As a principal funder, collateral warranties are used as a supporting document to a primary contract where an agreement needs to be put in place with a third party outside of the primary contract. Sometimes an architect, contractor, or sub-contractor will need to warrant to a funder that it has fulfilled its duties under a building contract. Collateral warranties create a contractual link where none had previously existed and give these interested third parties a right to bring a contractual claim against the parties that designed or built the project.<\/p>\n
<\/p>\n
What does a collateral warranty include?<\/p>\n
It is important that a collateral warranty is consistent with the underlying contract that it relates to and there are certain clauses that would be expected in any collateral warranty such as:<\/p>\n
\u2022 A covenant that the warrantor has and is continuing to fulfil their obligations under the underlying contract (be that the building contract, appointment, or sub-contract) and will carry out any design with reasonable skill, care & diligence.
\n\u2022 The granting of a copyright licence to use\/reproduce any designs, drawings, calculations etc produced by the warrantor; and
\n\u2022 An obligation to maintain professional indemnity insurance at a certain level for a set number of years following completion of the project.<\/p>\n
Collateral warranties may also include various caps on liability which seek to limit the warrantor\u2019s liability to the beneficiary of the collateral warranty. Such clauses can include a financial cap on the warrantor\u2019s liability, a net contribution clause but we cannot accept the vast majority of these as each 3rd party must be fully liable for any loss attributed to them.<\/p>\n
<\/p>\n
Key points:<\/p>\n
\u2022 The promise to perform the underlying contract.
\n\u2022 \u2018Equivalent rights of defence\u2019 wording.
\n\u2022 Granting of copyright licence with reasonable conditionality.
\n\u2022 Step-in rights in favour of the Lender so that we can utilise the contract in event of default of the mortgage.
\n\u2022 Reasonable limitation provisions.
\n\u2022 Assignment<\/p>\n
It is worth noting that as the warrantor\u2019s covenant (that they are fulfilling their obligations under the underlying contract) is only as strong as that underlying contract. Any review of a proposed form of collateral warranty must not be undertaken in isolation and a copy of the underlying contract must be provided to ensure it includes all the key terms.<\/p>\n
<\/p>\n
Why are collateral warranties and third-party rights needed?<\/p>\n
A construction or engineering project needs collateral warranties or third-party rights for three main reasons:
\n\u2022 Privity of contract prevents third parties relying on other people\u2019s contracts. Unless you are a party to a contract or section 1(1) of the Third-Party Rights Act 1999 applies, you cannot enforce a term of a contract and as a development funder, we need to be able to enforce these contracts
\n\u2022 They provide construction security. If something goes wrong on a project, a funder does not want to be out of pocket; it wants to be able to claim its losses directly from the person who caused the loss, such as an architect or a contractor. Without a collateral warranty or third-party rights, a funder may be unable to make an effective claim.
\n\u2022 A claim in tort is unlikely to succeed. The law of tort in England and Wales does not generally allow a claim for pure economic loss, such as damage caused to a building by a defect in that building; you need a contract.<\/p>\n
<\/p>\n
What is the difference between collateral warranties and third-party rights in practice?<\/p>\n
In one sense, there is no difference in practice between collateral warranties and third-party rights on a construction or engineering project. Either may give effective construction security.<\/p>\n
However, collateral warranties remain popular, in part because:<\/p>\n
\u2022 They are familiar. Historically, construction lawyers are more familiar with collateral warranties. Once a collateral warranty is formally entered into, it is a contract like any other. Even though they have been available for ten years, third party rights are a more recent creation of statute.
\n\u2022 It may be easier to grant step-in rights. If a borrower (such as a developer) becomes insolvent, a funder wants to be able to step into its shoes to complete and sell the project for the best price. Some argue it is easier to include effective step-in rights in a collateral warranty. However, those who prefer third party rights feel it is just as straightforward in practice to use third party rights to grant step-in rights.<\/p>\n
<\/p>\n
When Bath & West Finance ask a third party to sign a collateral warranty, we are not trying to catch anyone out or put further liability on the contractor, other than the original appointment\/contract with our client for any contracted works. This is merely to ensure full continuity of a project due to any unforeseen eventualities where as a lender, we do need to take charge of any given contract and protect everyone\u2019s invested interest in the project until all works have been completed.<\/p>\n","protected":false},"excerpt":{"rendered":"
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