Collateral Warranty Agreement (Contractor) (B142)

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This collateral warranty agreement template is for use where a contractor enters into a direct agreement with a purchaser, tenant or funder of a development. Drafted by a construction lawyer.

This four page document contains 9 clauses covering

  • definitions
  • warranty
  • deleterious materials
  • copyright
  • indemnity insurance
  • assignment & third party rights
  • notices
  • law & jurisdiction
  • step-in rights

The contract is accompanied by Explanatory Notes that explain the background and purpose of collateral warranties as well as dealing with individual clauses in the document.

You need this document if you are a contractor entering into a direct agreement with a purchaser, tenant or funder of a development.

[English law edition]

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Explanatory Notes

INTRODUCTION

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 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.  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.

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 consultants and contractor in their contracts 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 these agreements has been developed and our form is in line with current developments in the English legal market.

Consultants and contractors who undertake any design responsibility 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 that 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: signing contracts.

SPECIFIC CLAUSES

Turning to the specific terms of the agreement:

DATE.  This will be the date upon which the agreement has been executed by all the parties.

PARTIES.  The contractor 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.

1. DEFINITIONS

This clause will need to be completed with a brief description of the development, and the works.   The “Contract” is the contract to which this Collateral Warranty agreement is collateral and the date should be specified.   Since the obligations of the contractor to the beneficiary parallel the obligations of the contractor to the developer under the contract for the works, the beneficiary should always ask to see a copy of the contract.  If, for example, there are restrictions on the contractor’s liability in the principal contract, that might affect the rights of the beneficiary under the Collateral Warranty.  It is not unknown for a copy of the principal contract to be attached to a Collateral Warranty agreement.

“Insured Sum” and “Insurance Period” relate to the professional indemnity insurance being maintained by the contractor – see clause 4.   The insurance period will usually be 12 years from the date of completion – see the comments above concerning deeds.

2. WARRANTY

In this clause, the contractor 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 3 parts, perhaps the most important of which is Clause 2.1.1 which imposes a duty of care on the contractor.  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 contract.

Clause 2.2 makes it clear that the contractor does not have any liability to the beneficiary if it fails to complete the works under the contract on time:  that will usually be covered by the principal contract under which the contractor is likely to have to pay liquidated damages for delay.  The purpose of a Collateral Warranty agreement is not to give a third party any extra rights with respect to delay in completion.

Clause 2.3 makes is clear that the contractor’s liability to the beneficiary is no greater than the contractor’s liability to the developer under the principal contract.

3. DELETERIOUS MATERIALS

It is usual to have a short clause under which the contractor gives a warranty that it will not specify or 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, there is often 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 contractor and is, therefore, covered by the wording of Clause 3.1.

4. COPYRIGHT

It is usual for a beneficiary under a Collateral Warranty agreement to have a right to use designs and other documents prepared by the contractor but only in connection with the development for which those design documents are prepared.  Copyright is nonetheless retained by the contractor.

Under clause 4.3, the beneficiary has to pay for any copies of designs and documents, which it may request.

5. INDEMNITY INSURANCE

This clause imposes on the contractor 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 principal contract – “Practical Completion” or “Taking Over” should be used in the Collateral Warranty agreement to avoid any inconsistency.)

If the principal contract 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.

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 contractors 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 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.

7. NOTICES

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 contractor, 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 principal contract by requiring the contractor to give notice to the beneficiary before he terminates that contract.  The beneficiary then has the right to take over the developer’s role under the principal contract and an obligation, under those circumstances to pay the contractor any money that is outstanding.

Consequently this clause has a potential benefit for the contractor: 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 principal contract it is important that, when the collateral warranty contains such a clause, the developer should be a party to that document in order for clause 9 to be effective.