A collateral warranty is an additional contract usually formed between a contractor, consultant or subcontractor (warrantor) and an interested third party (beneficiary) giving the third party the right to sue the warrantor. It creates a direct contractual link which would not otherwise exist and provides an additional level of security for the stakeholders in a construction project who are not directly appointing the parties to the project.
Usually only the parties to a contract can enforce the rights and obligations under it, which means that they don't have to worry about unexpected claims from third parties. However, where a third party (i.e. a tenant) has an interest in a construction project - that third party would not usually be able to bring a claim against the original parties to the contract, as they wouldn't have any right under the contract.
A collateral warranty may contain / enable:
- A covenant that the warrantor will fulfill its obligations under the contract without prejudice to that covenant, and that it will carry out any design with reasonable skill and care;
- A clause restricting use of design documents for purposes connected with the project (copyright and use of information);
- Step-in rights, which are provided to beneficiaries who have an interest in the project before completion (e.g. funders). They enable the beneficiary to take the place of the employer under the contract so that if the employer gets into difficulty the beneficiary can "step-in" and take responsibility for unpaid sums under the contract. Step-in provisions usually aim to postpone the warrantor's rights to terminate the contract to give funders time to deal with contractual issues so they can exercise the step-in rights. If two or more parties have step-in rights there should be agreement on whose rights will take priority;
- Assignment without restrictions; so that the benefit of a warranty can be assigned in the same way as a contractual benefit. (for obvious reasons, warrantors often try to restrict the limit of the number of third parties they may become liable to);
- limitation / exclusion of liability clauses:
- no greater liability clause: the warrantor seeks to ensure that it doesn't take on any greater risk as a result of the collateral warranty than it would have under the main contract;
- equivalent rights of defence clause: the warrantor seeks to ensure that it has all the same rights of defence under the collateral warranty as it does under the main contract;
- economic and consequential loss: restricted by beneficiaries.
- net contribution clause:
- if two warrantors are liable to the beneficiary for the same defective work, the beneficiary could seek to recover all its damages from warrantor A, despite the joint liability of warrantor A and warrantor B. Warrantor A could then seek to recover a share of those damages from Warrantor B.
- a net contribution clause will often state that where two (or more) warrantors to a construction project are jointly liable, and the liability of each warrantor will be limited to the amount which would be just and reasonable in respect of their contribution to the problem. Here the beneficiary has to pursue each warrantor, and this transfers the burden of pursuing the other defaulting parties from the warrantor to the beneficiary and can be problematic if any of the defaulting parties becomes insolvent (which is why net contribution clauses are often resisted by beneficiaries).
The Contracts (Rights of Third Parties) Act 1999
The Contracts (Rights of Third Parties) Act 1999 was aimed at the construction industry, and was designed to remove the requirement for collateral warranties on construction projects. The Act enables a person who is not a party to the contract to enforce a term of the contract if:
- the contract expressly provides that they may; or
- the contract term implies to confer a benefit on them.
The Act is often expressly excluded in contracts and collateral warranties remain the most common mechanism to give third parties rights of recovery under construction projects.
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