notice of assignment collateral warranty

Assignment of a collateral warranty

Published by a lexisnexis construction expert.

This Practice Note focuses on the assignment of collateral warranties (see Practice Note: What are collateral warranties?). For more detailed guidance on assignment in general, see Practice Notes: Assignment in construction contracts and Legal and equitable assignment in construction contracts. Although this Practice Note refers to collateral warranties, the principles also apply where third party rights are used as an alternative to collateral warranties, see: Contracts (Rights of Third Parties) Act 1999 in construction—overview.

Assignment provisions in collateral warranties

The general rule is that if a contract is silent on the issue of assignment, this means that the benefit of the contract can be assigned without limit or without requiring consent (as permitted by law under section 136(1) of the Law of Property Act 1925 (LPA 1925))—there is no requirement to obtain the consent of the obligor to any proposed assignment. See Practice Note: Restrictions on the assignment of rights in construction contracts.

Most construction contracts contain express assignment clauses to clarify the rights of each of the parties in respect of assignment and this is also usually the

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Related legal acts:

• Contracts (Rights of Third Parties) Act 1999 (1999 c 31)
• Law of Property Act 1925 (1925 c 20)

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Assignment definition, what does assignment mean.

An assignment is 'an immediate transfer of an existing proprietary right, vested or contingent from one party to another'. Assignments can occur by consent or by operation of law.

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Home » News & publications » Latest news » Collateral warranties: an overview

Collateral warranties: an overview

Posted: 04/01/2013

Everyone involved in the construction industry will be aware of the traditional contractual relationships that exist in the basic structure of most construction projects. That is, the employer contracts with the contractor, who in turn contracts with any sub-contractors and/or sub-consultants. This arrangement leaves the employer with no contractual relationship with any of the sub-contractors or sub-consultants.

This is not normally a problem provided the employer appoints a financially robust and competent contractor. In fact, in many instances the employer often prefers to have a contractual relationship with only one party because it creates a single point of responsibility. This means that should problems arise during construction, or, should a defect arise during the liability period, or later, the employer merely has to turn to the contractor to resolve it or to pay up.

However, there may be situations where this lack of contractual relationship with sub-contractors or sub-consultants could be problematic. These typically arise on contractor insolvency, whether during the construction or post completion. Here, if the employer’s only contract is with the contractor, the employer has no contract on which to seek damages and the doctrine of privity of contract prevents him using any agreement between the contractor and sub-contractor or sub-consultant as a means of redress.

Further, the employer is likely to face difficulties in bringing a tortious claim against sub-contractor/sub-consultant because of the restrictions places on the recovery of pure economic loss and because of the difficulty in establishing that a sub-contractor/sub-consultant owes a sufficient duty of care to a distant employer.

In order to address these problems, the employer can require the sub-contractor/sub-consultant to enter into a collateral warranty with them. This creates a direct contractual relationship between the two parties.

Key clauses

Collateral warranties typically follow a standard approach. Some are now standard form documents but many bespoke collateral warranties exist and they need to be read closely to fully understand their effect. The following are examples of the most common clauses. However, more complex projects will likely require tailored collateral warranties.

Consideration : collateral warranties are normally executed as a deed and so do not require consideration. However, sometimes the parties choose to include some nominal consideration just in case the deed is not executed properly. The collateral warranty will then take effect as a contract.

Principal covenant : this is where the sub-contractor/sub-consultant warrants that they have complied with the terms of their sub-contract/appointment. If they have a design responsibility they will also warrant that they have performed this duty with the skill, care and diligence to be expected from a person of the relevant profession.

Employers beware: the principal covenant is only as strong as the sub-contract/appointment. Employers should ensure the sub-contract/appointment includes all key terms and requires the sub-contractor/sub-consultant to exercise a good degree of care. If not, the value of a collateral warranty will inevitably be limited.

Non use of deleterious materials : the sub-contractor/sub-consultant warrants to the employer that he will not use or specify materials that will be deleterious to any part of the works.

Step in rights : these can be very important. They allow the employer to ‘step into the shoes’ of the contractor if the contractor becomes unable to complete the construction – typically through insolvency. In the current economic climate where contractor insolvency is all too common, this clause can be of great importance. However, the sub-contract/appointment should be drafted to make the exercise of these rights optional: for example, the employer may not wish to insist on stepping in as this may not be financially prudent for the employer depending upon the overall financial position of the sub-contract/appointment.

