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 or a bank or other company providing the finance for the development.
The purpose of a Collateral Warranty agreement is to create a contractual link between the beneficiary and a consultant or contractor involved in its 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. 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.
In this case, the warranty agreement is being given by a subcontractor of the main contractor for the development. As much of the work on a development is subcontracted by the developer's main contractor, it is common for the most important subcontractors, in particular those with a design responsibility, to be asked to provide a collateral warranty in favour of a third party purchaser etc. It is also quite common for the developer himself to require a warranty from those subcontractors: the existence of the warranty agreement gives the developer a right of recourse directly against the subcontractor for negligence as well as the opportunity to step into the shoes of the main contractor and take over the subcontract, in the event of the main contractor's insolvency
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. This requirement is then imposed on the consultant or contractor in his contract with the developer. And the contractor will pass down the obligation to those of his subcontractors who may be required to provide a collateral warranty.
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 broadly 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 contractor/consultant’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.
For a company to execute a deed effectively, the document must be signed by two directors or a director and the company secretary, unless the Articles of Association contain some other requirement.
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 subcontractor who gives the warranty - sometimes known as the warrantor - will be one party. The "Beneficiary" will be either the employer under the main contract - i.e. the developer - or a purchaser, funder or tenant of the development . In our document we have also provided for the main contractor 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 various details, including a brief description of the development, and of the subcontract works. The “Subcontract” is the contract to which this Collateral Warranty agreement is collateral and the date should be specified. Since the obligations of the subcontractor under this agreement parallel his obligations under the subcontract, the beneficiary should always ask to see a copy of the contract and it is not uncommon for a copy to be attached to a Collateral Warranty agreement. If, for example, there are restrictions on the subcontractor’s liability in the subcontract, 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 subcontractor - 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 subcontractor gives warranties to the beneficiary that it has exercised and will continue to exercise reasonable skill and care in its obligations to the contractor under the subcontract.
Clause 2.1 is broken into 3 parts, Clause 2.1.1 imposes a duty of care on the contractor. Clause 2.1.2 contains a warranty with respect to design. Clause 2.1.3 has a specific warranty with regard to the obligations under the subcontract.
Clause 2.2 makes it clear that the subcontractor's liability under this agreement is no greater than that under the subcontract.
3. DELETERIOUS MATERIALS
It has become fashionable to have a clause separate from the general warranty obligations, under which a contractor gives a warranty that it will not specify or use materials, which are generally known to be deleterious to health and safety. For many years, it was usual to have a long list of prohibited substances in the agreement and this is still not uncommon. However, reliable authorities nowadays recommend that only a short clause with general words, such as this one, should be adopted.
We have incorporated a deleterious materials clause because a beneficiary or developer will expect to see one. It is, however, arguable that there is little point in such a clause. The use of unsuitable materials is most likely to be failure to exercise reasonable skill and care on the part of the subcontractor and, therefore, covered by the wording of Clause 3.1. In addition, the use of deleterious materials may contravene relevant legislation or regulations even if it is not expressly prohibited in the subcontract.
It is usual for a beneficiary under a Collateral Warranty agreement to have a right to use designs and other documents prepared by the subcontractor but only in connection with the building for which those design documents are prepared. Copyright is retained by the subcontractor.
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 subcontractor an obligation to maintain professional indemnity insurance during the 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. This is usually a period which commences with the subcontract and ends 12 years after completion of the main contract. (In this connection, the terminology used in the main contract - “Practical Completion” or “Taking Over” should be used in the Collateral Warranty agreement to avoid any inconsistency.)
If the subcontract is not 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 - otherwise the subcontractor would have a greater liability to the beneficiary under this document than he would to the contractor under the principal contract.
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.
N.B. Not every subcontractor maintains professional liability insurance and in that case the clause may have to be omitted. Alternatively, if the subcontractor is a supplier of plant or equipment, it may have product liability insurance, in which case the clause can be adapted to refer to it instead of professional indemnity insurance.
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 restrictions in their policies. 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 insurers - hence they are optional.
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 only appropriate when the beneficiary is the developer. In those circumstances, if the main contractor becomes insolvent or if the subcontractor wants to terminate his contract, the developer may want to take over the subcontract from the contractor so that the subcontract works can continue without interruption. Clause 9 has the effect of varying the terms of the subcontract by requiring the subcontractor to give notice to the contractor before he terminates the subcontract. The beneficiary then has the right to take over the contractor's role under the subcontract and an obligation, under those circumstances to pay the subcontractor any money that is outstanding.
Consequently this clause has a potential benefit for the subcontractor: the developer may rescue it if the main contractor 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 clause 9 is to vary the subcontract it is important that, when the collateral warranty contains such a clause, the contractor should be a party to that document in order for the clause to be effective.