Collateral Warranties | Extending the Provisions of a Construction Contract
Collateral warranties are used in the construction industry in order to extend the provisions of a construction contract to other parties in a project. Here’s what is a collateral warranty and how they work.
What Exactly is a Collateral Warranty?
In the construction industry collateral warranties are used in building projects. They are used to create a contractual link between parties who do not directly have a contract with each other. Collateral warranties are supplementary warranties.
In the absence of a collateral warranty, one party in a project will only have a contract with their client or supplier. They will not have a responsibility to parties who are not their client other than that which is otherwise stipulated in wider law. A collateral warranty creates a direct legal responsibility between third parties and defines more clearly what that is.
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How Does a Collateral Warranty Work?
The reason for the use of collateral warranties is that so many different parties (or stakeholders) are involved in a construction project. For example, a commercial office property or retail development. A construction project may involve an architect, a developer, a funder or investor, the main contractor, and many sub-contractors. Once the project is completed, there may be an occupier who buys the property, or an investor or landlord who buys and lets it out, and a tenant who rents it.
While all those parties have a relationship they only have a legal, contractual obligation to the parties who are their own clients and suppliers. They do not have a direct legal commitment to the other parties. This can cause difficulties if there is a dispute over the work that is or has been done or if one of the parties goes out of business. For example, the original contractor may not have a direct contract with or responsibility to the buyer of the building.
Collateral warranties seek to remedy this situation by creating a formal contractual relationship amongst the many different parties in a construction project. Any party in a project can be involved in a collateral warranty.
There are other legal ways where one party can hold another party in a construction project responsible for the goods or services they have provided under general law. These can be complex and difficult to apply, however. The collateral warranty is a way of more clearly defining responsibilities and the course of action if things go wrong.
In the context of a collateral warranty, collateral means ‘that which supports something else’, in this case, the original construction contract. It does not mean collateral in terms of security or a bond.
A Brief Explanation of Collateral Warranties
Here we will briefly explain some of the different aspects of and typical clauses within a collateral warranty.
- The underlying or primary contract: This is the original contract between the original contracting parties to which the collateral warranty is a supplementary warranty.
- The employer: Normally the party who requests the collateral warranty.
- The contractor or sub-contractor: The party who gives the collateral warranty.
- The warrantor: The party who gives the warranty.
- The beneficiary: The party (or parties) who benefits from the warranty.
Duty of Care Obligations
A party agreeing to a collateral warranty warrants that they will perform their obligations under the underlying contract with reasonable skill and care and will continue to do so.
Collateral warranties warrant to another party that a party has fulfilled its obligations correctly under the original contract.
The duty of care obligations in the collateral warranty should not be more onerous than those involved in that underlying contract.
Collateral warranties may cover under what circumstances one party is entitled to bring a claim against another.
Collateral warranties should specify the liability the party giving the warranty has. This might be in the form of a financial cap (a specified monetary amount) or a contribution cap.
Liability under a collateral warranty should not be greater than that under the underlying contract. This is known as a ‘no greater liability’ clause.
Materials – Fitness for Purpose
A party giving a collateral warranty may be asked to agree only to use appropriate materials that are fit for purpose.
The term 'deleterious' may often appear in a collateral warranty. Those giving a warranty are required to give an undertaking that they will not use deleterious materials. Deleterious means something that is harmful or damaging, either to people or the building.
Indemnity Insurance Requirements
A party who agrees to a collateral warranty usually agrees that their professional indemnity insurance will remain in force until the end of the warranty period.
Collateral warranties typically last for 12 years. (Beyond which claims are legally barred by a statutory limitation period in any case.)
Implications for professional indemnity insurance: Those asked to agree to collateral warranties should discuss this with their broker or insurer. The insurance should cover the value specified in the warranty. However, indemnity insurance will not always cover the warranty being given.
Intellectual Property Rights
The party giving the warranty will normally agree that the other party may use their intellectual property. This might include copyright to plans or drawings. It would usually include granting a license to use them.
Right to Assign
The party giving the warranty may be asked to agree that the warranty may be assigned to another party. This can create a further obligation and risk to a party or parties unknown.
This provision within a collateral warranty allows one party to give instructions to another that could normally only be done by parties having a primary contract together. For example, a developer could give instructions to a sub-contractor who is employed by a main contractor.
A collateral warranty will also contain clauses as in any other legal contract, such as governing law, jurisdiction, and details for service of notices.
Do You Have to Agree to a Collateral Warranty?
The parties in a construction project do not have to agree to give collateral warranties. It is a matter of their own commercial judgement. However, It is likely that the client with whom they have a contractual obligation (the underlying contract) will require their agreement to collateral warranties.
The cost implications of a collateral warranty: The cost of a collateral warranty extends just beyond the cost of creating it. It involves agreeing to additional commitments and taking on extra risk and the cost of this should be considered from the outset.
It is advisable for parties to a construction project to consider the collateral warranties they may be required to give, and the costs and risks involved, when negotiating and agreeing to their own original, underlying contract.
How to Obtain a Collateral Warranty
Collateral warranties can be written by a lawyer experienced in this area of law.
As collateral warranties involve a legal commitment expert legal advice should always be taken before requesting or entering into a collateral warranty.
What does a collateral warranty cost? It is possible to buy a template collateral warranty for as little as £30. However, this does not cover the cost of legal advice.