Building Blocks: What is a Collateral Warranty? (1)

What is a collateral warranty (to a beneficiary)?

A collateral warranty is provided by a party who has agreed to provide services or works under a building contract or consultant’s appointment. It warrants to an interested third party, such as a funder, purchaser or tenant (usually described as a beneficiary) that it has fulfilled its obligations under the contract or appointment.

The contract or appointment gives the Employer contractual recourse against the contractor or consultant if a breach of contract arises. However, it does not offer a beneficiary the same protection. Beneficiaries do not have a contractual link as they are not a party to the contract or appointment.

This is the gap that collateral warranties fill: they create a contractual relationship between the party responsible for the works or services and the beneficiary, under which the responsible party promises to the beneficiary that it will comply with its obligations under the contract or appointment.

Who should receive a collateral warranty?

Construction projects involve a range of parties with an interest in the development (funders, purchasers, tenants). These parties usually require collateral warranties from the key members of the design team and the main contractor. For example, a tenant will often have entered into a lease on a fully insuring and repairing basis. They may therefore require collateral warranties to allow them to claim against the key members of the design and the main contractor in the event they have to pay for the rectification of a defect.

The step-in option

Some collateral warranties contain “step-in” rights which effectively allow the beneficiary to step into the shoes of the Employer in certain circumstances. Such circumstances include, for example:

• where the Employer becomes insolvent and a funder wants to ‘step into’ the shoes of the Employer an employ the contractor to complete the build

As well as the collateral warranties mentioned above, it is also the case that the Employer often seeks collateral warranties from sub-contractors.