Collateral Warranties In Construction Contracts ' The Basics

• Published date: 27 July 2021
• Subject Matter: Corporate/Commercial Law, Real Estate and Construction, Contracts and Commercial Law, Construction & Planning, Landlord & Tenant - Leases
• Law Firm: Hill Dickinson
• Author: David Banks and Adam Kitchin

A collateral warranty is a contract under which a party involved in the works warrants to a third party beneficiary that it has fulfilled its obligations under its underlying building contract, subcontract or professional appointment (referred to as underlying contract in this article).

In this article we explore the purpose and typical content of a collateral warranty in the context of a construction project. We also briefly consider an alternative approach as provided by the Contracts (Rights of Third Parties) Act 1999.

Purpose

In a simple construction project, an employer may contract with a contractor to carry out building works. Those two parties usually have a clear contractual relationship.

However, construction projects invariably involve a wide range of parties with an interest in the development (funders, purchasers, tenants for example) and also those involved in the works (contractors and consultants). Some of those parties will not have a direct contractual link or a commercial relationship of any sort.

Ordinarily, only a party to a contract is entitled to enforce said contract. Therefore, if a subcontractor were to commit a breach of its subcontract (with the contractor), and that breach adversely impacted on the employer (this could also be a funder/purchaser or tenant), an employer would be unable to enforce the same. That creates a problem for the employer particularly in a situation where the main contractor is insolvent.

In addition, if the employer identify defects in the subcontract works, in the absence of a collateral warranty the employer would have no realistic contractual recourse against any party in the example above.

In the absence of that contractual link, the employer would have to rely on a claim in negligence. This is not desirable as it would require the employer to establish that the subcontractor owed it a duty of care before its claim was even considered. Even if successful, the employer would also be limited as to what it could recover in negligence.

Collateral warranties are used to bridge the contractual gap and create a direct contractual link for the benefit of those parties that may otherwise have no recourse.

The step-in option

Some collateral warranties can also contain 'step-in' rights which effectively allow the beneficiary to step in to the underlying contract and issue instructions.

Should the main contractor of a project fall into insolvency the subcontractor will be under no contractual obligation to...