Collateral

Warranties
...a little bit of law

Inside
What are they?
Who are the parties?
Why bother?
The alternatives
Key points to include

What is a collateral warranty?

A warranty is essentially a promise
made by one party (the warrantor)
warrantor to
another (the beneficiary).
beneficiary A collateral
warranty is a warranty which exists
collateral
collateral
collateral to, or next to, an underlying
agreement.
The most common example is a
collateral warranty that sits alongside
the building contract. The building
contract will be between the contractor
and the employer.
employer The collateral
warranty is a promise by the contractor
to someone else, say a prospective
tenant, that they have performed and
will perform their obligations under the
building contract.
Collateral warranties are also often
given by sub-contractors and subconsultants (subbies) on a project. It will
be the contractor who appoints the
subbies and enters into contracts, or
appointments, with them. The subbies
will then give collateral warranties to
the employer.
Common warrantors include:
Contractors, architects, subcontractors
and sub-consultants
i.e. people whose work is important to
more than just the person who appoints
them.
Common beneficiaries include:
Employers, purchasers, tenants and
funders
i.e. people who care that the
development is built properly but who
wont themselves be appointing the
people building and designing it.

I want you to listen to me. Im going to

say this again. I did not have contractual
relations with that woman, Miss
Lewinsky
We now know what collateral warranties
are and who gives them. The next question
is, why have them at all? Well, in this
regard, its important to be clear about
who you do and do not have contractual
relations with.
In the case of a building contract, the
contractual relationship exists between the
building contractor and the employer
they are the ones that actually enter into
the contract.
If we take the relationship between the
building contractor and a purchaser of the
development however, no contract exists
between them. As a result, if the building
falls over, a purchaser will not necessarily
have a claim against the building
contractor for breach of contract. The
contract wasnt made with them so they
cant sue for breach of contract even if a
breach has taken place.
Sometimes the purchaser might have a
claim against the builder for negligence.
But the Courts have tended to take a very
restricted approach as to which losses are
recoverable in those circumstances.
Lawyers love the debates that ensue but
its rarely fun for the person picking up the
bill.
The solution for a purchaser or funder of a
development is to receive collateral
warranties from parties with whom they
would otherwise not have a contract with.
This enables them to pursue that
warrantor directly for breach of contract.

There is no alternative!
Well actually there is...
In the example of a purchaser buying a
newly constructed building, the
purchaser could possibly take a transfer
of benefits under the building contract.
In practice, however, thats usually
problematic as a way forward. In
particular, transfer only really works
when the party giving up their benefits
is no longer going to have any interest in
the development. You can only assign to
one party at a time so if there is a
purchaser and a funder, who gets the
assignment?
The purchaser might be able to take out
(or be provided with) insurance to cover
certain risks. However, insurance can
be costly and is inherently fraught with
exclusions so its rarely an attractive
option.
Instead, the main rival to collateral
warranties has been the use of the
Contracts (Rights of Third Parties) Act
1999. This Act allows for third parties to
obtain the benefits from contracts,
which are entered into by others.
Subject to several key requirements,
third parties who are named in the
contract may obtain the benefits under
it, without actually having to be a party
to it.
The key advantage of going down this
route is that it removes the need to have
to negotiate and get the warrantors to
execute large numbers of individual
collateral warranties. Third party rights
can be granted upon execution of the
main agreement without any further
formalities but in cases of JCT building
contracts for instance, the rights will be
granted to the third party on the date of

receipt by the person granting the rights

(eg. the contractor) of a notice identifying
the third party. This also avoids the need to
try to track down the warrantors several
years later to get them to execute
collateral warranties when the property is
re-sold.
When to get collateral warranties? Carpe
diem
Its a mistake to leave the negotiation of
the collateral warranties until after the
building contract has been agreed or even
after the building work is completed. Once
the building contract has been entered
into, the building contractor may not be
keen to extend its contractual obligations
to more people and any obligation to
provide a collateral warranty in a form to
be agreed is unlikely to be enforceable. It
is best to have those discussions when the
contractor is keen to secure the work!
One of these days I'm going to get help for
my procrastination problem
A common misconception is that even if
you provide in the contract for collateral
warranties to be given when called for, it
doesnt matter if you dont actually ask for
them to be issued until the work is near to
completion. No. No. No.
It may seem like a pain at the time but, if
you know who is getting the collateral
warranties, the best time to get them
printed and signed is at the same time that
everyone is signing the main contract. If
the collateral warranties contain certain
step-in rights this is essential. 18 months
later people will forget, youll need to dig
around to find the contract or the
personnel at the company giving the
warranty may have changed and not know
what you are talking about...

Key things they should cover

Collateral warranties must marry up
with the main agreement which they are
collateral to. Amongst other things,
provision is often made for the following:

who the benefit of collateral

warranties may be assigned to
(and how many times)

what standard of work is

warranted for and how this
compares with the standard
provided for in the underlying
agreement;

the extent of the warrantors

liability and whether there can be
greater liability under the
collateral warranty than under
the underlying agreement;

copyright;

rights to step-in and take over

from the employer if the need
arises, such as in an insolvency
situation;

net contribution (the extent to

which the warrantor can limit its
liability based upon the culpability
of others);

the limitation period during which

any claim must be brought; and

the maintenance of an agreed

level of professional indemnity
insurance.

The warrantor will often need to get

their insurers to sign off on the form of
warranty before it is given.

Ben Halsey
ben.halsey
@lewissilkin.com

5 key things to remember

1.
Collateral warranties are minicontracts.
2.

They create contractual relations

between parties which would
otherwise not exist.

3.

They are usually provided for the

benefit of purchasers and funders.

4.

They should be agreed upfront and

completed as soon as the beneficiary
is known.

5.

Their precise wording, together with

the wording of the contract they are
collateral to, will determine the
extent of liability.

A largely irrelevant fact

Carpe diem is a phrase from a Latin poem
by Horace. It is popularly translated as
"seize the day". Carpe is the second-person
singular present active imperative of the
Latin verb carp, which literally means "I
pick, pluck, pluck off, but Ovid used the
word in the sense of, "enjoy, seize, use ".
little bits of law
This is one in a series of leaflets published
by Lewis Silkin LLP, providing information
on a range of legal issues that face our
developer clients.
Professional advice should be obtained
before applying the information in this
client guide to particular circumstances.
For a full list of available leaflets please
visit our website or contact Ben Halsey at
ben.halsey@lewissilkin.com.

Clare Reddy
clare.reddy
@lewissilkin.com

Horace
horace
@lewissilkin.com
November 2012