A Collateral Warranty is an agreement between a consultant or contractor involved in the design and/or construction of a development and a third party, the beneficiary, who acquires an interest in that development. The beneficiary may be a purchaser or tenant of all or a part of the development or a bank or other company providing finance for the development.
The purpose of a Collateral Warranty agreement is to create a contractual link between the beneficiary and the consultant or contractor involved in its design and construction. Under the English law of negligence, as it has developed over the years, the end-user of property who suffers economic loss because of defects that are due to negligence on the part of the builder or designer, is unlikely to be able to recover any damages if he sues that builder or designer for negligence. However, by having a collateral agreement between the designer or builder and the end-user, this problem is overcome - the beneficiary can sue the designer or builder under the collateral agreement on the grounds that there has been a breach of contract.
Collateral Warranties are unlike most contracts, in that the two parties to the collateral agreement do not have any real commercial relationship. Indeed, it is unlikely that they will ever speak to each other. The beneficiary, under his agreement with the developer is likely to have a requirement for collateral warranties. That requirement is imposed on the consultant or contractor in his contract with the developer.
The precise terms of the Collateral Warranty agreement are usually negotiated amongst the lawyers for the various parties.
Over time the wording of warranty agreements has been developed and our form is in line with current developments in the English legal market.
Consultants and contractors maintain professional indemnity insurance to cover their potential liability in negligence. It is therefore usual for a consultant or contractor, when presented with a Collateral Warranty, to refer that document to his insurance brokers. It is important for all parties that the wording of the Warranty is acceptable to the insurers so that, if a claim does arise, the insurers will be there to meet the claim - up to the insured limit which sometimes, but by no means always, is also the limit of the consultant/contractor’s liability under the Collateral Warranty agreement.
One further general point: a Collateral Warranty agreement is usually executed as a “deed”. Under English law, a document, which is executed as a deed, differs from an ordinary agreement in two respects. Firstly, the limitation period - i.e. the time after a breach of contract has occurred within which one party can sue another - is 12 years, as opposed to 6 years for an agreement which is executed “under hand”. Secondly, whereas under English law consideration is needed for a contract to be effective, that is not the case with a deed.
There is more information on deeds in our free note at this address: http://www.contractstore.com/signing_contracts
Whenever the consultant firm entering into the agreement is a partnership, we suggest that an extra clause is added to the Agreement stating: "Where the Consultant is a partnership, all the partners from time to time are jointly and severally liable for the obligations of the Consultant under this Agreement." In addition, the Agreement should be signed by all the partners unless one or more partners are formally authorised to sign on behalf of the partnership. In that case the attestation clause at the end will need to be modified.
Turning to the specific terms of the agreement:
DATE. This will be the date upon which it is executed by all the parties.
PARTIES. The Consultant who gives the warranty - sometimes known as the warrantor - will be one party and the beneficiary - the purchaser, funder or tenant of the development - will be another. In our document we have also provided for the developer to be a party but this is only required if clause 9 applies. See our comments under clause 9 below.
This clause will need to be completed with a brief description of the development, and the Services.
The “Appointment” is the contract between the Developer and the Consultant to which this agreement is collateral and the date of the Appointment should be specified. Since the obligations of the Consultant under this agreement parallel the obligations of the Consultant under the Appointment, the beneficiary should always ask to see a copy of the Appointment and it is not unknown for a copy to be attached to a Collateral Warranty agreement. If, for example, there are restrictions on the Consultant’s liability in the Appointment, that might affect the rights of the beneficiary under the Collateral Warranty.
“Insured Sum” and “Insurance Period” relate to the professional indemnity insurance being maintained by the Consultant - see clause 4. The insurance period will usually be 12 years from the date of completion - see the comments above concerning a deed.
In this clause, the Consultant gives warranties to the beneficiary that it has exercised and will continue to exercise reasonable skill and care in its obligations to the developer under the principal contract.
Clause 2.1 is broken into 2 parts, Clause 2.1.1 which imposes a duty of care on the Consultant, and clause 2.1.2 which has a warranty with regard to the Consultant's obligations under the Appointment.
Clause 2.2 makes it clear that the Consultant’s liability to the beneficiary is no greater than the Consultant’s liability to the Developer under the Appointment.
