Is latent defects insurance better than a collateral warranty?

Any homebuyer will want to know that their house has been built to the best possible standards, and any developer or builder will want to make sure their liabilities to buyers and lenders are covered by the appropriate insurance policies.

Neither wants the building to develop defects, but this is always a risk in construction work. That’s why it’s essential to have the right cover in place in case a claim needs to be made for repair costs.

However, the right insurance for the project depends on the type and extent of cover each party requires. There are cases when latent defects insurance may be better than a collateral warranty, and cases when both might be necessary.

These two policies shouldn’t be treated as the same thing, so you’ll need to know the differences and the pros and cons of both to decide which is the most appropriate option.

What are collateral warranties?

A collateral warranty is a contract in which a consultant or contractor warrants that they have carried out their services to a specific standard to a third party – usually the buyer of the property. They are typically used in larger, more complex projects with many parties involved.

Typically, only the named parties specified in a contract can legally enforce the obligations stated in the terms, which offers them protection against unexpected claims by third parties.

However, when another party should have the right to sue for non-compliance with the contractual responsibilities – such as the buyer or investor, who could lose money and potentially the building itself – the named parties may wish to extend the contract with a collateral warranty naming the third party and their rights to recover related losses.

If a defect does occur against the standards warranted, the third party beneficiary then has a contractual right to seek compensation, backed by the warrantor’s professional indemnity insurance. This could be a developer, buyer, tenant, investor, or lender – but they would have to legally prove that the warrantor breached the contract terms to claim damages for contractual negligence.

As a type of sub-contract or contract extension, a collateral warranty will be linked to the primary contract of the warrantor and run alongside it. It will specify exactly what the warrantor agrees to do and what the third party can claim against if these obligations aren’t met.

Collateral warranties are quite complicated and require a lot of paperwork, which can be costly and time-consuming. They’re also non-transferable, and claims may not be possible if the warrantor goes out of business during the next 6–12 years of the warranty period.

This is why collateral warranties are often considered risky, and those involved with smaller construction projects may prefer latent defects insurance.

How is latent defects insurance different?

Latent defects insurance is another name for a structural warranty, which provides cover against latent structural defects. It can be set up by the developer, builder, or investor, and passed onto subsequent buyers throughout the duration of cover (currently a mandated minimum of 15 years for new build homes).

This is because the policy is assigned to the property and not individual parties, so it stays with the building until it expires or is upgraded (for example, if the property is later refurbished with structural alterations or converted for a different use).

Rather than worrying about identifying a responsible party and proving liability, if a named structural defect is found and a successful claim made to the insurer, then the repair costs should be paid out to the property owner by the warranty provider. No fussing over establishing fault or chasing a company that may be insolvent or no longer have professional indemnity cover.

This involves less paperwork and hassle than a collateral warranty and often has a longer period of cover, but latent defects insurance also requires an upfront investment to set up. The latter also may not cover mechanical and electrical defects, concerning load-bearing structural components only.

However, most structural warranties cover up to the total cost of replacing the structure, and part of the process involves chartered surveyors inspecting the construction quality for regulatory compliance. This offers further reassurance that the risks of inherent structural defects are reduced, and there is a straightforward route for financial recourse if any are discovered after completion.

Of course, this primarily benefits the property owner, but the developer or builder can also benefit from appealing to buyers for an easier sale and passing the policy on.

Does your project need a collateral warranty or latent defects insurance?

A collateral warranty is a good option when there are multiple parties involved in a construction project, and a third party that hasn’t been named in the primary contract would benefit from becoming a named party with the right to seek damages for breaches of contract.

That said, it wouldn’t be recommended alone, as buyers and lenders will be looking for properties with the protection of a latent defects insurance policy – not least because it’s a legal obligation for new builds under the Building Safety Act (2022).

So, while collateral warranties aren’t always necessary or suitable, latent defects insurance policies almost always are. They can be tailored to the circumstances of a particular build, and will reassuringly stay with that building for the remainder of the policy term.

At Architects Certificate, we help many different parties with many different properties to set up collateral warranties and structural warranties to suit their needs. Contact us today to find out how your project would benefit from either or both of these policies.