How do collateral warranties work?

Collateral warranties are used to extend the provisions of a contract to other parties who have an interest in the outcome of the contract’s performance. This is common in the construction industry, where various contractors, sub-contractors, and consultants can be involved in one project, and the primary developer needs to limit their future liability.

While it may be familiar term to people working in real estate and construction, not every contract comes with a collateral warranty as standard, so not everyone is aware of this type of warranty and what it does. If you’re wondering what exactly a collateral warranty is and how it works, this blog is here to answer your pressing questions.

What are collateral warranties for?

A collateral warranty supplements an existing contractual agreement by extending it to a third party who would otherwise have no legal link to one or more parties in the original contract. Essentially, it’s a contract that runs alongside an existing contract to create a new contractual relationship.

These warranties are often used when there is no building warranty or other policy that would give the third party a similar level of legal recourse if the originally contracted parties failed to uphold the agreement. The collateral warranty allows buyers or tenants to hold the other parties liable.

These policies enable the consultants, contractors, or sub-contractors involved to warrant that they have delivered the required standards of work, not only to the developer or primary responsible party, but also to the owner or tenant who buys or rents the completed property from them.

Then, if a defect becomes apparent and the buyer or owner suffers losses as a result of those workers failing to comply with the contracted standards, the policy allows the third party to make a claim against them for negligence. Without a collateral warranty, it would be very difficult or impossible for the affected party to recover such losses through a court of law.

Who benefits from collateral warranties?

The various professionals involved in completing a construction project will enter into contracts with each other detailing their individual duties and mutual obligations. However, to cater to the third parties who will have an interest in the finished project, the lead party may require the consultants and contractors they work with to also provide collateral warranties.

The beneficiaries of collateral warranties are usually the buyer, tenants, or lenders who funded the building or development. The third party doesn’t have to be an individual – for example, it could be a group, management company, venture partner, sponsor, or facility operator. The employer also benefits, as they can pass liability for faults on to the responsible contractor.

Parties asked to provide a collateral warranty may be wary of doing so, as it could seem like they are opening themselves up to extensive liabilities on top of their existing business responsibilities. This isn’t the point of such warranties, however – a collateral warranty provider only does so to ensure continuity in case of unforeseen eventualities, and beneficiaries can be limited to specified parties.

What is included in a collateral warranty?

As the policy warrants to a third party that the holder will fulfil the obligations of the original contract, a collateral warranty is only as reliable as the underlying contract, and cannot exceed those terms or liabilities. Key clauses that collateral warranties should include are:

Duty of care – stipulation to fulfil the obligations of the primary contract with the expected level of skill and care and reasonable diligence.
Fitness of materials – agreement to only use materials that are appropriate for the design and purpose (may specify which materials are considered ‘deleterious’).
Copyright licence – granting of intellectual property rights to the other party (use of plans, drawings, calculations, or other documents produced by the warrantor).
Indemnity insurance – obligation to uphold a set level of professional indemnity insurance for a set number of years (typically the entire duration of the warranty).
Liability – specifying the extent of the warrantor’s liability, including the start and end date, circumstances entitling third party claims, and financial caps for claims.
Right to assign – agreement on whether the beneficiary can assign the policy to another party and under which conditions (commonly allowing up to two future buyers or renters).
Step-in rights – provision or denial of the beneficiary’s right to ‘step in’ to the primary contract and instruct the warrantor directly.

This is not exhaustive nor the default, but it should give you an idea of what to expect from a collateral warranty. Rather than accepting a generic agreement, collateral warranties are normally tailored to suit the needs of a particular beneficiary and the circumstances of the specific project.

How long do collateral warranties last?

Most collateral warranties will have a ‘no greater liability’ clause, meaning that the warranty will not be liable for longer than the underlying contract specifies. As many such contracts are executed as deeds, which are generally enforceable for up to 12 years, the warranty is also likely to have a limitation period of 12 years.

A collateral warranty is also likely to specify that claims can only be commenced within 12 years of the construction project’s completion date – not within 12 years of the defect being discovered or identified. While this is a similar term to that of a structural warranty, a collateral warranty is much more limited regarding transfer and claim capabilities during this period.

Collateral warranties are usually arranged between the developer and contractor before work commences, but in some cases, it may be possible to arrange the policy retrospectively. The caveat is that with fewer inspections during the construction process, the warranty’s financial cap is likely to be lower and the cost higher – and it could also increase the holder’s indemnity insurance premiums.

Should you get a collateral warranty?

While it’s not legally required to set up a collateral warranty, you may feel commercial pressure to do so as a contractor, sub-contractor, or consultant. Rather than feeling forced into an additional contract you’re not sure about, taking the initiative to arrange your own policy that meets your needs in addition to those of the beneficiaries can help you to design and build with confidence.

At Architects Certificate, we are trusted providers of a range of warranties, including a reliable 12-Year Collateral Warranty. Our team would be happy to discuss which warranty is most suitable for you and your construction project, so don’t hesitate to contact us by phone call, WhatsApp message, or email for more information or to request a quote.