60 Sec Collateral Warranties Guide

What is a Collateral Warranty?

A Collateral Warranty is a legal document created as a support document to a primary contract. It is created because there is an agreement which needs to be put in place with a third party outside of the primary contract.

Third Parties can be an architect, contractor, or sub-contractor who may need to warrant to a funder, tenant or purchaser that it has fulfilled its duties under a building contract.

Collateral warranties can contain obligations that affect the consultant or contractor, such as using materials of an appropriate quality, and carrying out work in a professional, workmanlike manner. It can also provide the third-party contractual rights enabling it to claim for losses which would not otherwise be recoverable.

Agreeing to a Collateral Warranty will increase the Insured’s potential liability by increasing the range of potential claimants who may bring a claim against them.

Our sixty second guide to Collateral Warranties looks the key facts and what you do when your client asks for assistance.

1. The legal position

The purpose of a contract is to allocate risk between the parties; in theory, that allocation of risk is a matter of negotiation between the parties. In practice, in collateral warranties, there is not a balancing of risks – most of the risks are undertaken by the person giving the warranty.

A contractor can of course agree to accept any risk he wishes, and commercial pressures sometimes mean he is “forced” to accept a collateral warranty as drafted by the project owner. However there are many liabilities of which the contractor should be aware, that Professional Indemnity insurers will not support.

2. Why do you need to send them to Insurers?

Collateral warranties are agreements which are associated with another ‘Primary’ contract. The collateral warranty should be collateral – ie sitting beside this Primary contract and not create a greater or longer lasting duty of care, or greater liability than exists under that Primary contract or that exists in common law.

If you can get a copy of the Primary contract please do so, because it is directly relevant to reviewing the collateral warranty.

3. This is quite tricky – here is an example.

An example of the common law position would be that a design or other consultant should not accept any greater liability than Reasonable Skill & Care, because a consultant is classed in the same category as a doctor or a lawyer.

A doctor cannot guarantee a cure nor can a solicitor guarantee the outcome of a lawsuit. Providing they have exercised Reasonable Skill & Care they will have fulfilled their legal obligation. The same is true of an architect or engineers. Remember they can still be liable for negligence!

4. Collateral Warranties as a Deed.

Be careful to mention that if the collateral warranty is executed as a Deed, the Primary contract to which it relates should also be signed as a deed, otherwise if the Primary contract is signed as a simple contract liability will expire at the end of six years after practical completion while the liabilities under the collateral warranty will continue for a further six years.

5. Be Careful – manage expectations

While a Construction Project of course carries an implied fitness for purpose, Professional Indemnity insurers will not cover express guarantee or warranty of fitness for purpose or guarantee of performance.

Neither will they agree to cover financial penalties agreed under contract, such as Liquidated or Ascertained Damages

6. Does the Insured have to give a Warranty?

A warranty does not have to be given by anyone unless they are under a contractual obligation to do so, subject to the commercial pressure that can be brought to bear.

The reality is that Subcontractors want to get the contract, and there is competition for every project. All we can do is warn the insured that while they can agree anything they wish, insurance may not respond to certain things such as Fitness for Purpose, Liquidated or Ascertained Damages etc.

Remember – If the Insured is planning to retire or cease trading, run-off cover must be purchased to comply with the terms of the Collateral Warranty entered into.

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