Every construction project is accompanied by an array of documents. From plans and specifications to permissions and contracts. Some projects are also subject to a collateral warranty.1 Collateral warranties have been around in the industry for a long time. But collateral warranties in construction can be time-consuming and difficult to arrange.2.
Naturally, any uncertainty in construction documentation, including collateral warranties, creates risk. So it is vital that anyone entering into a collateral warranty agreement understands:
A collateral warranty in construction is a contract under which a professional consultant warrants to a third party that they have complied with their professional appointment, building contract or sub-contract.
Professional consultants could be architects, engineers, surveyors or building contractors/sub-contractors. And third parties could be funders, purchasers, or tenants for example.
In essence, a collateral warranty is a way of giving contract rights to a party with an interest in a construction project. Specifically, when they are not provided those rights under the main contract.
Collateral warranties often include obligations that affect the consultant or contractor. For instance, using materials of an appropriate quality and carrying out work in a professional manner.3 What’s more, they give the third-party funder, tenant or purchaser contractual rights. These rights enable them to claim for losses incurred through defective design or construction.1
The role of the collateral warranty in construction is perhaps best illustrated by way of example.
An employer might engage a developer to work on the construction of a new hotel. In turn, the developer appoints a contractor to take on the building work. That developer/contractor relationship is governed by a building contract.1
The issue for the employer in this scenario is that it has no direct contract in place with the contractor.1 So, despite having a development agreement in place with the developer, it is essentially a third party to the building contract. As a result, the employer would have little to no protection in law against any potential losses. For example this would be the case if the contractor makes a mistake during design or construction, resulting in a defect in the completed work.3
In these circumstances, a collateral warranty serves to bridge the gap between the employer and the contractor.1 This gives the employer the right to enforce the original building contract. And they can claim any losses directly from the contractor that caused them.
Similarly, the eventual purchaser or tenant of the hotel wouldn't have a direct contract with the builder. So they would suffer the same lack of contractual protection against defective workmanship. They may seek similar protection against future losses by putting in place a collateral warranty.1
The main purpose of a collateral warranty is to grant a third party a duty of care from a building contractor, professional consultant, or sub-contractor. However, a collateral warranty may specify a range of other provisions, including but not limited to:4
Contractors, sub-contractors, consultants or sub-consultants, whatever the discipline, are legally obliged to grant a collateral warranty if there is an obligation to do so under their main contract/appointment.
Finally, for organisations providing collateral warranties, there are a number of insurance considerations to take into account. A collateral warranty may increase a contractor’s overall exposure to liability. This is because it expands the number of organisations that could make a claim against it. And it also extends the time period after construction that a claim could be brought.
On the one hand, this makes it all the more important to carefully consider collateral warranty wording. For instance, including ‘no greater liability’ clauses and clauses to limit the period covered by the warranty.5
Equally, it is very important to review professional indemnity (PI) insurance arrangements. PI policies pick up design failures and not constructions issues i.e. workmanship. Therefore, it’s important to seek the support of an expert broker, before finalising a collateral warranty. This is to ensure the policy already in place offers sufficient protection.
At Marsh Commercial, our professional indemnity for construction professionals includes a collateral warranty review service (dependent on insurer terms and conditions). This helps ensure our construction clients can enter collateral warranties with confidence. They can be secure in the knowledge that they have appropriate insurance in place.
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