Collateral warranties (if you don’t know what they are, read what is a collateral warranty) are common on UK construction projects.
The problem that they were designed to address is that if the works or services are performed defectively then it won’t necessarily be the employer of the wrongdoers who suffers the loss.
Their employer has often passed all their interest as well as other legal interests to the owner, tenant, purchasers or investors. This produces a problem, as a principle called ‘privity of contract’ means only the employer of the wrongdoer can bring a claim as it has the only direct contractual relationship.
Stakeholders are rarely involved during the project, not able to give instructions or change the nature of the works, and do not pay any money directly to the project team. Nonetheless defects can mean they suffer huge financial losses. If those losses were caused by negligent design or workmanship, or defects which were avoidable, then the stakeholders want to hold the relevant members of the project team accountable, and recover their losses.
The process was further described in Scottish Widows v Harmon (2010):
A collateral warranty provides, in summary, that the person giving the warranty [the warrantor] undertakes various contractual duties to the person who receives the warranty [the stakeholder]; where the warranty is given by a contractor the obligation is to perform the obligations undertaken in the contract with the employer… and where the warranty is given by a member of the professional team the obligation is to perform the duties undertaken to the employer with due care and diligence.
A collateral warranty is a contract between the stakeholder and the warrantor. If the warrantor fails to perform its duties to the required standard, and the stakeholder suffers loss as a result of that defective performance, it can bring proceedings against the warrantor.
The right to sue is based on:
- the existence of a contractual obligation (in the underlying contract and then reinforced in the warranty)
- breach of that duty, and
- loss caused by the breach and suffered by the stakeholder.
Are warranties a solution?
There are a number of problems that collateral warranties create for the stakeholders:
- secondary liability: if the underlying contract is limited in scope or liability, or the collateral warranty contains restrictions on remedies, the stakeholder may not be able to recover all its losses.
- evidential: the stakeholder may not have copies of the relevant underlying contracts to determine which parties may be at fault.
- sharing liability: whether it is through net contribution clauses or the Civil Liability (Contribution) Act 1978, the liability for defects on the project will be jointly and severally owned. This will result in the stakeholder having to bring claims against multiple parties, and can result in incomplete recovery where members of the project team became insolvent.
- insurance: the only asset most warrantors have to pay for damages is their professional indemnity insurance which may not be valid, respond to the specific claim or may have already reached its annual aggregate limit.
- when the loss was suffered: in Scottish Widows the property was defective at completion and before several of the stakeholders took interests in the property. It was unsuccessfully argued that this prevented their claims.
The court has said that despite these issues collateral warranties ‘must be construed in such a way as to further their essential purpose, namely to ensure that the party who suffers loss has a right of action against any contractor or member of the professional team who has provided defective work.’
What should you do?
Always consider the purpose of the collateral warranties and don’t just treat them as paperwork for paperwork’s sake (or the digital equivalent). Consider carefully their scope, the entire package of protections on a project, the insurance that will respond to any claims and alternatives.
If you want simpler collateral warranties, or to know what they really don’t need to include, read my book on the subject.
Book: How to Write Simple and Effective Collateral Warranties in Just 500 Words, available from Amazon in paperback and kindle. Case: Scottish Widows Services & Anor v Harmon/CRM Facades Ltd  ScotCS CSOH_42