Collateral warranties are a familiar feature of large construction projects and are commonly provided by contractors, subcontractors, consultants and other members of the project team. The process of signing them can sometimes feel like a routine administrative task, particularly towards the end of a project.

They should not, however, be treated as a formality. A collateral warranty creates a separate contractual relationship with a third party and can give that party valuable rights directly against the party providing the warranty.

This article identifies some of the key provisions to consider before signing a collateral warranty and explains how warrantors can protect their position and avoid taking on unnecessary additional liability.

In brief: the role of collateral warranties

A collateral warranty is a separate contract which sits alongside your underlying appointment or contract and creates a direct contractual relationship between you and a third party, typically an employer, funder, purchaser or tenant. It allows that third party to pursue you directly for breach of the warranty, despite not being a party to your underlying appointment or contract.

Put simply, each collateral warranty creates an additional party with direct contractual rights against your business and therefore increases your potential claims exposure. For that reason, warranties should not be treated as an administrative formality. Their number and terms should be carefully controlled to ensure that they do not impose obligations, liabilities or periods of exposure beyond those accepted under the underlying contract.

Some of the key provisions to consider are set out below.

‘No greater liability’ and equivalent rights of defence

These provisions are intended to ensure that your liability to the beneficiary is no greater in scope or duration than your liability under the underlying appointment or contract, and that you can rely on the same limitations and defences that would have been available to you under that agreement. Warrantors should therefore seek the inclusion of both protections.

The warranty should also be drafted on a back-to-back basis with the underlying contract. If the wording diverges, there is a risk that the warranty may impose a greater or different obligation than that originally accepted.

Net contribution clauses

Where the same loss has been caused by the concurrent defaults of several members of the project team, liability may effectively operate on a joint and several basis. This means that, provided the relevant legal requirements are satisfied, a beneficiary may be able to pursue one responsible party for the whole of the loss, rather than only that party’s proportionate share. It is then for that party to seek contributions from the others. This creates a significant commercial risk, particularly where another responsible party is insolvent, uninsured or otherwise unable to meet its share.

A net contribution clause provides important protection against this risk by limiting your liability to the amount that it would be fair and reasonable for you to pay, having regard to the responsibility of the other parties involved. In practical terms, it is intended to prevent you from being left responsible for losses properly attributable to others simply because you are the party with the means or insurance to meet the claim.

For that reason, a net contribution clause can be a valuable protection for any party providing a collateral warranty and should be sought where possible. Beneficiaries will often resist these provisions because they restrict their ability to recover the full loss from a single party, so they may not always be achievable. Nevertheless, they are a worthwhile point to raise and negotiate, particularly where several members of the project team have overlapping responsibilities.

Standard of care

Where your underlying appointment or contract includes design responsibility, check carefully that the warranty does not impose a higher standard of care. In particular, warrantors should be cautious of wording which introduces an absolute or “fitness for purpose” obligation where the underlying contract only requires the exercise of reasonable skill and care.

Taking on a higher standard under the warranty not only increases your contractual exposure but may also create difficulties with professional indemnity insurance.

Caps on total liability

An overall financial cap on liability can provide important protection and should, where possible, be included in the underlying appointment or contract and reflected in each collateral warranty.

Crucially, consideration should be given to whether the cap applies in aggregate across the underlying contract and all related collateral warranties, rather than separately to each individual beneficiary. Otherwise, the warrantor’s potential exposure may multiply as additional warranties are provided.

Warrantors should also check whether particular types of liability are excluded from the cap and whether the proposed limit is consistent with the level and duration of their professional indemnity insurance. As a general principle, a collateral warranty should not expose you to a greater level of liability, or a longer period of exposure, than the underlying appointment or contract.

A liability cap can also be a useful negotiating point. Where a beneficiary is unwilling to accept a net contribution clause, it may nevertheless be prepared to agree an appropriate financial cap on liability.

Insurance requirement

Collateral warranties will commonly require the warrantor to maintain professional indemnity insurance at a specified level for a defined period, potentially extending for a number of years following practical completion.

Given the length of this obligation, the warrantor should consider whether both the required period and level of cover are appropriate and whether the insurance can realistically be maintained throughout that period. The wording should also be checked for appropriate qualifications concerning the continued availability of insurance in the market on commercially reasonable terms, rather than imposing an absolute obligation to maintain cover regardless of availability or cost.

Summary

Collateral warranties are a necessary and established feature of many larger construction projects, and the additional exposure they create can usually be managed through careful drafting and negotiation.

They should not, however, be treated as a routine administrative formality. Contractors, subcontractors, consultants and other warrantors should review collateral warranties with the same care as their underlying appointment or contract, paying particular attention to the scope of their obligations, liability provisions, limitation periods and insurance requirements.

The Construction team at Druces regularly advises contractors, subcontractors, consultants and other construction professionals on collateral warranties and the wider suite of construction documents. If you require assistance reviewing or negotiating a collateral warranty, please get in touch with a member of our team.