Collateral Warranty is a separate contract, for example between a tenant/buyer and architect, and a funder and contractor where otherwise a contract would not normally exist. It warrants compliance with the underlying contract.
If a party has a problem with a defect in a building then without a Collateral Warranty, recovery against the negligent party may be difficult. Any claim in tort would have problems due to the difficulty in recovering financial or economic loss which a defective building is (as opposed to damage to another property or physical injury). Occasionally there may be a developer’s warranty, but often the developer may be a SPV whose only asset is the building project which once completed and sold, will mean that there are no more assets or funds available.
A purchaser can have a survey undertaken but this does not overcome the problem with latent defects and the liability of the surveyor will be subject to the terms of his appointment. Latent defects insurance is another alternative but this does cost money.
Third Party Rights under the Contracts (Rights of Third Parties) Act 1999 is an alternative to Collateral Warranties because either can give construction security. However, Collateral Warranties are more popular because they are more familiar and become a contract like any other, whereas Third Party Rights remain a more recent creation of statute.
In addition it may be easier to grant step-in rights with Collateral Warranties and the Act can only be used to confer rights and not obligations. Also, the Act may confer an unexpected benefit on a third party by expressly extending a limitation clause to a third party.
A step-in right is where a party is providing development or property finance and a Collateral Warranty or schedule of Third Party Rights, allows the Beneficiary to take the place of the employer under a building contract or the client under professional appointment (such as the appointment of an architect or engineer).
Key clauses for a buyer/tenant include that the Warranty must be a Deed or for nominal consideration, the Warranty is to comply with the underlying contract, and there is a duty of care and a right to assign and a duty to insure and also the grant of a copyright licence. There should be a provision covering the right to inspect (but no right to instruct the Warrantor) and a duty not to use harmful materials. Liability is normally limited on the basis of no greater duty, equivalent rights of Defence and usually there is a liability period of 12 years. There is normally a net contribution clause providing for recovery of what is “just and equitable”. Damages are limited to the reasonable costs of repair, renewal and/or reinstatement.
The position with a Collateral Warranty for a funder is different. It is a tri-lateral agreement between a professional consultant or contractor (Warrantor) the funder (Beneficiary) and Employer (as Employer of Warrantor).
There will be a right to step-in if the Employer breaches the funding agreement, or is insolvent or breaches the underlying contract.
With Collateral Warranties for a funder, there are fewer limitations – no net contribution clause, and damages are not limited to reasonable costs of repair, renewal and/or reinstatement – for example loss of profits may be recovered. Notice of Termination has to be given on default or insolvency and the funder is liable for properly due payments in the event of stepping-in rights being exercised.
In summary, a Collateral Warranty creates a contract where none would otherwise exist and without one a person affected by defective design or workmanship is unlikely to recover losses from those responsible.