A Collateral Warranty is a supplementary 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 as specified under the original contract. It is not a defects liability warranty or project guarantee.
Essentially, a Collateral Warranty is a supporting document, used to make an agreement with a third party who is not involved in the primary contract. These are ‘beneficiaries’ like financial providers, buyers, and tenants, who would otherwise have no contractual links to the consultant hired by the developer or builder.
Without a Collateral Warranty in place, third parties like these would have no legal right of recourse against the consultant or contractor if something went wrong with the building. This means that they cannot claim to recover financial losses if the surveyor or builder does not uphold the primary contract.
What’s the difference between a Collateral Warranty and Structural Warranty?
A Structural Warranty allows compensation claims for structural defects for at least 15 years after completion. Making claims under this type of warranty is a straightforward and simple process, and it typically 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 the contractor to maintain a specified level of professional indemnity insurance for the period of the warranty (up to 12 years). Claims also require proof of negligence by the liable party, which can be costly and time-consuming to obtain. The contract may also limit the type and number of claims.
Structural Warranties can also protect the claimant even if the liable party goes out of business during the policy term, whereas Collateral Warranties do not. This is because 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 the other party 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. This type of policy will provide the third party with the right of redress to recover losses from contractual negligence. It reduces the risks of speculative lending for banks, and protects buyers and tenants who own and/or live in the property.
As sub-contracts, Collateral Warranties usually contain statements confirming that the contractor has diligently designed the building project, completed all 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) or Structural Warranty is. Therefore, we recommend backing up the Collateral Warranty with a PCC or Structural Warranty for each property within the project. This type of structural assurance is transferable to the future purchasers of the dwelling. Without it, the property will not be secure enough for a loan or mortgage.
It’s essential for Collateral Warranties to be totally consistent with the underlying contract that they relate to. The warranty and any attempts to claim under it will not be valid otherwise. This is why arranging and executing a Collateral Warranty can be an expensive and lengthy process that many in the construction industry are not fans of.
However, those who are investing money into projects – whether as employers, funders, or buyers – can recognise the value of a well-drafted Collateral Warranty and how it can protect their investment. These warranties can also help sub-contractors to limit their liabilities.
For more information about Collateral Warranties for your building project, get in touch with our team. You can call us on 0161 928 8804, contact us via WhatsApp, or send an email to firstname.lastname@example.org and we’ll answer your queries as soon as possible.
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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.
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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