Collateral warranties
Harry King, Junior Associate, Quigg Golden
COLLATERAL warranties (CWs) play a pivotal role in construction projects where multiple parties are required to fund, develop, design and construct. For those in the industry, understanding CWs can be the difference between a successful or unsuccessful project.
The doctrine of privity, as reformed by the Contracts (Rights of Third Parties) Act 1999, provides that anyone who is not a party to a contract cannot usually have rights conferred or obligations imposed upon them by said contract, unless said contract specifically provides for them to do so. In construction, the usual chain is that an employer contracts with the contractor and the contractor in turn, with the subcontractors and so on.
They serve as a bridge between parties who have no direct contractual link, to ensure the rights and obligations of a separate contractual agreement are enforceable.The lack of contractual relationship between the employer and the subcontractors leaves scope for several issues during and after the construction process.
This is where CWs are useful.
They serve as a bridge between parties who have no direct contractual link, to ensure the rights and obligations of a separate contractual agreement are enforceable.
To explain it in the context given above, a CW between the buyer (the beneficiary) and the subcontractors (the warrantor) would give the beneficiary legal recourse if the warrantor failed to perform its obligations under its contract with the contractor. In essence, CWs act as a guarantee.
Typically, a construction professional, such as a consultant, contractor or subcontractor will be the warrantor. The beneficiary is often a main contractor, employer, funder or tenant.
What is a construction contract?
Section 104(1) of the Housing Grants, Construction and Regeneration Act 1996 (the HGCRA) provides that a construction contract is:
“An agreement for carrying out construction operations, arranging the carrying out of construction operations by other or providing labour or the labour of others for carrying out of construction operations, amounts to a construction contract”
Where a construction contract fits the above definition, section 108 of the HGCRA will afford the parties a statutory right to refer any dispute arising from this contract to adjudication. Adjudication is often the most desirable and commercially pragmatic form of dispute resolution in construction. It is a relatively quick 28-day process (albeit this timeframe is often extended), cost-effective compared with court proceedings, and it ensures projects can stay on track while preserving business relationships.
Are collateral warranties construction contracts?
CWs are contracts in their own right and the enforcement of the rights and obligations under a CW are separate from that of the main contract.When considering whether you have a statutory right to adjudicate it is important to recognise the distinction between a CW and the main contract. CWs are contracts in their own right and the enforcement of the rights and obligations under a CW are separate from that of the main contract. Just because the main contract is considered a construction contract does not automatically make the CW alongside it one.
In Parkwood Leisure Ltd v Laing O’Rourke Wales & West Ltd (2013) it was held that a CW could be a construction contract under the HGCRA. This decision was expressly overruled by the Supreme Court via its judgment in Abbey Healthcare Ltd v Augusta 2000 LLP (2024). This is a landmark case for the construction industry and signifies a major shift on the contractual status of CWs. This decision has established that most CWs will not fall within the definition of a construction contract, and consequently, will not carry forth the statutory right to adjudicate.
The Supreme Court ruled against the CW being a construction contract for the following reasons:
- The main objective of a CW is to afford a right of action in respect of defectively carried out construction work, not the carry out of such work.
- Abbey’s CW was merely a promise by Simply to perform obligations owed to the employer under the main building contract and
- Consequently, Abbey was not entitled to the statutory right to adjudicate under section 108.
The primary focus of future CW disputes will likely shift from the wording of the clause and when it was granted to what the consultant or contractor is warranting.
Despite the Supreme Court’s ruling, the decision has not entirely precluded the parties to a CW of the right to adjudicate. A CW may include the right to adjudicate as an express term.
Employers
For employers, CWs serve as a crucial safeguard. They ensure that contractors, subcontractors and consultants are held accountable for their quality of work and adherence to contractual obligations. If defects or issues arise after project completion, the employer has a direct legal recourse to demand rectification or compensation from the parties responsible, even if there is no direct contract with them.
Funders, purchasers and tenants
For funders, purchasers and tenants, CWs act as a security net. CWs offer assurance that the project’s key participants can be held accountable to meet the standards they are contractually obliged to meet. This reduces the risk associated with funding the project, as funders can rely on these warranties to recover potential losses or for the rectification of defects. The same can be said for purchasers and tenants.
The ability to enforce CWs provides a level of confidence that encourages investment and funding in large-scale construction projects.
Risk management
In the case of dispute or project failures, these warranties can provide a clear legal framework for resolution and compensation, thereby reducing financial and operational uncertainties.CWs are an extremely useful risk management tool. They ensure accountability and minimise the risk of non-compliance and unremedied defects. In the case of dispute or project failures, these warranties can provide a clear legal framework for resolution and compensation, thereby reducing financial and operational uncertainties.
The warrantor should take care to ensure that a CW does not expand his liability or contractual duties. For instance, if the scope of the warrantor’s obligations is limited to construction, the CW should not impose obligations for another party’s design obligations. There are several key provisions a Warrantor should include in a CW to protect themselves, including:
- No greater liability clause: This ensures that the warrantor takes on no greater risk or duty as a result of giving a CW than they have under the main contract. This clause can be specifically drafted to ensure there is to be no liability of longer duration than under the main contract.
- Net contribution clause: This reduces the liability of the warrantor to reflect the extent to which the court would deem fairly and reasonably attributable to their level of culpability. This provision essentially reverses the common law position of joint and several liability.
- Equivalent rights of defence clause: This ensures that the warrantor has the same rights of defence against claims under the CW as they do under the main contract.
- Assignment restrictions: This limits the number of times the CW can be assigned, protecting the warrantor from unforeseen liabilities to several third parties.
Beneficiaries of a CW can also include provisions to provide further security on the project. A commonly included provision is a ‘step-in rights’ provision. This provision gives the beneficiary a right to step in, in place of the employer/contractor on a project. For example, this could ensure the project will continue where the employer/contractor has gone insolvent.
Collateral warranties will remain a feature of construction contracts for the foreseeable future, acting as a safeguard to keep projects on track and manage risk accordingly.
Harry King, Junior Associate
Quigg Golden
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