Collateral Warranties – an Overview

Construction has returned and with each construction project comes a suite of construction documents. One of these documents is a Collateral Warranty and in this article we will provide an overview of the purpose of the Collateral Warranty and some points to look out for when reviewing a draft.

What is a Collateral Warranty?

A Collateral Warranty is a contract under which a consultant, a building contractor or a sub- contractor warrants to a third party that is has fulfilled its obligations under its professional appointment, building contract or sub-contract.

What is the purpose of a Collateral Warranty?

The purpose of a Collateral Warranty is to give a third party, who is not a party to the original contract, rights to enforce that original contract.

To illustrate the purpose of a Collateral Warranty, we set out below an example:

• An employer engages with a developer to develop a hotel. This relationship is governed by a Development Agreement.
• The developer appoints a contractor to build the hotel. This relationship is governed by a Building Contract
• There is no direct contract between the employer and the contractor.
• In order to bridge that gap, a collateral warranty is put in place between the employer and the contractor.
• A third party funder or a tenant may also require a collateral warranty in order to have a direct contract with the contractor.
• If the contractor is in breach of its obligations under the Building Contract an employer or a funder, who has the benefit of a Collateral Warranty, can claim its loss directly from the contractor who caused that loss.

Main points of negotiation

• Insurance – The Collateral Warranty will set out for how long the insurance policy must be maintained and at what level this insurance policy should be. This can be difficult to govern in practice, particularly after project has completed. It can be difficult to police whether the contractor or consultant, after the project has completed, has the insurance at the required level still in place.
• Duration of Collateral Warranty – Collateral Warranties tend to range from 6 years – 12 years. The beneficiary of the Collateral Warranty will want it for a longer period while the contractor or consultant will want it for as short a period as possible.
• Step In Rights – This allows the beneficiary of a Collateral Warranty to step into the shoes of the employer, if the employer becomes insolvent, so that the beneficiary can complete the project.
• Assignability – This point is very important to a contractor or a consultant. It will set out the amount of times a Collateral Warranty can be assigned to another third party. In practice, it usually provides for assignment twice without consent of the contractor or consultant and that any further assignments must be with the consent of the contractor or consultant.

A word of caution

• Collateral Warranties should be consistent with the building agreement or professional appointment as it is a promise to comply with that contract. It is frequently the case that the Collateral Warranty contains additional obligations or is expressed in an ambiguous way.
• The contractor or consultant should carefully review the terms of a Collateral Warranty as often they are more onerous than terms found in the standard RIAI warranty. This is particularly so if there is a third party funder involved. The contractor or consultant should not automatically accept the terms of a Collateral Warranty and, where appropriate, should seek to negotiate its terms.
  The contractor or consultant should bear in mind that a Collateral Warranty can often be assigned to an unknown third party who may be a subsequent funder or financing party with whom they are unfamiliar.
• For an employer, it is important to agree the form of a Collateral Warranty before engaging the contractor or consultant and arrange to have them executed at early stage as this can be required for Practical Completion. The employer does not want to find themselves in a situation where they are delayed reaching practical completion.
• A Collateral Warranty is only of benefit if, at the time it is being enforced, the party who gave the Collateral Warranty or their insurer is “a mark”.

For further information on the above, please contact Paul Keane at pkeane@reddycharlton.ie