Claims under a Guarantee or Warranty when the Contractor is in Liquidation

Claims under a Guarantee or Warranty when the Contractor is in Liquidation

On occasions in Malaysia Contractors are required under a contract to provide a joint and several form of guarantee with a manufacturer or specialist Sub-Contractor, guaranteeing a product and/or the installation of the product, against defects resulting from the failure of the manufactured goods or poor workmanship. Common examples in building construction would be metal sheet cladding, waterproofing works or exterior painting works and materials. The guarantee is usually provided to the Employer at the time of taking over the works (practical completion certificate) or shortly thereafter and normally runs for periods of between five and ten years from that date depending upon the product or installation. The requirement for the provision of a guarantee is normally stipulated in the contract specification or method statement forming the contract documents.

The Contractor who provided the guarantee is obliged to remedy any defects which may arise during the guarantee period. However, in the event that the Contractor stops trading is wound up or goes into liquidation disputes may emerge as to how any subsequent claims under the guarantee may be dealt with.

It is not unheard of that after a Contractor has been wound up a Liquidator will receive claims from an Employer purporting to have a right to claim against a guarantee given under the contract with the wound up Contractor. Unsurprisingly this argument is normally raised when the Employer is being pursued by a liquidator for payment of monies outstanding to the Contractor who has provided the guarantee in the first place. The Employer may purport to have a claim under the guarantee with respect to potential or future defects which may occur (i.e. as yet unknown and therefore unable to be quantified) and/or with respect to the cost of obtaining a replacement guarantee. The justification given for the purported claim is usually on the grounds that should a claim arise the Contractor who has provided the guarantee is now in liquidation and is therefore no longer in a position to fulfil its contractual obligations under the guarantee.

The Employer in effect is arguing that the Contractors obligations under the guarantee are now a contingent liability which should be set off against the outstanding monies the Employer owes the Contractor or Liquidator as the case maybe.

Clearly the role of the liquidators is to ensure that realisations are maximized for the benefit of creditors and to admit or reject proofs of debt and claims from creditors and to subsequently apply the Contractors assets towards discharging its liabilities. Accordingly when dealing with an insolvent Contractor the issues of potential claims under a guarantee may have a significant impact on the realisation of assets and thus the potential pay out to Contractors creditors.

There are essentially three types of claims purported or otherwise, which the Employer can make pursuant to a guarantee of this nature.

1)   A claim for the costs to rectify defects which have occurred prior to the expiration of the guarantee period.

2)   A claim for the costs to rectify defects which are anticipated to occur (and are therefore as yet unknown and unable to be quantified) during the guarantee period.

3)   A claim with respect of the cost of obtaining a replacement guarantee.

For the Employer to prove the debt to the Liquidators he must show that the claims represent the values of any obligation the Contractor had to pay money under the guarantee for the cost of rectification works. Where there is no debt but a contingent liability is shown the Employer becomes a contingent creditor to the Contractor.

The Employer may attempt to argue that the contingent liability should be set-off against any monies owing to the now insolvent Contractor on the basis that they are mutual debts.

In these circumstances, an account shall be taken of what is due from both the Contractor and the Employer to each other in respect of the mutual dealings and the sums due from one party shall be set-off against the sums due from the other. The mutual dealings do not have to be in relation to the same transaction between the parties, although the mutual dealings must be between the Employer and the Contractor and not other parties.

The effect of the existence of a set-off in a liquidation is that only the net balance owing will be paid to (or due from) the liquidator i.e. only one sum will be owed. The purpose behind this is to provide substantial justice between the parties. If set-off were not allowed in the case of insolvency, it would mean that a creditor would be bound to pay his debt to the company in full and at once. However in relation to the debt owed to him by the company, he would have to enter a proof of debt in the liquidation and would only be entitled to receive a dividend from the liquidator months or even years later. In other words, to the extent that a set-off is available, the creditor gets in full the relevant amounts.

It is the Liquidator’s duty to quantify any contingent liability. This will enable any set-off to occur and also allow the Liquidator to safely proceed and distribute any assets that may result.

Clearly where actual defects have occurred within the stipulated guarantee period and such claims can be fully substantiated then the quantification of a contingent liability is straightforward. Being the costs incurred in the rectification of the defect or defects.

Where the purported contingent claim is with respect to future or potential claims which may arise under a guarantee then the Liquidator must consider this matter carefully. The Liquidator may endeavour to quantify the contingent claim by making enquiries of the previous management of the insolvent Contractor, conduct his own investigations as to the likelihood that a claim will be made pursuant to the guarantee and establish whether the Employer is able to produce evidence that a claim may exist.

The Employer may also claim the cost of obtaining a replacement guarantee. To accept such a claim the Liquidator will need to be persuaded that there is legal basis for the insolvent Contractor to provide an additional guarantee to cover any defective workmanship.

A claim under a guarantee from an Employer may reduce or eliminate any monies which are properly due and payable to the insolvent Contractor with respect to work completed prior to the Contractor going into liquidation. Accordingly the Liquidator must carefully scrutinise the legitimacy of any claims made pursuant to a guarantee provided by the now insolvent Contractor.

Claims for defects or poor workmanship from an Employer which fall within the guarantee period and which can be fully substantiated are valid claims which the Liquidator is under a duty to allow.

However a purported contingent claim for potential or future claims which may arise under a guarantee is not a valid claim. This is because the guarantee is still valid even though the Contractor is in liquidation. The guarantee provided is to warrant the performance of a product or to ensure quality of workmanship and is not a guarantee of the solvency of the Contractor. In other words, although the guarantee was provided by the company when it was (presumably) solvent the subsequent insolvency of the Contractor does not render the product or the workmanship to be defective or of poor quality. If the Employer had wanted a guarantee as to the solvency of the Contractor then they should have asked for one at the commencement of the contract.

An Employer should not use the insolvency of a Contractor as an excuse to avoid making payment to a Contractor for work which is properly completed and for which monies are properly due and payable. Should such a stance taken by an Employer be valid then this would have serious ramifications for the construction industry in Malaysia. In effect an Employer would never have to pay any funds to a Contractor in circumstances where a guarantee has been given regarding workmanship (including implied guarantees) unless and until that guarantee period has expired or alternatively an additional guarantee is provided. Such a position is simply untenable.

In the event that the guarantee was to state something along the lines of “upon the Contractor going into liquidation the guarantee shall be deemed to be null and void and the cost of obtaining a replacement guarantee will be claimed against the guarantor” then the liquidator would appear to be obliged to consider such a claim. The claim however would need to be a fair and reasonable claim for costs incurred in procuring a replacement guarantee and thus could be deemed acceptable for damage’s claim to be made against the defaulting Contractor. This would also facilitate the right to set off with respect to any payment payable to the defaulting Contractor.

Finally where a guarantee is jointly provided by the Contractor with a supplier, manufacturer or Sub-Contractor consideration should be taken as to the obligations which still remain on the Sub-Contractor, supplier or manufacturer to rectify the defects regardless of the demise of the Contractor. It maybe that the Employer has indeed lost future recourse against the Contractor but he may not have lost the benefit of the guarantee or warranty completely as claimed.