Collateral Warranties: What to look for?

Collateral warranties are a key feature of the construction industry, and they enable beneficiaries such as funders, tenants or purchasers of a development to have a contractual link with the project team. Whilst it is possible to utilise the third party rights act, this route is limited, as seen in the case of Hurley Palmer Flatt Limited v Barclays Bank plc [2014] and you can read our analysis here.

Given the importance of collateral warranties, the focus of this article will be to provide a general overview on some of the clauses and limitations that appear in collateral warranties.

Clauses and their effects?

There are a range of clauses that are typical to collateral warranties, but the key ones highlighted here relate to deleterious materials, professional indemnity insurance, copyright, assignment and step-in rights.

• Deleterious materials – Such a clause will usually contain an obligation to confirm that no deleterious materials which may be damaging to health or the environment will be specified or used in the project. However, it is limited to the level of skill care and diligence required by the professional appointment or building contract.

• Professional indemnity insurance – This clause requires professional indemnity insurance, with reference to asbestos and contamination exclusions under the policy, to be maintained for a specific period of time (usually 12 years from practical completion of the project).

• Copyright licence and use of information – These clauses are commonly included to allow a third-party beneficiary to use design information generated by the project, but only in connection with the project. Copyright should be retained by the warrantor.

• Assignment – It is common for beneficiaries to be afforded the right to assign the benefit of the collateral warranty to a third party. This right to assign may be limited in number to restrict the number of assignments the beneficiary is entitled to.

• Step-in rights – These are often included to give the beneficiary (usually a funder) the right to take the place of an employer under the main contract if the employer were ever to commit a serious and un-remedied breach, that would otherwise enable the warrantor to terminate their contract with them. In practical terms, this right is beneficial to both the warrantor and the beneficiary as the project may continue to completion even though the employer has committed the serious breach, and so allowing the project value to be realised.

Limitations for the party granting the collateral warranty

A wide range of limitation and exclusion of liability clauses will be relevant when a collateral warranty is being negotiated. These include:

• No greater liability – If this clause is included, then it confirms that the warrantor will take on no greater risk under a collateral warranty than under the main contract; meaning that they cannot be made to pay more than they would be liable for under the original contract.

• Equivalent rights of defence – Such a clause stipulates that all the same rights of defence under the main contract will be available to the warrantor under the collateral warranty, ensuring that the contracts are back-to-back.

• Limitation to the claim period of a beneficiary – This clause limits the period during which a claim can be made by a beneficiary against the warrantor; this is often 12 years from practical completion.

• Net contribution – This clause apportions liability between each party liable for the same loss or damage and are used to limit the warrantor’s liability to a fair and reasonable amount.

These limitations all should take into account the parties’ bargaining positions and the nature/value of the project.

Comments

In considering these clauses and limitations, the essence of a collateral warranty is that it is ‘collateral’ to the professional appointment or building contract. In practice, collateral warranties may be harder to enforce if the equivalent provisions in the underlying contract are not the same.

Therefore, collateral warranties are only as good as the underlying contract, and so special attention must be paid to ensuring that they are fully ‘back-to-back’ with the underlying contract.