The Scottish Appeal Court (the Inner House) has confirmed my suspicion that a collateral warranty is impliedly limited by the scope and terms of the underlying agreement.
What are collateral warranties?
A collateral warranty is a simple document designed to create contractual links between the provider of goods, works or services (the warrantor) and a party with a financial interest in the project (the stakeholder).
In its purest form, a collateral warranty simply allows the stakeholder (also known as the beneficiary) – who was not a party to the contract between the warrantor and its employer – to bring a claim if the warrantor breaches that contract and causes the stakeholder a loss.
Read more about what a collateral warranty is.
How are the contracts linked?
The collateral warranty included two key clauses stating that:
- the warranty did not create any greater liability than the liabilities in the underlying agreement, and
- the warrantor can rely on like rights of set-off, contra-charge or defence to those in the underlying agreement. Effectively preventing double-recovery.
The court stressed that the fundamental purpose of the collateral warranty was to place the stakeholder in an equivalent position to the original employer in the underlying agreement; and not to extend the obligations of the warrantor:
their purpose is to provide [stakeholders] with rights against the [warrantor] that are equivalent to the rights that were enjoyed by the original employer under the [underlying contract]. The notion of equivalence is central. The purpose of the warranty is not to provide [stakeholders] with rights greater than those held by the original employer; to do so would make no commercial senseBritish Overseas Bank v Milne (2019)
‘Equivalent position’ means that the stakeholder has the same rights as the original employer BUT subject to the same limitations as would apply between the warrantor and that employer.
What should you do?
If you don’t want to bet your business on a project, consider limits on your liability or on those making promises to you.
As a supplier, include sensible limits on your liability in every contract. If you end up giving collateral warranties, those limits will form the basis of your defence and limit the amount of any stakeholder claim under the warranty.
Case: British Overseas Bank Nominees Limited v Stewart Milne Group Limited  CSIH 47