Collateral Warranties

When it comes to the construction industry warranties are so important as a way to help cover and progress any disputes happening as part of a project.

In general, it is the parties to a contract that can sue to enforce any rights and obligations under it and because of this parties will not have to worry about any unexpected claims from third parties.

Sometimes, when a third party has an interest in a construction project, such as a funder or tenant, the third party may not be successful in bringing a contractual claim against the person(s) at fault, who have no rights under the relevant contract. We will take a look at third-party rights soon, but first, let us look a bit more in-depth at collateral warranties.

The Importance of Collateral Warranties

Collateral warranties are very critical to building contracts and consultant appointments. For this reason, contracts will often involve a clause which makes the provision of collateral warranties a condition precedent to payment or practical completion being certified.

What is a Collateral Warranty?

A collateral warranty has the purpose of creating a direct contractual relationship between a designer or contractor, with a third-party that has an interest in the building, for example, a funder, purchaser or leaseholder. This set up means an interested third party can pursue the designer and/or contractor in the event of a breach of contract claim in the case of a defective building.

Why are Collateral Warranties Used?

With the considered standing of English law, anyone who has an interest in a building which is defective will have great difficulty in trying to pursue the designer and/or contractor who has the responsibility for the defects if they do not have a contractual relationship with them.

The reason for the difficulty of the above scenario is that if a contract is absent, the only way a designer and/or contractor can be pursued is by bringing a claim in negligence forward.

A solution to the above issue is a collateral warranty which creates a direct contractual relationship between a designer or contractor and the third party with an interest in the building in question, the third party being either a funder, purchaser or leaseholder. If a building does turn out to be defective, the interested third party can pursue the designer and/or contractor for breach of contract claim.

The Importance of Third Party Rights

On the other hand, we have the third party rights act to consider We are talking about the Third Party Rights Act 1999, which allows parties of a contract to allow a third party the right to enforce a term of the contract in question.

What are Third-Party Rights?

Essentially, third party rights allow a third party to enforce a term(s) of a professional appointment, building contact or a sub-contract that otherwise the third party could not enforce.

Why are Third Party Rights Used?

Certain construction solicitors will develop and use their own sets of third party rights in regards to building contracts and professional appointments as there are no universal forms set in stone.

Those exercising third party rights will generally have used one of two methods for their drafts:

a) Maybe the most common option, a stand-alone schedule of third party rights

b) Or a schedule that identifies clauses in the underlying contract that a third party may enforce.

But, remember, third party rights can only be used to give funder rights. With this in mind, the involved parties should be avoided including forms of a step-in right that place obligations on the funder.

Collateral Warranties vs Third Party Rights

So, now we have had an overview of collateral warranties and third party rights, let us look at the pros and limitations of both options.

Most commonly, a collateral warranty will include a ‘no greater duty’ and/or and ‘equivalent rights of defence’ clause. The in greater duty clause entails that the consultant or contractor is not able to owe the beneficiary greater duties under the collateral warranty then it would owe the employer under the professional appointment or a building contract.

Then we have the equivalent rights of defence clause. This details that the warrantor may use any defence under the professional appointment or building contract which it would have against the employer in order to defend a claim from the beneficiary under the collateral warranty.

Now, most collateral warranties include a clause that limits the period during when a beneficiary is entitled to make a claim against the warrantor, usually to a period of 12 years from the completion of the project. It depends on the exact nature of the project, as well as the relative bargaining positions of all parties but other limitations may include ‘a net contribution clause’ which limits the liability of the warrantor to a ‘fair and reasonable’ or ‘just and equitable’ amount or a limit that relates to the types of loss that the beneficiary may recover. In other words, a beneficiary may only be able to claim losses that are ‘reasonable costs of repair, renewal and/or reinstatement’.

One of the reasons why the construction industry may still favour collateral warranties is that they are more familiar within the industry. Many sub-contractors are unfamiliar with third party rights meaning to include such points in a sub-contract often requires additional explanation and negotiation which adds a further cost and time factor to proceedings.

Additionally, a collateral warranty counts as a separate contract between parties to the collateral warranty and while a collateral warranty is a collateral to a specific factor it is a contract in its own right that can be enforced and has benefits that may be assigned on the terms set out in the collateral warranty.

Another consideration lies with a larger-scale project. Say that a sub-contractor has agreed on the third party rights a sub-contractor could still leave the client needing to amend the schedules of third party rights in order to accept collateral warranties.

Even a convenience factor plays its part as procuring collateral warranties from sub-contractors is generally more convenient than trying to include a third party right provision in every sub-contractors.

Finally, it should be noted that The Third Party Rights Act 1999 does not allow a third party to be placed under any obligation to complete something (ie. a burden) and instead The Third Party Rights Act 1999 allows a third party to enforce the benefit of a contract term(s) only.