What is a Collateral Warranty?

A Collateral Warranty is a contract under which a consultant (such as a surveyor or architect) warrants to a third party (such as a lender, landlord, or buyer) that they have complied with their duties under a building contract. It is not a defects liability warranty or project guarantee.

Essentially, a Collateral Warranty is a supporting document, used when it’s necessary to make an agreement with a third party who is not involved in the primary contract. These are ‘beneficiaries’ like financial providers and tenants, who otherwise have no contractual links to the consultant.

Without a Collateral Warranty in place, such third parties have no legal right of recourse against the consultant or contractor if something goes wrong with the building. This means that they cannot claim to recover financial losses if the surveyor or builder did not uphold the primary contract.

What’s the difference between a Collateral Warranty and Structural Warranty?

A Structural Warranty ensures liability for structural defects for at least 10 years after completion. It’s a straightforward and simple process to makes claims under this type of warranty, and it doesn’t matter if the liable party has professional indemnity insurance or not or how many claims you make.

By contrast, Collateral Warranties do require professional indemnity insurance for the period of the warranty (up to 12 years). Claims require proof of negligence for the liable party, which can be costly and time-consuming to obtain. The type and number of claims may also be limited in the contract.

Structural Warranties also continue to protect the claimant even if the liable party goes out of business, whereas Collateral Warranties do not. A Collateral Warranty is a kind of sub-contract that extends the responsibilities of another contract, rather than a self-sufficient contract in itself.

Why would you need a Collateral Warranty?

As explained, only the parties mentioned in a contract are able to enforce the obligations within it and exercise the right to sue for failure of contractual responsibilities. This protects those involved from unexpected third party claims – but in some cases, a third party should have the right to claim.

This is where Collateral Warranties come in. It takes away the risks of speculative lending for banks and protects buyers and tenants who own and/or live in the property. The Collateral Warranty will provide the third party with the right of redress to recover losses from contractual negligence.

As sub-contract types, Collateral Warranties usually contain statements confirming that the contractor has diligently designed the project, completed work skilfully using appropriate quality materials, and maintained adequate insurance policies as per the original building contract.

A word of caution about Collateral Warranties

You should be aware that a Collateral Warranty is NOT transferable in the way that a Professional Consultant Certificate (PCC) is. Therefore, we always back up the Collateral Warranty with the PCC for each property within the project. This type of structural assurance is transferable to the future purchasers of the dwelling. Without it, the property is not secure enough for a loan or mortgage.

Collateral Warranties must be totally consistent with the underlying contract that they relate to. The warranty will not be valid otherwise. This is why arranging and executing a Collateral Warranty can be expensive and lengthy process that most in the construction industry are not particular fans of.

However, those who are investing money into projects – whether employers, funders, or buyers – can recognise the value of a well-drafted Collateral Warranty that can protect their investment. For more information about Collateral Warranties for your building project, get in touch with our team.

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When is a 12 Year Collateral Warranty needed?

In some circumstances, a third party may require a Collateral Warranty for a contractual link to the builder/consultant’s main contract. An employer might want a direct link to a subcontractor, or someone who provides funding for the contracted work may want to protect their investment.

When you need to extend a contract to establish a contractual relationship and the associated legal rights and responsibilities, then a Collateral Warranty can run alongside the original contractual agreement. It’s usually taken as a security measure to ensure that all obligations are fulfilled.

Without a Collateral Warranty, third parties may find the risk too great to work with the original contractors. This could mean losing out on funding and delaying stages of the project, which nobody wants. The Collateral Warranty will expressly confer rights to other individuals and businesses.

What does a 12 Year Collateral Warranty cover?

Most Collateral Warranties follow a standard format, but bespoke Collateral Warranties can be drafted if required. Generally, a Collateral Warranty will contain key clauses like the following:

  • Consideration – something of value that the party is not already entitled to in exchange for contractual promises
  • Principal covenant – the subcontractor/consultant warrants that they have performed their duties in compliance with the underlying contract
  • Step-in rights – allowing the beneficiary to ‘step in’ to the contractor’s place and take over the project if they’re unable to do so
  • Copyright – giving parties the right to use information generated by the project
  • PI insurance – ensuring that the subcontractor/consultant has professional indemnity insurance for the full duration of the warranty
  • Liability period – specifying the warranty length (12 years if executed as a deed and 6 years as a regular contract)
  • Assignment – setting restrictions (if any) on the third party’s abilities to claim under the warranty

For the principal covenant, it’s important to note that this is only as strong as the terms specified in the original appointment. If it doesn’t explicitly state their duties of care, this will limit the warranty.

What are the limitations of 12 Year Collateral Warranties?

Of course, the contractors will want to limit their liabilities under the Collateral Warranty. They normally do this by including ‘no greater duty’ or ‘equivalent rights defence’ clauses. These specify that no duties are owed other than those mentioned, and that the defending party can use anything available in the contract against a warranty claim. They’ll also try to limit what can be claimed.

Normally, the third party is entitled to recover the total losses from one contractor, who is then responsible for recovering anything above their ‘share’ from the other liable parties. With a ‘net contribution’ clause, the amount that can be recovered from one party is limited to their ‘share’.

These can be a hard sell during warranty negotiations, as there is always a risk that a contractor could go out of business and no longer be liable, leaving the other parties to cover the claim costs. Contractors may also request to limit claims to what their professional indemnity insurance covers.

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