Copyright : many collateral warranties will contain a copyright clause allowing the employer to use any design documents the sub-contractor/sub-consultant prepares. The licence should be royalty free, irrevocable, non-exclusive and include the right to assign.

PI insurance : if the sub-contractor/sub-consultant has design responsibility, the collateral warranty will require that PII is kept in place for the full length of the warranty, typically 12 years if in deed form or six years if in contract form.

Liability period : this will again be 12 years if the collateral warranty is executed as a deed and six if a contract. Employers should seek a liability period equal to the liability period under the building contract.

Assignment : there is usually a restriction on the employer’s ability to assign; often the collateral warranty will provide that two assignments are allowed. Subject to the nature of the works, and whether or not they are likely to be sold often, the warranty may need to expressly provide for assignment more than twice throughout the 12 year period.

Limitations

The sub-contractor/sub-consultant will want to try and limit his liability under the collateral warranty. The most common method of doing this is the use of “no greater duty” and “equivalent rights defence” clauses. These state, respectively, that the sub-contractor/sub-consultant owes no greater duty to the employer than he does to the contractor under the professional sub-contract/appointment and that the sub-contractor/sub-consultant may use any defence available under the sub-contract/appointment when defending any claim under the collateral warranty. In addition, the sub-contractor/sub-consultant will try to limit what can be recovered to make repairs or take remedial action. For example, if consequential trading losses can be claimed, this may be prohibitively expensive.

The sub-contractor/sub-consultant may also try to use a net contribution clause, though the use of these is fairly controversial and usually a matter for negotiation. As often, commercial bargaining power will probably determine who triumphs.

The effect of a net contribution clause is to adjust the default position of joint and several liability. That is, normally, the employer would be able to recover all losses from just one sub-contractor/sub-consultant. The responsibility would then be on that particular sub-contractor/sub-consultant to recover the money he has paid out over and above his ‘fair share’ (i.e.: the proportion of damages attributable to his breach) from the other sub-contractors/sub-consultants by reference to the Civil Liability (Contribution) Act 1978. However, a net contribution clause limits the employers recovery from each sub-contractor/sub-consultant to that which is “just and equitable.” In such circumstance the employer therefore needs to sue all sub-contractors/sub-consultants individually and demonstrate the amount of their contribution. All of this can be significantly harder for an employer than simply demonstrating that damages are due from any one of the sub-contractors/sub-consultants.

Sub-contractors/sub-consultants often push for such net contribution clauses because they push the risk of another sub-contractor’s/sub-consultant’s insolvency and the risk of litigation onto the employer. Employers will wish to resist them for the same reasons.

In the current economic climate when everyone is aware of the increased likelihood of contractor insolvency, the allocation of this risk is often hotly negotiated.

Court’s view

It is perhaps surprising given their prevalence but cases concerning collateral warranties before the English courts are not large in numbers. However, where they have been discussed, it appears the court supports the commercial principle behind collateral warranties; How Engineering Services Ltd v Southern Insulation (Medway) Ltd [2010] and Linklaters Business Services v McAlpine Ltd and others [2010].

Cases concerning net contribution clauses are rarer still. However, the Scottish courts have stated that, even though they seek to limit liability, the clauses do not fall foul of the Unfair Contract Terms Act 1977 ( Langstane Housing Association Ltd v Riverside Construction Aberdeen Ltd & Ors [2009] ScotCS CSOH 52). Whilst this view is not widely supported by legal practitioners, it is by institutions such as RIBA and ACE.

Alternatives

Alternative options to the use of collateral warranties are assignment and third party rights. Neither have proved particularly popular. The trouble with an assignment is that it can only be used once and the Employer may also want to keep part of the benefit. Third party rights are potentially more useful. In fact, they may be more efficient, requiring modified drafting to only one document. However, although use of third party rights has been available since the Contracts (rights of Third Parties) Act 1999 came in to force in November 1999 these have not been widely used and few within the construction industry after familiar with them.

Other requests

Other involved parties may also request collateral warranties. These include any future tenant or purchaser of the property, and freehold owner or any funder of the project.