Clause 2.3 is usually referred to as a "net contribution clause" and designed to protect the Consultant against a quirk of the legal system. In the absence of such a clause, if, say, the architect and structural engineer are each held to be responsible for 50% of the damages arising out of their respective negligent actions, and the architect had became bankrupt or ceased to exist, then the structural engineer would be liable to pay 100% of the damages to the Beneficiary. This clause is designed to limit that risk for the Consultant. Not all beneficiaries accept it but consultants' insurers will usually insist on it being included - unless it is already in the underlying appointment, in which case the wording of clause 2.2 should be sufficient on its own without 2.3.
3. DELETERIOUS MATERIALS
It is usual to have a clause separate from the general warranty obligations, under which the Consultant gives a warranty that it will not specify for use materials, which are generally known to be deleterious to health and safety.
We have incorporated a deleterious materials clause because a beneficiary or developer will expect to see one. In truth, however, it is arguable that there is little point in such a clause. For a consultant to specify unsuitable materials is most likely to be failure to exercise reasonable skill and care on the part of the Consultant and, therefore, covered by the wording of Clause 2.1.
It is usual for a beneficiary under a Collateral Warranty agreement to have a right to use designs and other documents prepared by the Consultant but only in connection with the development for which those design documents are prepared. Copyright is nonetheless retained by the Consultant. Sometimes a consultant will want wording which expressly prohibits the beneficiary from using design documents for any extension to the development.
Under clause 4.3, the beneficiary has to pay for copies of any drawings and documents, which it may request.
5. INDEMNITY INSURANCE
This clause imposes on the Consultant an obligation to maintain professional indemnity insurance during the design and construction period and until the risk of legal proceedings against him has passed - i.e. for the limitation period which is specified in clause 1. As already mentioned, this is usually a period which commences with the contract and ends 12 years after completion. (In this connection, the terminology used in the building contract - “Practical Completion” or “Taking Over” should be used in the Collateral Warranty agreement to avoid any inconsistency.)
If the Appointment is not in itself executed as a deed, the limitation period under that contract will not exceed 6 years. In those circumstances, the same period should apply in the Collateral Warranty agreement.
Clause 5.3 contemplates the possibility of professional indemnity insurance ceasing to be available at commercially acceptable rates. It does not say what will happen except that the parties will meet to try to resolve the matter amongst themselves.
6. ASSIGNMENT & THIRD PARTY RIGHTS
Although a modest little clause, the wording of an assignment clause in a Collateral Warranty agreement can generate a lot of argument. The main reason for this is because professional indemnity insurers like to limit their risks by imposing obligations on the Consultants who take out insurance with them. The standard practice nowadays is to allow the benefit of a Collateral Warranty agreement to be passed on twice by the beneficiary. Usually this will occur when the beneficiary is an owner or tenant and wants to sell his interest.
In clause 6.1 the words "not to be unreasonably withheld" may be resisted by consultants and their insurers - hence they are in italics as an option.
Clause 6.3 states that the Contracts (Rights of Third Parties) Act 1999 does not apply. There is a certain irony here: that Act was introduced to enable a third party in certain circumstances to have the benefit of a contract made between two other parties in which the third party has an interest - i.e. the end-user of a development such as the one contemplated here. Sadly, English solicitors generally take the view that it is better to continue with the use of Collateral Warranty agreements rather than take advantage of this new legislation, which could dispense with the need for those agreements! Having said this, where a collateral warranty agreement is entered into, there is little point in having undefined third parties getting any benefit.
This is a standard provision and needs no comment.
8. LAW & JURISDICTION
We have specified that English law governs this agreement and that the English courts will have jurisdiction. Collateral Warranties, thanks to the spread of English lawyers around the globe, are being used in other jurisdictions. However, if some law other than English law is to apply, care should be taken since the form of Collateral Warranty which we have provided is designed for use in England and may not be appropriate elsewhere.
9. STEP-IN RIGHTS
This clause, as indicated, is usually only appropriate when the beneficiary is providing finance for the development. In those circumstances, if the developer fails to pay the Consultant, the beneficiary is likely to want to step in and take over the development. Clause 9 has the effect of varying the terms of the Appointment by requiring the Consultant to give notice to the beneficiary before he terminates the Appointment. The beneficiary then has the right to take over the developer’s role under the Appointment and an obligation, under those circumstances to pay the Consultant any money that is outstanding.
Consequently this clause has a potential benefit for the Consultant: a lending bank may rescue it if the developer becomes bankrupt. As will be seen, there are strict time limits contained in the clause and the beneficiary does not have any obligation to step in - only the right to do so.
As the effect of this clause is to vary the Appointment, it is important that, when the collateral warranty agreement contains such a clause, the developer should be a party to that agreement in order for clause 9 to be effective.