protection a purchaser may seek from the vendor:
Warranty from vendor
The safest option for the purchaser is to obtain a warranty as to the quality of the building from the vendor. However this presents real risks to the vendor as to whether it could recover any liability it may have to the purchaser from the builder. This is because the vendor's liability to the purchaser under such a warranty may be a loss that is too remote to be recoverable against the builder. The builder may argue that the vendor giving a warranty to future purchasers was not something that is in the usual course of business practice, nor did the builder contemplate that it would happen.
Assignment of rights under building contract
The safest option for a vendor is to give the purchaser an assignment of its rights under the building contract. For the assignment to be effective, the vendor will need to check if the builder's consent is required under the building contract, and if so, obtain that consent. Further, even if the assignment is effective, there is some legal doubt as to whether the purchaser would be able to recover damages from the builder. It is argued that a legal "black hole" arises when a vendor of a property with a latent defect sells the property without any discount on account of the latent defect (as the defect is not known to the parties). If the vendor sells for full value, it doesn't suffer any loss. Then, when the defect becomes manifest, the purchaser suffers loss, however a rule of law provides that an assignee cannot have greater rights than the assignor. Since the assignor has not suffered any loss, it is argued that the assignee cannot recover. There are English cases which provide relief against this legality, and Australian cases that take a different approach altogether, however it cannot be said with certainty what approach would be adopted if the argument was squarely raised in Australian appellate courts.
Vendor holds rights "for benefit of" purchaser
A possible compromise position involves the vendor holding its rights under the building contract "for the benefit" of the purchaser. This does require the vendor to play an ongoing role in the transaction, as it may need to take action (including possibly litigation) if a defect does become manifest. Further, a similar uncertainty arises as to what damages may be payable. If the vendor sells for full value it will not have suffered any loss, and thus a similar question arises as the one above - does the vendor have a right to substantive damages which it can hold on behalf of the purchaser? Again, the English cases, if applied in Australia, should relieve this difficulty. In addition, Australian cases have favoured a line of legal reasoning that permits a principal to recover substantive damages for a builder's failure to comply with a building contract, without focussing on the economic loss that flows from that failure. This has been termed enforcing a principal's "performance interest". These cases would allow the purchaser to hold its rights for the benefit of the purchaser even though it doesn't suffer any economic loss itself.
For a detailed analysis see Stuart Connor, "Protection of the rights of purchasers of commercial properties where latent defects arise: Assignment of ongoing rights under building contracts" in (2005) 21 BCL 248.
For further information, please contact Stuart Connor.
