Do your contractual warranties properly cover your business risks

In a recent appeal before the Supreme Court, the court was asked to interpret a customary warranty written in a lease.

A and B signed a lease in which B warranted that its premises would comply with the applicable health and safety laws.

Ordinarily, the local authorities inspect buildings to make sure they meet the minimum health and safety standards legislated. If the inspection is affirmative, the owner is presented with a certificate of occupancy, and tenants may move in.

One important item for inspection is a fire suppression system. In this case, when the local authorities inspected the premises, the fire suppression system was operational. B was accordingly presented with a certificate of occupancy and A moved into the premises.

Unbeknownst to A, the fire suppression system was subsequently deactivated, presenting a significant risk to A’s business.

Shortly after taking occupation a fire broke out which damaged A’s assets and caused substantial loss. A sued B on a breach of the warranty (that the premises would comply with applicable health and safety laws).

The court had to determine whether the premises complied with health and safety laws, however it was the moment at which that determination ought to be made which presented difficulties in argument. Was compliance to be determined when the premises were handed over, when the fire broke out, or for as long as B had a certificate of occupancy?

The court found that B had not breached the warranty. Implicit in this finding was that the premises complied with health and safety laws when the damage was caused, and, at all relevant times while B had a valid certificate of occupancy.

In other words; based on an interpretation of the wording of the warranty, the premises did not cease to comply with relevant health and safety laws once the fire suppression system was deactivated, even though its activation was required during inspection before a certificate of occupancy could be issued.

This case aptly illustrates the need for business owners to properly assess risks and draft contract warranties to properly cover those risks, particularly in circumstances where they are not assumed by an insurer.

If the warranty in this case had been couched in broader terms by, for example; warranting that the fire suppression systems would remain operational at all times, the matter may have been decided differently.

A proper risk assessment should have revealed the risk of the suppression system being deactivated or damaged for some reason, which should also have raised a red flag on the limited wording of the warranty and the consequences of the risk arising.