In this article, we will be giving an overview of what collateral warranties are and an insight into the key requirements that should be considered and / or incorporated when asked to either provide a collateral warranty or when seeking the benefit of one in a construction project.
What are collateral warranties?
Collateral warranties have become an essential part of construction project documentation and are used to create a contractual link with a third party, where there otherwise would not be one. This link enables a third party to have a direct contractual relationship with a party providing construction services or works.
Parties to the collateral warranty
The parties that are typically asked to provide a collateral warranty in a construction project are usually the contractor, subcontractor and / or any design consultants.
The person providing the collateral warranty is usually referred to as the "warrantor" and the person receiving the benefit of the warranty is known as the "beneficiary".
The beneficiary can be any party who may have an interest in the project. This would usually include a tenant, a funder or a purchaser.
In the case of a purchaser or a tenant occupying or buying completed buildings, they would want to have a collateral warranty to establish a direct contractual relationship with relevant key construction team members. This is particularly key to have should they need to rely on any undertakings or covenants within the collateral warranty to bring a claim against the warrantor, especially if down the line, it becomes apparent that there are defects or any breaches that they would need to claim for.
A funder would have an interest in recovering their investment and would therefore be keen to see a project through to completion. Should it be required, in seeking a collateral warranty this would allow them to "step-in" and oversee a project to completion.
Important elements of a collateral warranty
The main purpose of a collateral warranty is to provide the beneficiary with the same or similar rights to those of the employer under the original contract.
Whilst it is important to ensure that when drafting the collateral warranty it does not contain any terms that are inconsistent with those of the original contract, it is equally essential that the warrantor in particular undertakes a careful review of the proposed collateral warranty that they are asked to enter into, to ensure that they are not exposing themselves to any unnecessary risk.
The below provides a non-exhaustive list of key requirements that is advisable that you should look out for when reviewing a collateral warranty:
- Standard of care
The collateral warranty should set out the required standard of care that is to be expected to be exercised by the warrantor. This will need to be consistent with the required standard of care that is expected under the underlying building contract or appointment that the collateral warranty is derived from to avoid any inconsistency between them.
Any inconsistencies or discrepancies between the underlying contract and the collateral warranty could lead to uncertainty, potentially triggering disputes later down the line.
- 'No greater liability'
The warrantor will want to ensure that their liability under the proposed collateral warranty is no greater than that of the underlying contract. This is often a requirement of professional indemnity insurance providers, because it can limit or invalidate cover for claims in respect of the collateral warranty under the policy,
This can be achieved by either using terms that go strictly to the same extent of liability as the terms of the underlying contract or including a well-worded "no greater liability" clause in the collateral warranty. The purpose of this is to ensure that the warrantor is not exposed to any more risk than it has already agreed to undertake under the underlying contract.
In the case of Safeway Stores Ltd v Interserve Project Services Ltd [2005], Interserve entered into a collateral warranty with Safeway that contained the following provision:
"The Contractor shall owe no duty or have any liability under this deed which are greater or of longer duration than that which it owes to the Developer under this Building Contract."
Safeway later sought to commence proceedings for damages relating to remedial works against Interserve under the collateral warranty. However, the court held that the above clause in the collateral warranty meant that Interserve's liability to Safeway was limited to its equivalent liability to the developer under the underlying building contract. In this particular case, Interserve had the right to set-off which prevented Safeway from recovering damages unless Interserve had been fully paid under the building contract.
This case highlights the importance of ensuring that a suitable "no greater liability clause" has been agreed upon and in particular, care should be taken to ensure that it operates the way that you intend it to do, should you need to call upon it.
- Copyright
It is not uncommon for a collateral warranty to include a copyright licence in favour of the beneficiary so that they are able to copy and use the warrantor's documents in relation to the property. The beneficiary would want to ensure that a suitable copyright clause has been agreed upon so that they are granted the adequate rights and permissions to either reproduce or to use the design without any sanctions or penalties.
The warrantor may seek to impose certain limits on the use of the material and / or make granting such a licence conditional on payment of their full fees under the main contract.
- Assignments
A beneficiary may require that the collateral warranty is capable of being assigned so that the rights can be transferred. It is not uncommon to restrict the number of times that the collateral warranty can be assigned, because warrantors are keen to ensure that they limit the number of third parties that they might be liable to – the industry standard is usually two free assignments and any further assignments will be subjected to the consent of the warrantor.
It is, however, not uncommon that there is no limit for assignments between group companies or assignments made by way of security.
- Step-in rights
Certain beneficiaries (such as a funder) may seek the right to 'step-in' and to take over from the employer of the underlying contract in certain circumstances, such as where there is an insolvency situation.
The step-in clause must be clear on when notifications are valid to ensure that there is no uncertainty or ambiguity. In addition, it is also recommended that the clause ensures that there is a hierarchy of rights to step-in, to address the scenario where more than one party wishes to step-in at the same time.
- Limitation
The limitation under the collateral warranty should reflect the same limitation period as that of the underlying contract – i.e. if the underlying contract was executed as a deed, the beneficiary would seek the collateral warranty to be executed in the same manner in order that it will provide them with the same 12-year limitation period.
Third-party rights
The Contracts (Rights of Third Parties) Act 1999 is usually expressly excluded from construction documentation, but express terms can provide an alternative method for third parties to enforce a term of the contract. Specific third party rights can be incorporated within the building contract, consultants' appointments and / or subcontracts – usually found by way of a third-party rights schedule (and appropriate notice) annexed to the relevant contract documentation. The rights in the schedule are akin to those conferred by a collateral warranty.
Care should be taken to ensure that when drafting the relevant clause, schedule and notice they expressly and clearly identify which third party will have the benefits of these rights in order to avoid any ambiguity down the line.
Whilst the introduction of this legislation was aimed predominately at the construction industry to confer the rights of third parties without the need to enter into a further document, warrantors still prefer the reassurance of a physically signed contract enforcing this right.
Conclusion
The brief summary above illustrates some of the key features that we would recommend should be looked out for when reviewing a collateral warranty. It is worth bearing in mind that this is a very short overview of some of the important elements to consider. The terms of a collateral warranty can be complex particularly when viewed alongside the underlying contract and it is recommended to seek legal advice to understand these, if required.
It is essential that any party who is either seeking the benefit of a collateral warranty or is requested to provide a collateral warranty carefully checks the terms to ensure that the collateral warranty correctly reflects and protects their position as either the warrantor or the beneficiary, and advice is sought to ensure that neither party is exposed to any unnecessary risks.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
