Collateral Warranties & Bonds – Your Questions Answered by Henry Hathaway
October 3, 2018 | Silver Shemmings
One of the most misunderstood and misapplied sequences during a construction development is the use and application of collateral warranties. They are documents that are ordinarily left to the end of a project and can sometimes cause quite a number of difficulties, when especially sub-contractors or other parties have left the realms of the project and perhaps have been paid.
It is not unusual, and indeed it is quite common, for solicitors to be instructed to review the wording of a collateral warranty but generally when instructed it is usual to merely take receipt of the collateral warranty without the underlying contract. It is important to realise that a collateral warranty creates a contract. The whole position arises from the House of Lords authority in Dunlop Pneumatic Tyre Co Limited -v- Selfridge & Co Limited  UKHL 1 and to which underlined the privity rule, that is to have the effect of protecting parties to a contract from being sued by strangers. The collateral warranty or Third Party Rights provisions allow for others not party to the contract to derive benefits from it. Defective design or workmanship by a professional consultant or contractor could cause the parties with different interests in a construction project different losses. While an employer is likely to have a contract with the party responsible for a defect, other affected parties may not.
Without a contract, a party affected by this defective design or workmanship may not be able to recover its losses from the professional consultant or contractor responsible. It would be an extraordinary suite of documents if all parties were to directly contract with one another.
The first principle point is that in order to review and/or consider the collateral warranty, the underlying contract should and ought to be considered as to the agreement between the parties in the first instance. This is especially important for the Fund and/or those who perhaps will be a first purchaser or tenant. This is especially true when considering the rights granted under the contract itself as there certainly will be no greater obligations. It is especially true when considering the sub contracts which maybe required in the future long after the project has indeed been completed. In all instances, the collateral warranty should be drafted back to back and considered in tandem.
Secondly, and this applies to the actual contract itself, the insurance provisions must be quite certain. Those entering into such agreements would be well advised to have their insurers review the terms of the contracts and the levels of insurance required. Ordinarily, this is important for all parties, from the warrantor’s position, in such an event or breach where losses arise, it will hopefully rely upon its insurance provisions instead of being potentially sued directly. It is certainly in the interests of the Beneficiary to ensure that the terms of any policy insurance meets those as required. The warrantor may not be in a position to provide the sums in order to remedy the breaches in many cases. Straightforward and basic principles as to whether a claim is in the aggregate or for each and every event are unfortunately terms that are not applied nor match the existing policies.
Often parties including, for example, the contractor is the actual procurement of the collateral warranties themselves from sub-contractors when there is an express requirement in the main contract itself to do so. Such provisions may include a condition precedent where there is an amount withheld if upon being given seven days notice the contractor fails to procure and deliver the warranties from its chain. It is not uncommon that contractors fail or forget to include those provisions or clauses in its own sub-contracts leading to much difficulty. This is made all the more problematic on account of the fact that at the start of a main contract, it may not be known who the sub-contractors will be. It is important therefore at this stage that the disciplines at least are captured, and in the instance where the Beneficiary is not known, that the class or classes are identified.
When taking an interest in a new or recently built or recently refurbished property or project, typically a buyer, tenant or funder wants to minimise the risk that it will have to pay for remedial works out of its own pocket: it wants construction security.
For example, a funder providing development finance to an employer:
• Will want construction security to help protect its loan so that, if something goes wrong on the project, it can claim its losses from the person who caused the loss, such as an architect or a contractor
• May also want to be able to step in and complete (or “build out”) the project if the employer becomes insolvent before the project is completed. This part of construction security is commonly effected using step-in right
Construction security may take the form of collateral warranties from those who designed and built the project, or rely on third party rights granted under the Third Party Rights Act 199. Although, without collateral warranties, a buyer may have no effective rights against the parties who designed, constructed and managed the project, the parties may be able to use an alternative to a collateral warranty to bypass the rule of privity of contract, such as:
• Using the Third Party Rights Act 1999 to grant enforceable rights in favour of a funder, buyer or tenant
• Assigning the benefit of the construction documents to one of a funder, a buyer or a tenant
The parties may choose to use a collateral warranty rather than using the Third Party Rights Act 1999 or an assignment because:
• The construction industry is familiar with collateral warranties
• A collateral warranty is a separate contract between the parties to the collateral warranty – while a collateral warranty is collateral to, for example, a professional appointment, it is a contract in its own right. It may be enforced and its benefit may be assigned on the terms set out in the collateral warranty
• The Third Party Rights Act 1999 does not allow a third party to be put under an obligation to do something (a burden), it only allows a third party to enforce the benefit of a contract term (or contract terms)
• An assignment of the entire benefit of a construction document would mean that the assignor could not later make a claim under the construction document. The assignment would have transferred the benefit of the right to bring a claim from the assignor to the assignee
•An assignment would only assign the benefit of a construction document to one party. Separate collateral warranties can be given to more than one party (such as both a buyer and a tenant).
One widespread difficulty when using collateral warranties is that they can be problematic to procure, even if the underlying contract is clear that they must be provided. This difficulty arises most often when a project is complete or, even if it is ongoing, where the warrantor has received payment for its particular works or services. The problem is compounded if there is a dispute relating to the project
If a party fails to comply with its contractual obligation to provide a collateral warranty, that may be a breach of contract for which damages are payable. However, it is less clear whether one party can force another to provide a collateral warranty by relying on the equitable remedy of specific performance. There is little authority on this point, although the Scottish decision in Kier Construction Ltd v WM Saunders Partnership LLP  CSOH 17 indicates that specific performance may be decided. However, this is a decision that is not binding in English and Welsh courts, it could however, be seen as persuasive
It is important to understand whether the collateral contract is executed or to be executed as a Deed and whether the underlying contract has been executed as such. Further, the engrossed copies should be executed in the manner so that the required number of signatures are signed in wet ink and thought should be given as to whether there should be a counterpart clause included. This can be very much an issue at the last moment when couriers are being sent the breath of the country.
Lastly, it is still the position that consultants, sub-contractors and contractors will sign the collateral warranty! Leave blank for the Beneficiary to date!
Author Henry Hathaway is a Partner with Silver Shemmings Ash and is a graduate of Trinity College Dublin (Civil Engineering). He is a qualified Civil & Structural Engineer and has previously spent twelve years in the Construction Industry representing both Contractors and Clients in Engineering and Project Management, he specialises in Pre-Contract Negotiation, Contract Formation, Project Lifecycle, Tender Development, Identification of Delay & Disruption, Establishment of Claims, Ascertainment of Costs
At Silver Shemmings Ash, we provide seminars and training alongside our core activities in contentious and non-contentious matters, the purpose if these is to facilitate a greater knowledge and understanding of construction and property law. There remains a considered lack of training in such areas for companies and one to which we look to address.
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