Collateral warranties and the ones nobody executes

Contracts bind the parties to them. A funder lending against a building, or a tenant taking a lease on it, has no contract with the contractor or the designers and therefore no obvious route to sue anybody if the roof leaks.

A collateral warranty fixes that. It is a separate contract between, say, the structural engineer and the funder, in which the engineer warrants to the funder that it exercised reasonable skill and care. It creates the relationship that the project structure did not.

Who typically needs them

• The funder, so its security has value if the building is defective.
• Purchasers and tenants, for the same reason.
• The employer, from subcontractors with design responsibility, since its contract is with the main contractor and not with them.

On a development of any size that is easily thirty documents: main contractor, six or seven consultants, and every design subcontractor, each to two or three beneficiaries.

Why they go missing

The obligation to provide them sits in a contract signed at the start, and the demand for them arrives at the end, from a party that was not in the room. By then the subcontractor has been paid, has moved on, and has no commercial reason to sign a document that increases its liability.

The leverage to obtain them exists while money is still owed. Once the final account is settled, there is very little.

Third party rights as an alternative

The Contracts (Rights of Third Parties) Act 1999 allows a contract to confer rights directly on named third parties, which can achieve much of what a warranty does without a separate document to execute.

Some standard forms now provide for this by way of a schedule and a notice. It is administratively far lighter. Whether a funder will accept it instead of a warranty is a separate question, and many still will not, so the practical answer is often both routes drafted and one used.

What to check in one

• Net contribution clause. Limits the warrantor’s liability to its fair share rather than the whole loss. Common, and materially reduces recovery.
• Step-in rights. Let a funder take over the appointment if the employer defaults. Usually the funder’s main interest.
• Limitation period. Should match the underlying appointment. A warranty executed as a deed against an appointment signed under hand creates a mismatch.
• Assignment. How many times the benefit can be passed on, since buildings change hands.

The commercial point

Chase them while you are still paying. A register that shows which are executed, which are in draft and which have never been sent is worth building at contract stage, because the answer at practical completion is always worse than anyone expects.