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Collateral warranties: claims are on the increase

Collateral warranties are increasingly relied upon by the majority of projects despite legislation that could have removed them, and their application is likely to widen.

Collateral warranties have been a mainstay of the construction industry for many years.

Despite the introduction of the Contracts (Rights of Third Parties) Act 1999, which could potentially have done away with the need for them, the majority of construction projects still rely on a package of collateral warranties.

Simply, a collateral warranty creates a contract between two parties where otherwise there would be none, and warrants that a party has complied or will comply with its obligations under the building contract, subcontract or appointment.

They are given by parties building or designing the works (main contractor, subcontractor, architect, etc) to those with a third-party interest in the finished works (employer, buyer, funder, tenant, etc).

Two recent cases illustrate the increasing reliance on collateral warranties in the industry – a trend which is likely to develop and widen their application.

Insolvency and insurance

The first case, Oakapple Homes (Glossop) Limited v DTR (2009) Limited (in liquidation) and others, relates to a key benefit of collateral warranties: that design liability is often backed by professional indemnity insurance.

It depends on the wording of the collateral warranty and the policy, but such insurance can provide a source of recompense for the beneficiary, even if the relevant designer/contractor has since gone insolvent.

“The judge’s ruling came as a surprise to many and provided another way to sue under a collateral warranty: statutory adjudication”

The Oakapple case took this a step further.

Here, purchasers without collateral warranties (but contractually entitled to them) sought a court judgment forcing the architects, who had entered liquidation, to enter into the collateral warranties.

This was in order to rely on the architect’s insurance, following the destruction of the property by fire.

Collateral warranties and the Construction Act

The second case, Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd considered whether a collateral warranty given by a design-and-build contractor to a tenant was a ‘construction contract’ under the Housing Grants, Construction and Regeneration Act 1996 (‘the act’). 

The judge held it was, much to the surprise of many, thereby providing another way to sue under a collateral warranty: statutory adjudication.

The judge stressed that not all collateral warranties will be construction contracts under the act – it will depend on the facts and the wording of the warranty.

“The extra protections collateral warranties provide will keep them ever popular with beneficiaries”

In this case, it was a construction contract because the contractor’s obligations included carrying out and completing the works, and was not just in respect of a completed project.

However, this is standard wording in collateral warranties and is likely to affect a large number of them.

The future and practical tips

We’ll have to wait and see where the courts go next and whether the market will start to include adjudication provisions in collateral warranties.

Whatever happens, collateral warranties are unlikely to disappear any time soon.

The extra protections they provide in terms of parties to sue, and now the option of adjudication, will keep them ever popular with beneficiaries.

In the meantime, if you are asked to provide a collateral warranty, consider:

  • Including a provision stating it is a construction contract and the parties can adjudicate – this would avoid potential uncertainty;
  • Limiting the number of warranties you provide to reduce the potential number of claimants;
  • Whether it is appropriate to simply warrant the finished project rather than “carrying out and completion of the works”.

Remember, a claim under a warranty could be taken to adjudication.

Consider early on whether you want to challenge any adjudication on the basis that the contract is not a construction contract. 

Helen Jones is a solicitor at Dundas & Wilson

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