Using Collateral Warranties in Construction Projects
Construction projects typically involve numerous parties beyond the project owner and the main contractor. Most of these parties do not have contractual links with each other.
Collateral warranties are common in construction operations to confer some benefits and consequent rights of enforcement on interested parties who would otherwise have no protection at law.
Explaining Collateral Warranties: Who Benefits?
A collateral warranty is a promise contained in an agreement made by a contractor, subcontractor, or other professional party to perform certain obligations under a building contract, referred to as the underlying contract.
Collateral warranties create a direct contractual link for these parties who would otherwise have no recourse in law to a remedy other than via negligence; this requires proving a duty of care and limits the available damages.
What Is a Collateral Warranty?
Collateral warranties benefit those who are not a party to the construction contract but who have an interest in it. It offers reassurance that the contractor will meet their obligations under the main contract and provides the option of enforcement if they fail to do so.
A third party adversely impacted by breach of a contract to which they are not a party usually has no contractual relationship. In English law, only signatories to a contract can enforce its terms; this is called privity of contract.
Collateral warranties bridge the contractual gap.
Who Can Be the Beneficiary and What Rights Do They Have?
Beneficiaries include sub-contractors, investors, purchasers, tenants, and professional consultants who have a clear interest in the project but were never parties to the original contract.
The person giving the collateral warranty (the warrantor) warrants to the beneficiary that they will or have complied with the construction contract. This confers on the beneficiary the right to make a contractual claim if they breach the terms of the agreement.
Assessing Whether Collateral Warranties Are Construction Contracts
Construction contracts confer certain rights under ‘the Construction Act’, the short name for the Housing Grants, Construction and Regeneration Act 1996, one of which is the right to adjudicate.
Adjudication is desirable in a construction dispute as it’s typically cheaper and quicker than arbitration or litigation.
The question of whether a collateral warranty is a construction contract within s. 104(1) of the Construction Act has been recently considered in the case of Abbey Healthcare (Mill Hill) Ltd v August 2008 LLP in the Supreme Court.
The Supreme Court decision was that a collateral warranty is not a construction contract for the purposes of the Construction Act, meaning that there is no statutory right to adjudication.
The court described the collateral warranty in this case as an ‘entirely derivative promise’, making the distinction between warranties which replicate undertakings already present in the building contract, and those which create separate undertakings within the construction operations.
What Counts as a Construction Contract Under the Act?
Section 104 of the Construction Act defines a construction contract. It is any agreement with a person to carry out construction operations or to arrange to carry out construction by others, including providing labour.
Section 105 of the Act defines construction operations very broadly, including all kinds of associated activities surrounding the development of land and buildings, including repair, restoration, and extension. It also covers internal works.
There are noted exclusions. For example, a contract of 45 days or less in duration is not considered a construction contract under the Act, nor are contracts for residential occupiers, such as a house extension.
Adjudication Rights Under Collateral Warranties
There is no right to statutory adjudication under collateral warranties for third parties, such as tenants, purchasers, and investors, unless specific and express drafting permits it.
If there is a breach of obligations under a collateral warranty, beneficiaries may only seek redress via a breach of contract claim heard in the courts.
New collateral warranties can be drafted to confer the express contractual right to adjudicate, with a similar process to statutory adjudication.
The Supreme Court, in its judgement, stated that a construction contract as defined in the Construction Act was never intended to cover collateral warranties when it was drafted.
Commentators have suggested that the Supreme Court judgement achieved the clarity which Parliament originally intended in the 1996 legislation: that collateral warranties should not fall within the scope of the Act.
Right To Adjudicate Under the 1996 Act
The 1996 Act confers a legal right to adjudicate for any party to a construction contract using an independent adjudicator. The adjudicator’s decision is legally binding.
Adjudication is designed to complete within 28 days, making it the ideal vehicle for the construction industry, which can be fraught with delays.
There are strict timelines governing adjudication as set out in the Construction Act. From the point of issue of the Notice of Adjudication, the adjudicator must reach a decision within 28 days, and there is no leeway on this.