Arranging and securing fully executed collateral warranties can be hugely time consuming. Many involved in the construction industry are not fans of collateral warranties for this reason. However, those who are putting up the money for projects, whether they be employers or funders, fully recognise the value of securing well drafted collateral warranties and collateral warranties are likely to be around for some time to come.

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Collateral warranties – an update

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Last year, there were two key decisions relating to collateral warranties in Abbey Healthcare (Mill Hill) Ltd-v- Simply Construct (UK) LLP [2022] EWCA Civ 823 and Orchard Plaza Management Co Ltd -v- Balfour Beatty Regional Construction Ltd [2022] EWHC 1490 (TCC). 

In December 2022 it was confirmed that Simply has been granted permission to appeal to the Supreme Court in the case of Abbey Healthcare.

A collateral warranty is a promise by the contractor or a professional consultant (the warrantor) to carry out its obligations under a building contract or professional appointment for the benefit of a third party who has an interest in the construction project such as a purchaser, funder or tenant. 

These two cases cover (i) if a collateral warranty is a ‘construction contract’ under the Housing Grants, Construction and Regeneration Act 1996 (‘the Construction Act’) and (ii) the effect of assignment on the rights under a collateral warranty. 

Is a collateral warranty a construction contract? 

The question of whether a collateral warranty is a construction contract was previously considered in the case of Parkwood Leisure Ltd -v- Laing O’Rourke Wales and West Ltd [2013] EWHC 2665. This question is important because if a collateral warranty is found to be a construction contract, then the beneficiary has certain rights under the Construction Act including the right to adjudicate. The statutory process of adjudication is often a quicker and cheaper way to resolve disputes than litigation or arbitration. 

The decision in Parkwood was clear that not every collateral warranty would be a construction contract as it depended on the precise wording used; if a contractor warranted to positively carry out the construction operations, the collateral warranty would likely be a construction contract but if they only warranted to a previous state of affairs then it pointed towards the collateral warranty not being a construction contract. 

The case of Abbey Healthcare is an example of a beneficiary under a collateral warranty seeking to enforce its rights through adjudication. Abbey was the ultimate tenant and manager of a care home designed and built by Simply. There were some cladding and fire safety defects identified in the building which required remediation. The owner and Abbey commenced separate and successful adjudication proceedings against Simply for the cost of the remediation works. Simply did not pay and argued that the collateral warranty was not a construction contract and so the adjudicator had no jurisdiction. The judge at the enforcement hearing agreed that the collateral warranty was not a construction contract and seemed to rely on the fact that the warranty was given four years after practical completion so Simply were warranting to a past state of affairs and not providing a contract for the carrying out of construction operations. 

The decision of the judge was appealed and the Court of Appeal took a different view. Upholding Parkwood, the majority decided that whether a collateral warranty was a construction contract depended on its wording: whilst the wording in the Abbey collateral warranty differed from the Parkwood collateral warranty it still related to both past and future performance so was a construction contract. The Court of Appeal found that if a collateral warranty was akin to a performance guarantee, then the collateral warranty was not a construction contract. 

The position established by the Court of Appeal could be overturned by the Supreme Court. It remains to be seen if the Supreme Court will row back from the position in Abbey to the earlier more limited position in Parkwood. Until the Supreme Court reaches its decision, any beneficiary under a collateral warranty looking to commence dispute resolution procedure ought to be cautious about pursuing adjudication proceedings. 

Assignment of a Collateral Warranty 

The facts of Orchard Plaza are that a warranty originally given in favour of the funder was then assigned twice, as permitted by the terms of the collateral warranty, to the developer and then finally to the building owner. 

Warranties usually provide a right to assign, albeit usually such assignments are limited in number or limited to a category of beneficiary. It is common to also see what is called a ‘no loss’ clause. This clause is intended to prevent the warrantor arguing that an assignee cannot recover an amount under the collateral warranty because it is an assignee and the assignor has not suffered or incurred any loss or would not have suffered that type of loss. 

In Orchard Plaza, the building owner sought to recover the cost of remedial works from the contractor under the collateral warranty.

The contractor argued that the loss was too remote (ie not reasonably foreseeable as at the date of the underlying contract) as the losses that could have been foreseen by the contractor were those suffered by the funder who originally had the benefit of the collateral warranty (ie the diminution in value of its security). 

