Collateral Warranties in Construction Agreements Explained

Dan Nailer
Dan NailerLegal Assessment Specialist
Updated on 30th April 2024

In construction, agreements form the foundation of any problem, detailing who does what and when.

But what about those on the sidelines, like funders, end purchasers, or tenants? They've got skin in the game too, even if they're not in the thick of it but they want assurance.

That's where collateral warranties come in.

collateral-warranties-in-construction-agreements

In this article, we'll break down what collateral warranties are, why they matter, and, how they feature in construction agreements.

What is a collateral warranty?

A collateral warranty is a contract for people who aren't part of a main agreement. They're needed because, under English law, only those directly involved in a contract can enforce its terms.

Collateral warranties establish responsibility without making a direct contract, allowing third parties to sue the designers or builders if things go awry.

Architects, contractors, or subcontractors might use collateral warranties to show funders, tenants, or buyers that they've done their part in a building contract.

Is a collateral warranty the same as a guarantee?

Although both collateral warranties and guarantees protect third parties, they are applied in different situations.

Collateral warranties operate outside the main contract between parties involved in a construction project. They provide a way for third parties to seek compensation for defects or issues arising from the project.

On the other hand, a guarantee is a commitment made by a third party to cover the obligations of another party if they're unable to fulfill their financial responsibilities. Guarantees are commonly used in financial arrangements like loans and rental agreements.

Is a collateral warranty the same as a deed?

In many cases, collateral warranties are included in legally formalized agreements. In legal language, a "deed" holds greater weight and formality compared to a standard contract. Deeds typically require additional steps like signatures, witnesses, and seals.

So, when a collateral warranty is executed as a deed, it signifies a formal and legally binding commitment. This indicates that the parties involved have taken measures to ensure the collateral warranty is valid and enforceable.

Who benefits from a collateral warranty?

The primary purpose of a collateral warranty is to protect the interests of the 'beneficiaries' involved such as:

  • Funders providing capital for the project

  • Buyers of a finished building

  • Tenants agreeing to lease the building

If required, beneficiaries can claim compensation if the construction falls short of the agreed standards.

What are step-in rights in a collateral warranty?

Step-in rights allow a beneficiary to step in and take over certain rights of the developer, such as the ability to appoint third parties like building contractors or consultants. These rights come into play if the developer faces insolvency or commits a serious breach that would otherwise allow the contractor or consultant to terminate the agreement.

In practical terms, if the developer goes bankrupt during a project or breaches the building contract, a funder or another third party can step in, assume the role of the developer, settle any outstanding payments to contractors and consultants, and complete the project.

Step-in rights can also be included in a collateral warranty from a subcontractor to a contractor or employer. In this scenario, if the subcontractor becomes insolvent, the employer can step in and finish the project.

What should be included in a collateral warranty?

A collateral warranty should match the main contract it extends from. It usually includes:

  1. A promise that the warrantor is doing their job properly and will continue to do so.

  2. Permission to use the designs created by the warrantor.

  3. A requirement for the warrantor to have insurance in case of problems after the work is done.

There may also be clauses limiting the warrantor's liability, like:

  • Caps on how much they're responsible for.

  • Clauses making sure their liability matches what's in the main contract.

A construction solicitor can help draft and review contracts and collateral warranties to ensure they align and protect your interests.

How long does a collateral warranty last?

Usually, there's a time limit known as a limitation period lasting either 6 or 12 years from when the main construction work in the contract is finished. After this period ends, the warranty isn't valid, and you can't take legal action.

Are collateral warranties required in construction projects?

Collateral warranties aren't a legal requirement in construction projects but they are common.

Adding a collateral warranty boosts the warrantor's responsibility, so it's worth considering whether it's needed and suitable for the situation.

What are the risks of a collateral warranty?

A collateral warranty raises the stakes for a contractor in a project. It broadens the range of parties who could file a compensation claim against them if any issues arise with their work.

Additionally, it lengthens the timeframe during which such claims can be made, leaving them vulnerable for an extended period.

How can Lawhive help?

Our network of expert construction solicitors is here to guide you through creating collateral warranties in line with your construction agreements.

Whether you require assistance in drafting the agreement's terms or ensuring its enforcement, we're here to help.

If you're seeking further assistance and information on construction contracts, contact our legal assessment specialists today.

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