Collateral warranties establish a direct contractual relationship between a funder, tenant, or buyer and a consultant, contractor, or subcontractor who is working on their project, but not for them directly.
If you are a funder, tenant, or purchaser, this additional degree of protection protects you if there are any concerns with the development of the works or if a consultant, contractor, or subcontractor causes mistakes in the works. In this article, what are collateral warranties, we take a look at the process involved and the options available to you.
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What are the key points of Collateral Warranties?
In terms of reviewing the collateral warranty, there are a number of essential considerations.
The provisions of the collateral warranty should not be more stringent than those of the contract to which it relates. For instance, a subcontractor’s collateral warranty should not contain more stringent restrictions than those in the subcontract.
In addition to step-in rights, the collateral warranty should specify whether the service provider is required to consent to them. If they are not, offering step-in rights may not be a prudent business move.
Additionally, collateral warranties should specify when and to whom they can be assigned. If the warranty can be transferred without restriction, it can be unclear who can file a claim against the service provider.
In addition, it is essential to ensure that the warranty does not contain a “no greater liability” clause, so that the service provider does not owe you a bigger liability under the warranty than it does to its employer under the underlying contract. This would encompass any liability limitation in the underlying contract that was not incorporated in the collateral warranty.
Step-In Rights
Some collateral warranties may also include ‘step-in’ rights, which permit the beneficiary to assume control of the underlying contract and provide instructions.
If there is no contractual agreement, the subcontractor is not required to accept instructions from the employer to complete the job in the event that the project’s principal contractor becomes insolvent. The adoption of a collateral warranty in this circumstance creates a direct contractual link that enables the employer to offer instructions to the subcontractor, so assuring that the subcontractor fulfils its duties.
What is the significance of a collateral warranty?
By putting requirements on a service provider, you enable yourself to pursue a contract claim against that provider for defective work that has caused you loss. Having a collateral warranty simplifies claims and increases the amount of damages that can be claimed.
Without a collateral warranty, it would be extremely difficult to recover losses from or alleviate project delays caused by a service provider if the landlord or developer became insolvent or was unable to settle a damages judgement. The collateral warranty enables you to step in as the direct employer of the service provider to resolve the problem and ensure that any delays to the entire project are minimised to the greatest extent possible.
Due to the significance of collateral warranties, many contracts now make payment contingent on receipt of all executed and returned collateral warranties.
Who should provide a collateral warranty?
It may be advisable to require the General Contractor to issue warranties to the Funder, prospective buyers, and tenants, among others. This may be a requirement of the funding agreement for funders; for purchasers and tenants, it may increase the value of the asset they are purchasing, as they would have direct recourse against the General Contractor for any issues that may arise with the building during their ownership and occupancy.
When specialised subcontractors execute the design, it may be prudent to establish a direct contractual link through a collateral warranty.
Who should obtain a collateral guarantee?
The following parties frequently seek collateral warranties from the construction and design team on construction projects:
Banks and other lenders who finance construction projects by obtaining a lien instead of buying the property will require collateral warranties. This safeguards the lender in the event that the borrower defaults on the financing agreement and the lender is compelled to sell the development to recoup losses. If construction defects reduce the project’s worth, the funder should be allowed to file a claim against the construction and design team. To assume the employer’s position in the underlying construction contract and secure the development’s completion, the funder will also want step-in rights in its collateral warranties.
To assume the employer’s position in the underlying construction contract and secure the development’s completion, the funder will also want step-in rights in its collateral warranties.
Purchasers – A party that purchases the development (either before or during construction as a “forward purchaser” or after completion) will have a long-term interest in the building, even if they do not intend to occupy it; they may incur a loss due to defects in the construction. In the event of flaws, a purchaser will therefore seek legal redress against the construction and design team.
Typically, a tenant will have a lease that includes repair and insurance. Therefore, they will need collateral warranties that allow them to bring a claim against the building and design team if they are compelled to pay for the settlement of a problem. On developments with several tenants, warranties are typically restricted to those who lease a substantial portion. Generally, the building and design team’s obligation to give warranties is limited to the initial inhabitants.
Companies – Since the employer already has a direct contractual relationship with the general contractor and the consultants via the construction contract and consultant appointments, the employer will not require that they furnish a collateral warranty. However, the employer would request additional guarantees from the contractor’s subcontractors. Aside from that, it cannot assert a claim against them, particularly if the large contractor declares bankruptcy. In addition, when a design-and-build project is acquired, the design consultant positions are sometimes shifted to the contractor. The employer will need a collateral guarantee from the novated consultants in order to preserve its legal interests against them.
If they have a stake in the project, other parties, such as a local authority or freeholder, may also seek a collateral warranty. On big multitenant complexes, the management firm may require a collateral warranty, and if a tenant is renovating an existing property, the landlord may require one as well.
Is there an alternative to a collateral warranty?
The Contract (Rights of Third Parties) Act of 1999 can be utilised as an alternative to collateral warranties because it permits the creation of third party rights by contract; nonetheless, collateral warranties are currently the favoured method for establishing direct contractual relationships.
What are the risks of not having collateral warranties?
The biggest risk associated with the absence of a collateral guarantee is that reliance must be placed on the existing contractual relationships – the Main Contract and Subcontractors. If the Main Contract and its supply chain continue to trade, there is no need to see collateral warranties as “necessary” – perhaps “desirable” is a more appropriate adjective.
There is no reason why collateral warranties cannot be requested retrospectively, but the contractor would be under no obligation to provide them, and it would not be out of the ordinary to attach a monetary value to their delivery under such circumstances. Given that the Contractor is providing the warranty with a benefit, namely the ability to pursue him directly for a remedy in the event of difficulties with the building or warranted work, this is acceptable.
How we can help
We have a proven track-record of dealing with construction contracts and collateral warranties. Not only does our construction department have extensive legal experience and knowledge of construction law but we also have the benefit of chartered surveying experts. The nature of construction disputes often involves potentially complex areas of law. We will guide you through the process and ensure all checks are carried out swiftly and efficiently and we firmly believe that with the right solicitors by your side, the entire process will seem more manageable and far less daunting.
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It is important for you to be well informed about the issues and possible implications of construction contracts and collateral warranties. However, expert legal support is crucial in terms of ensuring a positive outcome to your case.
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Disclaimer: This article provides general information only and does not constitute legal advice on any individual circumstances.
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