Collateral Warranties in Construction

What are collateral warranties and do I need them on my project?

We put forward the following scenario to Jason Farnell, Adjudicator and CEDR Accredited Mediator:

I’m a Property Developer working on projects across London and the South East and I’m interested in understanding more about Collateral Warranties, their relevance to our business and how we can best utilise them.

We asked Jason the following questions:

1. What is a Collateral Warranty and in which cases do we need to have them in place?
2. From who are we required to get Collateral Warranties? Do we need to get them from the Main Contractor we employ on our schemes? Also, if we employ Subcontractors, is there any from whom it is vital that we get Collateral Warranties from as well?
3. What is best practice regarding Collateral Warranties, should these be included as a requirement in our contract documents to Main and Subcontractors?
4. There are standard form Collateral Warranties included within the JCT but is this all-encompassing? Should we consider getting this amended to better suit our specific projects?
5. What are the risks if we don’t have Collateral Warranties in place with our supply chain? Are Main Contractors and Subcontractors obligated by statute to provide them and can we request Collateral Warranties be provided retrospectively?

1. What is a Collateral Warranty and in which cases do we need to have them in place?

A ‘Collateral Warranty’ is a formal contractual agreement which runs alongside another contractual agreement – its purpose is to create a contractual relationship between two parties (e.g. companies; individuals) where one would not otherwise exist.

For example – where an Employer places a contract with a Main Contractor and the Main Contractor then places a number of subcontracts with its suppliers to actually do the works, the Employer has a direct contractual relationship with the Main Contractor but he has no contractual relationship with any of the subcontractors (this is known as ‘privity of contract’).

In these circumstances the Employer may wish to have a direct contractual relationship with the subcontractor so that it can enforce the obligations that the subcontract owes directly, or to create other obligations and rights between them. This might be considered as a security measure if the Main Contractor should become insolvent or if its employment were to be terminated for any reason. Some warranties create the right for the Employer to ‘step in’ to the place originally occupied by the Main Contractor in such circumstances.

Before design and build forms of contract became prevalent collateral warranties were frequently used to create a direct contractual relationship between the Employer and a subcontractor for design work carried out by the subcontractor.

The Contracts (Rights of Third Parties) Act 1999, which is expressly written into contracts was intended to create rights for businesses and individuals who were not a party to a contract which affected them (e.g. a home purchaser is not party to the contract between the builder and the developer for the construction of the house, but he is affected by that contract) provided that the contract identifies the person by name or as a member of a class of people or particular description.

This type of clause is one that is frequently deleted from construction contracts so that only parties to the contract may enjoy the benefits and burdens of it. Any rights that are to be conferred on other businesses and individuals are then expressly created through direct agreements such as collateral warranties.

2. From who are we required to get Collateral Warranties?

Do we need to get them from the Main Contractor we employ on our schemes? Also, if we employ Subcontractors, is there any from whom it is vital that we get Collateral Warranties from as well?

It may be desirable to require the Main Contractor to provide warranties in favour of say the Funder and future purchasers and tenants. For funders this may be a term of the funding agreement in any case; for purchasers and tenants this may increase the value of the asset they are purchasing since it would give them direct recourse to the Main Contractor for any issues they may have with the building during their occupancy or ownership.

Where design is being undertaken by specialist subcontractors then it would be prudent to have a collateral warranty to create the direct contractual relationship.

3. What is best practice regarding Collateral Warranties?

Should these be included as a requirement in our contract documents to Main and Subcontractors?

In terms of best practice, commercially it would be best to stipulate in the tender documentation pre-contract that collateral warranties will be required as a condition of the contract or subcontract and to provide a draft of the form of warranty so that the requirements are known at the outset.

Seeking to impose the requirement post contract may provide to be both costly and difficult to achieve.

4. There are standard form Collateral Warranties included within the JCT but is this all-encompassing?

Should we consider getting this amended to better suit our specific projects?

There are standard forms of collateral warranty available although bespoke lawyer drafted forms are common. It is best to have a form of warranty that provides the contractual obligations that are necessary rather than seeking to impose onerous or unrealistic forms which will require protracted negotiations and will be a barrier to achieving executed warranties which is ultimately counterproductive.

It is usual that the collateral warranty should not impose any greater obligation on the provider than is imposed under the underlying contract.

5. What are the risks if we don’t have Collateral Warranties in place with our supply chain?

Are Main Contractors and Subcontractors obligated by statute to provide them and can we request Collateral Warranties be provided retrospectively?

The risk of not having a collateral warranty in place is primarily that reliance will need to be placed on the contractual relationships which are already in place – the Main Contract and the Subcontractors. Collateral warranties should be considered as being part of the security package for a project – provided the Main Contract and its supply chain continue to trade then there is no reason why they should be considers as being ’necessary’ – perhaps ‘desirable’ is a better description.

There is no reason why collateral warranties cannot be requested retrospectively, but the contractor would be under no obligation to provide them and in such circumstances it would not be unusual for a monetary value to be attached to their provision. This is not unreasonable, since the Contractor is providing the warrantee with a benefit; effectively the right to pursue him directly for a remedy in the event of any issues with the building or warrantied work and it is proper that this has a value.

Collateral Warranties are not the only method of securing performance or remedies, there is the usual statutory frameworks (e.g. The Limitation Act 1980; the Contracts (Rights of the Third Parties) Act 1999, etc); the attraction of the Collateral Warranty is the creation of the direct contractual relationship.

About Paul Heming

Paul was a Quantity Surveyor who gained 10 years experience of managing £200 million worth of flagship UK projects, including 20 Fenchurch Street and Battersea Power Station. In 2015, Paul founded C-Link with the intention of sharing his expertise of managing major projects with the SME market.