What is Collateral Warranty?

Full Definition

A collateral warranty is a legal agreement entered into alongside (or "collateral to") a main construction contract or professional appointment, under which a contractor, subcontractor, architect, engineer or other construction professional gives contractual promises directly to a third party who is not a party to the original contract -- typically a funder providing development finance, a purchaser buying the completed building, or a tenant taking a lease -- promising that the works or professional services have been carried out with reasonable skill and care and in accordance with the relevant contract. The need for collateral warranties arises because, under ordinary contract law, only the parties to a contract can sue on it (a rule reinforced, though partly modified, by the Contracts (Rights of Third Parties) Act 1999); without a collateral warranty, a funder or a building's eventual purchaser would generally have no direct contractual claim against the contractor or design team if defects later emerged, even though they are the ones financially exposed to the cost of putting them right. A typical collateral warranty mirrors the key obligations of the underlying building contract or professional appointment -- confirming the standard of care owed, often including a duty regarding the selection of materials and compliance with relevant statutory requirements and Building Regulations -- and usually includes a right for the beneficiary to step in and take over the contract if the original employer defaults, which is particularly important to funders wanting to ensure a development can be completed even if the original developer becomes insolvent partway through. Warranties commonly also cap the contractor's or consultant's liability, cross-refer to the limitation period applying to any claim (commonly six years for a simple contract or twelve years for a contract executed as a deed, an important consideration since most collateral warranties are indeed executed as deeds to secure the longer period), and specify which types of loss are and are not recoverable, for example frequently excluding pure economic loss unrelated to physical defects. On a typical commercial development, a developer's solicitors will negotiate a suite of collateral warranties from the main contractor and each key subcontractor and consultant in favour of the funder, and then further warranties in favour of each significant tenant or purchaser as the building is let or sold, meaning a single defect discovered years later can potentially be pursued by several different parties under several different warranties, each with potentially different terms, liability caps and limitation periods, which is why construction lawyers pay very close attention to the precise wording of each warranty rather than assuming they are all interchangeable. Because collateral warranties add legal cost and negotiation time to every transaction in the chain, some modern projects instead use "third party rights" provisions under the Contracts (Rights of Third Parties) Act 1999 built directly into the main contract, which can achieve broadly similar protection for funders, purchasers and tenants with less duplicated paperwork, though collateral warranties remain the more traditional and still very widely used route.

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