Collateral warranties

What is a collateral warranty?

A collateral warranty provides a funder, tenant or purchaser with a direct contractual link with a consultant, contractor or subcontractor who is working on their project, but not directly for them.

If you are a funder, tenant or purchaser, this added level of security protects you should there be any issues with the progress of the works or in the event of defects in the works by a consultant, contractor or subcontractor.

Why are collateral warranties so important?

By imposing obligations on a service provider, you enable yourself to be able to bring a claim in contract against a service provider for defective works which has caused you a loss. Having a collateral warranty makes for a more straightforward claim and maximises the damages which you can claim.

Without a collateral warranty, it would be very difficult to recover any loss from, or mitigate project delays caused by, a service provider if the landlord or developer was to become insolvent or could not satisfy a damages award brought against them. The collateral warranty enables you to step in as the direct employer of the service provider to rectify the issue and ensure that any delay to the overall project is mitigated as far as possible.

The importance of collateral warranties is reflected by the fact that many contracts now make payment conditional on all collateral warranties having been executed and returned.

What to look for in a collateral warranty?

In terms of checking the collateral warranty, there are a number of key points to look out for.

The terms of the collateral warranty should not be more onerous than the terms of the underlying contract to which it relates. For example, a subcontractor’s collateral warranty should not contain terms which are more onerous than those in the subcontract.

Step in rights should also be included in the collateral warranty, as well as clarity as to whether the service provider is obliged to agree to them. If they are not, granting step in rights may not be a good commercial decision.

Collateral warranties should also dictate when and who they can be assigned to. If the warranty can be assigned without limitation, this can create uncertainty as to which party can bring a claim against the service provider.

It is also important to ensure that there is not a ‘no greater liability’ clause in the warranty to ensure that the service provider does not owe a greater liability to you under the warranty than it does to its employer under the underlying contract. This would capture any cap on liability in the underlying contract which has not been included in the collateral warranty.