What is a Collateral Warranty?

A collateral warranty is an agreement that links a party in a construction project—such as a funder, tenant, or purchaser—to a contractor, sub-contractor, or consultant. It bridges the gap between the underlying building contract and the rights of interested third parties, ensuring those not directly involved in the main contract have enforceable rights.

A warranty is a contract that gives third party beneficiaries the ability to enforce obligations in the underlying contract. These warranties are common in construction contracts, especially in large projects involving multiple stakeholders.

Why Do Collateral Warranties Matter?

In construction, the principle of privity of contract means that only the parties involved in a contract can enforce its terms. This creates a contractual gap for interested third parties who have an interest in the project but no direct contractual relationship with the construction team.

Collateral warranties address this gap by granting third party rights to funders, tenants, purchasers, or other stakeholders.

Example: A main contractor might provide a warranty to a funder, giving them legal recourse if there are defects or breaches of the underlying building contract.

Collateral Warranty Features

Direct Contractual Link
Creates a contractual link between a third party beneficiary and a contractor, sub-contractor, or professional consultant.

Party Obligations
The warrantor warrants to the party beneficiary that they will fulfil their obligations under the main contract, such as meeting agreed design or construction standards.

Third Party Rights
Grants third parties the ability to enforce the terms of the original contract, including addressing defects arising or financial losses suffered.

Step-In Rights
In some cases, warranties may include step-in rights, allowing a management company or funder to take over the contractor’s role if the original contractor defaults.

Statutory Rights
Although not a statutory right, collateral warranties are recognised under contract law as enforceable agreements.

Examples of Collateral Warranties

Funders
A funder financing a project may require a warranty to protect their investment in case of defects or breaches.

Tenants
Tenants often rely on collateral warranties to ensure the building meets agreed standards and is fit for occupation upon practical completion.

Purchasers
A purchaser might need a warranty to claim for defects or pure economic loss caused by issues in the underlying contract.

Management Companies
In multi-tenant buildings, a management company might use a warranty to address quality issues or defects caused by the construction team, such as a contractor or design team.

Advantages of Collateral Warranties

Legal Protection: Offers third parties legal recourse for defects or breaches in the building contract.

Direct Rights: Creates a direct contractual link where none previously existed, avoiding reliance on negligence claims.

Financial Protection: Safeguards stakeholders from financial losses caused by defective work.

Step-In Rights: Enables stakeholders to mitigate risks if a party involved in the project defaults.

Collateral Warranties in Construction

Collateral warranties are widely used in construction operations due to the layered relationships between the construction team, contractors, consultants, and stakeholders.

Examples:

A professional appointment between a consultant and an employer might require the consultant to provide collateral warranties to tenants or funders.

A sub-contractor may issue a warranty to the main contractor to address quality issues or defects after practical completion.

Note: Without a collateral warranty, interested third parties have limited options for claiming compensation, as they lack a contractual claim under the underlying building contract.

Common Clauses in Collateral Warranties

Obligations
The warrantor promises to fulfil their obligations under the main contract, such as maintaining specific design or construction standards.

Defects
Specifies the warrantor’s responsibility for addressing defects and ensuring work quality.

Assignment
Allows warranties to be transferred to new parties, such as future tenants or purchasers.

Step-In Rights
Permits a funder or management company to take over the contractor’s role if the contractor defaults.

FAQs

1. What is a collateral warranty for?
It creates a direct contractual link between a third party and the construction team, enabling enforceable rights.

2. Who benefits from a collateral warranty?
Funders, tenants, purchasers, and other third party beneficiaries.

3. Can collateral warranties be enforced?
Yes, they are legally binding contracts under contract law.

4. Do I need a collateral warranty for every construction project?
Not always, but they are essential when third parties need legal protection.

5. What happens if there’s no collateral warranty?
Without one, third parties must rely on negligence claims, which can provide limited financial recovery.

Summary

Most collateral warranties are crucial in construction operations, ensuring third party rights and accountability. They bridge the contractual gap between the underlying building contract and stakeholders, offering legal protection and mitigating risks.

Whether you are a tenant, funder, or purchaser, a well-drafted warranty will safeguard your interests.

Get legal advice to ensure the agreement suits your needs and aligns with your role in the project. For more information, consult experts in construction contracts and collateral warranties.