Whilst an ideal alternative to litigation for urgent matters, it’s not the best route for complex problems. These tend to fare better in arbitration, which is a more comprehensive and detailed process.
Practical Drafting and Risk Management for Collateral Warranties
Collateral warranties are a vital safeguard for third parties in the construction industry. They should contain the specific responsibilities and duties of the contractor or consultant and align with the terms of the main contract.
The idea is to protect the interests of both parties by defining the obligations and assurances the warrantor is providing to the beneficiary in a clear and enforceable framework.
Careful drafting is vital to avoid the risk of exposing the warrantor to extra obligations over and above those contained in the underlying contract. This risk is often contained by using a ‘no greater liability’ clause, for the avoidance of any doubt.
Key Drafting Features To Include
Performance Obligations
A commitment made by the warrantor to complete the project in line with the terms of the underlying contract.
Assignment or Step-In Rights
Assignment rights allow the beneficiary to assign the warranty to someone else, usually without the warrantor’s consent. This is important if ownership of the property changes so that enforcement rights remain intact.
Non-Variation Clause
This prevents the warrantor from changing, waiving, or supplementing the terms of the original contract without the written agreement of the beneficiary, protecting their position.
Insurance Requirements
The warrantor is obligated to take out and maintain professional indemnity insurance for a set period, which can be as long as twelve years from the date the project completes. This protects the beneficiary against defects during that period.
Third-Party Rights and Enforcement in Collateral Warranties
As an alternative to collateral warranties, which can be time-consuming and expensive to set up, Third-Party Rights (TPRs) can be made available within the original construction contract.
TPRs allow third parties to enforce certain terms of the contract without the need for a separate agreement (collateral warranty).
They are based on the Contracts (Rights of Third Parties) Act 1999, which allows third parties to benefit from and enforce the terms of a contract to which they are not a party.
TPRs and collateral warranties come from two different directions. TPRs must be embedded in the original construction contract, whereas collateral warranties are separate documents that align with the contract but are not otherwise connected.
Comparison: TPRs vs Collateral Warranties
The construction industry is more familiar with enforcing the rights of non-contractual parties via collateral warranties, so these are more popular.
A separate signed agreement is perceived as defining and assuring the rights of beneficiaries more distinctly and effectively.
What This Means for Your Project and Next Steps
It’s vital to protect your position and rights if you’re benefiting from a construction contract to which you are not a contractual party.
Third parties and beneficiaries must insist on protection from a collateral warranty, which should have a scope that mirrors the original contract, step-in rights, and mandatory insurance. It should also contain the right to adjudication.
Project owners and beneficiaries/third parties on either side of the table need practical and expert legal advice to protect their positions when creating a collateral warranty.
When To Seek Expert Advice
Construction law is a specialised area governed by complex rules and case law that continues to evolve. Consequently, specialist advice is vital at all stages of the project, particularly given that some developments can span several years.
Frequently Asked Questions
How Long Does a Collateral Warranty Last?
The terms of a collateral warranty should specify the duration of validity. The liability period is usually the same as the underlying contract, either expressly or because the warrantor will have no greater liability generally under the agreement. Most collateral warranties are executed as deeds, so the limitation period runs for 12 years.
What Is a Collateral Warranty Between Client and Architect?
A collateral warranty between a client and architect creates a direct contractual link, allowing the client to ensure the architect fulfils their obligations under the original construction contract. This protects the client’s rights as they will have no control over the architect’s work, allowing them to enforce the obligations of the contract if the work is defective.
Ready To Contact Helix Law for Expert Legal Advice?
The law surrounding construction projects reflects their complexity and duration. There are commonly multiple parties who can be affected by contractual delays and defaults, who would otherwise have no recourse in law to a remedy.
Collateral warranties are a vital part of the project process. Still, they require careful drafting to protect third parties and beneficiaries, and to ensure that project owners are not exposed to a more onerous liability than that contained in the original contract.
For specialist help and practical advice from the first brick in the ground to cutting the ribbon, get in touch with Helix Law today.
