- What is the purpose of a collateral warranty?
- Who provides a collateral warranty?
- What are the common clauses in a collateral warranty?
- Should I use a standard form of collateral warranty?
- How much does a collateral warranty cost?
- How long does a collateral warranty last?
- How should you limit liability and risk?
- What are third party rights?
- How do third party rights affect collateral warranties?
What is the purpose of a collateral warranty?
There are many parties involved in the delivery of a construction and engineering project and the contractual relationships between them are complex. Those parties include employers/developers, main contractors, construction professionals and consultants, sub-contractors and suppliers.
However, those who fund and ultimately enjoy the benefit of a construction and engineering project may not be party to the various contracts for the delivery of the project. These parties include employers/developers (in part), funders and end users such as purchasers, landlords and tenants. However, such parties may have to deal with issues arising in or after the delivery of the project, most notably in relation to defects in the works. A collateral warranty provides each such party (the beneficiary) with contractual rights against those involved in the delivery of the project.
Who provides a collateral warranty?
A collateral warranty is usually provided by a party (the warrantor) based on a requirement in the underlying contract.
It is common for a collateral warranty to be provided as a warrantor by the construction professionals and consultants, main contractors and sub-contractors with a material design responsibility. Although a collateral warranty can be provided by others involved in the delivery of the project.
A project may involve the provision of a separate collateral warranty by a warrantor to several parties.
What are the common clauses in a collateral warranty?
Common clauses include:
- a warranty that the warrantor will comply or has complied with the terms of the underlying contract (the building and engineering contract, the form of appointment of the construction professional/consultant or the sub-contract, as appropriate);
- a warranty that the warrantor has exercised or will exercise reasonable skill and care in the provision of its services, including design and management services as appropriate;
- an obligation to maintain suitable professional indemnity insurance and to provide evidence of that insurance;
- the granting to the beneficiary of a licence to copy and use material produced by the warrantor on the project;
- a limitation on the ability of the party with the benefit of the collateral warranty (the beneficiary) to assign the benefit of the collateral warranty (usually on a set number of occasions and/or to associated parties);
- terms that the warrantor will have no greater liability and will have equivalent rights of defence to those in the underlying contract;
- a limitation on the liability of the warrantor to the beneficiary;
- a time limit after which a claim cannot be commenced against the warrantor; and
- (in the case of funders) the ability to step into the underlying contract.
Should I use a standard form of collateral warranty?
The quality of the protection provided by a collateral warranty depends on the terms of the underlying contract, and the terms of that underlying contract will have to be carefully considered to ensure that it provides the required security for the beneficiary.
Whilst there are some standard form collateral warranties available, it is usual for a bespoke collateral warranty to be included in the underlying contract.
Given that a beneficiary should consider the terms of the underlying contract, a beneficiary should seek a collateral warranty drafted with the requirements of the particular project in mind.
How much does a collateral warranty cost?
A collateral warranty on its own is not a long document and is not usually expensive or time-consuming to prepare, review and negotiate.
To assess the protection provided by a collateral warranty, the underlying contract must be considered, and that exercise adds some expense.
However, the costs of a collateral warranty are not large when compared against the protection that a collateral warranty can provide.
How long does a collateral warranty last?
The period of liability under a collateral warranty is usually the same as that under the underlying contract, whether by reference to the express terms of the collateral warranty or by the warrantor having no greater liability (which would include any provision as to the time within which a claim must be commenced) than that under the underlying contract.
Most collateral warranties are provided in relation to an underlying contract which has been executed as a deed and it is usual for a collateral warranty itself to be executed as a deed.
On that basis, the limitation period for the commencement of a claim under a collateral warranty will be twelve years from a breach of contract. It is common for a collateral warranty to contain a provision that a claim must be commenced under the collateral warranty within twelve years from the date of completion of the project.
How should you limit liability and risk?
There are several ways in which a warrantor can seek to limit liability:
- The warrantor may seek to limit its liability to a capped amount or to a particular type of loss such as repair costs only (and exclude liability for other costs incurred by the beneficiary).
- The warrantor may seek to limit its liability to the level of its professional indemnity insurance (known as an evaporation clause).
- The warrantor may seek to limit liability to the amount of its share of any overall liability, considering the liability of other parties on the project who are jointly liable for the loss.
What are third party rights?
A third party to a contract can enforce the terms of a contract to which it is not a party if the contract provides that it may do so.
Third party rights are generally identified in a stand-alone schedule or in a schedule outlining the clauses in the underlying contract that the third party has the right to enforce.
How do third party rights affect collateral warranties?
If rights are to be granted to third parties, the terms of an underlying contract will provide for the granting of collateral warranties or for third party rights, not for both. That is because collateral warranties and third party rights both seek to achieve the same thing, that is, to give a third party rights under a contract which that party would not otherwise have.
Whilst the ability to provide for third party rights has been available for some time, a collateral warranty remains the common way in which to grant rights to a non-party on construction projects. This may be explained in part by the fact that a collateral warranty is a separately identifiable contract and that those in the construction industry are accustomed to and familiar with the concept of collateral warranties.