Get More TLC: #3: Tiny little contracts

This edition looks at tiny little contracts … or at least that’s what collateral warranties are meant to be.

A photograh with a miniature supermarket trolley on the lft next to a white rectangular box with a wide black shiny ribbon tied in a bow.

Time-Bound, Limited and Collateral?

If you’re not in the construction industry you may not know what a collateral warranty is. You can think of them as a ‘gift receipt’.

If your aunt buys you a new laptop, she might not want you to know how generous she has been, but she does want you to be able to get it repaired or replaced if it doesn’t work. The contract for the sale of your laptop was between the shop and your aunt. You have no rights to enforce that contract because you were not a party to it (called privity of contract). However, the gift receipt enables your aunt to pass her rights to repair or replacement onto you.

On construction projects, a collateral warranty allows a company with a financial investment in a property – such as the bank who funded it, the business buying it or part of it, or a retailer who is paying the rent on it – to claim compensation against those who provide goods, works or services for that property, when and if it is defective. Whether that is because the water-cooling system leaks, the supermarket car park is defective, or there is damp in your newly refurbished property.

An image showing the use of a collateral warranty. There are three entities represented by text boxes stacked in a column: company C interested in property X (recipient of the warranty), Party A (receiving goods, works or services) and Party B (providing goods, works or services). There is thick black arrow between the text boxes for Party A and Party B representing the contract between them. There is single-headed curvaceous arrow flowing from the textbox for Company C towards the textbox for Party B representing the collateral warranty from the provider to the company interested in the property. Image by Sarah Fox

If you are the provider of goods, works or services (party B in this diagram), giving a warranty feels like you are increasing and spreading your risk. But warranties are impliedly (and often expressly):

  • Time-bound ie company C must bring any claim within contract 1’s limitation period 
  • Limited ie company C cannot claim more compensation than party A would have claimed
  • Collateral ie company C’s claim is dependent on the terms of contract 1.

Warranties (and their cousin, third party rights) are a key part of the complex web of construction contracts and many investors are unwilling to forego their potential benefits. So, plan them into your risk analysis from the start.

Tip: Get your warranties reviewed if you are worried you are not getting TLC from them

For more, check the critical questions you should ask before you ask for or provide warranties. The alternatives (listed here) might be preferable. You can find out everything you don’t understand about warranties in my book.