Collateral Warranties

Nature of Collateral Warranties

Collateral warranties are commonly given in construction projects.  A collateral warranty is a contractual obligation, usually undertaken by a consultant, contractor or subcontractor to a third-party with whom he does not have a direct contractual relationship.  Contractual warranties will typically be required by the terms of the tender.

The contractual warranty provides a link and liability which would not otherwise exist.  It facilitates and makes clear the rights of the beneficiary to enforce against the person giving the collateral warranty.  Collateral warranties remove doubt as to the extent of the duty owed under the law of torts/civil wrongs by a contractor or consultant to third parties.

Collateral warranties may be given to tenants or financers where the development company is a single purpose or insubstantial project company.  For example, a tenant may be obliged to take a lease with a full repairing obligation.  It will typically have entered an agreement for development with a company that may have limited assets or be a single-purpose company.  The collateral warranties will seek to create rights for the lessee against the principal contractor (bypassing his relationship with the developer) significant subcontractors and consultants.

Similarly, financers may wish to have direct rights of enforcement to secure monies advanced for the construction project.  In the case of collateral warrantees with financers, they will typically want rights to step in in cases where the borrower/developer has defaulted.  Step-in rights will afford the lender the opportunity to remedy the breach before the consultant or contractor’s right to terminate the contract exists.  In this case, the lender will have to finance the sums due to the contractor, consultant etc.

In order to have as wide and complete a recourse as possible, the tenant or financer would require collateral warranties from all parties having construction and significant design obligations.  Where subcontractors have significant design responsibilities, collateral warranties may be required from them.  They may or may not have the requisite professional indemnity insurance.

Another type of collateral agreement that may be provided for under a standard contract such as the RIAI contract/collateral agreements by the subcontractor to the employer/developer.  In this case, the collateral agreement is required where the contractor does not have design and construction responsibility for the subject matter of the subcontract.

Content

The form and content of collateral warranties vary considerably.  There are a number of standard forms.  Typically, they provide as follows.

The consultant or the contractor gives assurances or contractual undertakings in favour of the third-party, e.g. lender, tenant etc. that it will perform the obligations in his, her or its appointment or contract. The purpose is to give the beneficiary a right of recourse against the party giving the warranty.

Tenants or financers may require  the consent or license of the consultants to use their drawings, calculations and materials.  This may be relevant to finishing the job or for the purpose of future maintenance or extension.

The collateral warranty commonly requires the party giving it to maintain professional indemnity insurance for a period.  This is generally six or more, commonly 12 years.  This may place an onerous obligation on the consultant and he will generally need to vouch the matter with his insurer.

Commonly there are provisions that certain deleterious materials have not been used in the building.  Generally, such materials would be wholly contrary to building regulations so that the provision is arguably superfluous.

The person giving the collateral warranty will not wish to give any further liabilities when he gives on to the original contract.  On the other hand, beneficiaries will want open-ended liabilities and even indemnities for all losses suffered.  Beneficiaries may seek warranties that buildings etc. are fit for use etc.  The parties giving the warranties will generally be concerned that this may extend their obligations too far.

An important issue is the question of the assignment of collateral warranties.  The beneficiary will wish to be able to assign the benefit of the warrantees to a party to whom he sells or assigns.  He may want to know that that the assignee /recipient can itself assign so that it is commonly sought that there should be a right to two assignments.  On the other hand, the person giving a collateral warranty will not wish to take liability to a succession of owners.

RIAI Collateral Warranties

The RIAI contract provides that collateral agreements in this form published by the RIAI Construction Industry Federation and Society of Chartered Surveyors acting jointly and current at the designated date may be required as in between the employer and nominated subcontractors.  The terms are deemed to be amended and supplemented to entitle the employer to give effect to the terms of the collateral agreement.

Under the relevant collateral warranty, the subcontractor warrants that it has exercised and will exercise all reasonable skill in the design of the subcontract works in so far as they have been designed by the contractor.  It warrants that it has exercised and will exercise reasonable care and skill in selecting materials and goods, where he has so selected them, under the subcontract.  Finally, it warrants the exercise of reasonable care and skill in the satisfaction of any performance specification or requirement in so far as it is included or referred to in the tender as part of the description of the subcontractor’s work.

The employer undertakes to pay the subcontractor directly in relation to both interim and final payments, if the contractor defaults in payment. The collateral agreement provides that the subcontractor is to pay compensation in the event of a termination of the subcontract, including additional costs and re-nomination.  It provides that the tender of the subcontractor shall not contain exclusions or limitations of his liability to the contractor.

The collateral contract may be bonded or guaranteed to protect against the risk of the subcontractor’s insolvency.  The bond would pay up to a percentage of the contract sum only. The main contract may itself be bonded.