In any construction project, there will be multiple parties with an interest in the works to be constructed, who have no contractual nexus with some or all of the parties responsible for designing and building those works. Collateral warranties create a contractual link between the construction professional (e.g. the building contractor, sub- contractor, professional consultant) and the third party, such as a funder, purchaser or tenant (or indeed an employer seeking a direct right of recourse against a sub-contractor/sub- consultant). As their name implies, collateral warranties are ancillary to the "primary" agreement, namely the building contract, sub-contract or consultant appointment. In providing a collateral warranty, the warrantor is promising the beneficiary that it has complied with the primary agreement and/or will comply with the terms of the primary agreement such that the beneficiary will have a right to sue the warrantor for any breach of contract.
Over time, similar contractual instruments have developed alongside collateral warranties, namely, (a) duty of care deeds, and (b) direct agreements. In essence, a duty of care deed is a simplified collateral warranty which extends a duty of care owed under a separate agreement to a third party. A direct agreement, usually sought by funders, has the distinguishing feature of affording a beneficiary the right to "step-in" to the primary agreement in the event of, for example, the counterparty to the primary agreement becoming insolvent before completion of the project. Direct agreements also contain additional terms reflecting further funder requirements (which may vary).
This briefing looks at some of the key clauses and issues which can arise in negotiating collateral agreements.
Performance of the Underlying Contract
The warrantor's promise to comply with the terms of the primary agreement is the essence of the collateral agreement and such promise should not be qualified. The collateral agreement will often also specify the level of skill, care and diligence to be provided by the warrantor when performing the services/ works under the primary agreement. In order to avoid uncertainty however, the skill and care obligations in the primary agreement and the collateral agreement must align.
Professional Indemnity Insurance
Whilst the primary agreement may already require the warrantor to maintain professional indemnity insurance, similar insurance undertakings are often also included in the collateral agreement. The level of insurance required to be maintained should be clearly stated (including the basis on which it is held, e.g. on an each and every claim basis, or in the aggregate), along with an obligation for the warrantor to produce evidence to the beneficiary of the insurance held. The period during which the insurance is required to be held should also be agreed, and preferably should be linked to the period of liability under the collateral agreement (e.g. usually 6 or 12 years following practical completion of the project). Some beneficiaries may also seek the option to take out this insurance and recover costs from the warranting party.
Beneficiaries will require a clause granting the beneficiary an irrevocable, royalty-free licence to use any documentation and the designs contained in them created by (or on behalf of) the warrantor for any purpose in connection with the project. Without such licence, the beneficiary will not have any rights to use/reproduce this information. Beneficiaries should seek that the copyright licence is unfettered and contains a right to grant sub- licences. Warrantors will often seek to be entitled to revoke the licence where they are not paid in accordance with the terms of the primary agreement, but this should be resisted.
Primarily sought by lenders to try to protect against loss of investment in the event of a borrower default (usually insolvency), step-in provisions afford the beneficiary the right to 'stand in the shoes' of the counterparty to the primary agreement and complete the project in its place. As step-in rights can be granted to a number of different beneficiaries on any given project, the collateral agreement should make clear which beneficiary's right to step-in is to take precedence.
LIMITATIONS ON LIABILITY?
Warranting parties will generally seek to limit their liability under collateral agreements that are given and some or all of the provisions below may be included. Some limitations are reasonable, but the various limitations need to be considered in their totality in order to understand their overall impact.
Net Contribution Clauses
Net contribution clauses are regularly sought by the warranting party to limit its liability to such element of the loss or damage that is properly attributed to it, such that it will not be fixed with responsibility for the acts or omissions of others involved in the project (whom the beneficiary would have to pursue separately).
No Greater Liability Clauses
Such clauses limit the warrantor's liability to that contained within the primary agreement, emphasising the need to check the terms of that agreement for any limitations it may contain, for example, monetary caps on liability.
Equivalent Rights of Defence
An equivalent rights of defence clause allows the warrantor, in the event of a claim under the collateral agreement, to rely on those defences it has against the original contracting party in the primary agreement. Once again, this means that the exercise of carefully reviewing the terms of the primary agreement is fundamental. Often, where a beneficiary is willing to accept an equivalent rights of defence clause, it will be on the basis that any 'set-offs' and counterclaims are excluded. If such exclusions are not included, the warrantor may be able to counterclaim or set off a sum due to it for example, outstanding fees, against the beneficiary's claim under the collateral agreement.
Exclusion of Consequential Loss
The warranting party will often seek to limit its liability to direct losses only such as the costs of remedying any physical defects, and exclude liability for consequential losses flowing from the breach of contract. If such a clause is to be accepted by a beneficiary, it may be helpful for the collateral agreement to expressly set out the excluded losses.
The warranting party may seek to limit its liability to a particular sum, often linked to the level of professional indemnity insurance held. The beneficiary will wish to ensure that the sum agreed is sufficient having regard to the nature and value of the works being undertaken.
Collateral warranties (and/or duty of care deeds / direct agreements) play an essential role in the majority of construction and engineering projects. Over time, the terms and conditions of collateral agreements have been refined and parties often seek to negotiate significant limitations of liability under the agreement. Ultimately, whatever the terms agreed, the "collateral" agreement will only ever be as good as the underlying contract. Close attention should therefore always be paid to ensure that each agreement "speaks to the other".
This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.