The court held that the losses suffered by the building owner were not too remote. It clarified the test for remoteness was whether the kind of loss now claimed was, at the time the contract was made, reasonably contemplated as a serious possibility . The judge decided that it was in the contractor’s reasonable contemplation as a serious possibility that an assignee would incur repair costs because of a breach by the contractor.

Key takeaways 

The Court of Appeal decision in Abbey was significant because many forms of collateral warranties in use were thought likely to be a construction contract. However, the appeal to the Supreme Court means that the right to bring adjudication proceedings in relation to a collateral warranty is still unclear. Until such position is clarified, there is significant risk that using adjudication to resolve a dispute under a collateral warranty could be subject to a successful jurisdictional challenge. 

Beneficiaries who have been assigned the benefit of a collateral warranty will take comfort in the upholding of the no loss provision in Orchard Plaza which is wording commonly used in well-drafted collateral warranties. However, warrantors and their insurers will be more anxious to limit the scope of any assignment provisions and also perhaps, to limit their liability.

Watch this space! We will provide a further update once the Supreme Court has made a decision on Abbey.

• Collateral Warranties

Construction

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Insights / Article 11.05.2023

Collateral warranties – why.

• Type Article Event News Publication
• Practice Area Business Crime & Regulatory Services Child Care Commercial Commercial Dispute Resolution Commercial Property Commerical Recoveries Construction & Engineering Corporate Criminal Defence Employment Employment & Business Immigration Family & Divorce Intellectual Property IT & Data Personal Injury & Medical Negligence Real Estate Residential Property Wills, Trusts & Probate

When it comes to construction contracts, there are often multiple parties involved, each with their own interests and concerns. An important aspect of these contracts is third party rights, which allow individuals or organisations who are not directly involved in the agreement to enforce certain terms or protections. In this article we look into third party rights in construction contracts, examining the legislation that governs them, the benefits they offer, and the importance of collateral warranties in ensuring their effectiveness. Whether you are a contractor, subcontractor, or other party involved in the construction process, understanding third party rights is essential for protecting your interests and ensuring a successful project outcome.

What are third party rights?

Third party rights exist to enable a third party who is not a party to a contract to enforce the terms of the contract.

In construction documents, third party rights are often a set of rights expressly enforceable by a third party and set out in a schedule to a professional appointment or building contract.

Third parties who often acquire third party rights are as follows:

• Purchasers; and
• Tenants who occupy the premises after completion.

Which piece of legislation regulates third party rights?

The Contracts (Rights of Third Parties) Act 1999 (“the Act”) regulates third party rights in a construction context.

The introductory text to the Act confirms that this is an act to make provision for the enforcement of contractual terms by third parties.

Section 1(1) of the Act allows the parties to a contract to grant a third party the right to enforce a term of that contract. Section 1(1) states as follows:

Subject to the provisions of this Act, a person who is not a party to a contract (a “third party”) may in his own right enforce a term of the contract if-

(a) the contract expressly provides that he may, or

(b) subject to subsection (2), the term purports to confer a benefit on him.

However, it should be highlighted that in accordance with subsection (2):

Subsection (1)(b) does not apply if on a proper construction of the contract it appears that the parties did not intend the term to be enforceable by the third party.

Prior to the introduction of the Act, parties relied on collateral warranties to protect third party rights, and indeed, this practice continues.

Whilst third parties can rely on the Act, it is restrictive. The Act does not allow a third party to be put under an obligation to do something (a burden) and only allows a third party to enforce the benefit of a contractual term.

Furthermore, where third party rights are not to be retained within a construction contract, the parties to the contract exclude the Act.

Why are third party rights required?

If a third party, for example a funder, purchaser or tenant involved in a construction project, suffers loss or damage caused by a party involved in the design or construction of a project, third party rights exist to protect their legal rights.

Defective design or workmanship could cause such parties different losses. An employer is likely to have a contract with the party responsible for a defect; however other parties may not have.

If third party rights are excluded, third parties may be able to obtain rights by:

• Collateral warranties – these can be used to specifically create a contract between a third party and the professional consultants/contractors; or
• Assigning the benefit of the construction documents to a third party; or
• Operation of the law of negligence – regardless of the existence of a contract, a duty of care is owed by those parties involved in a construction project and therefore third party claims in negligence are common.

However, there are various reasons why third parties may choose to rely on third party rights within a contract as opposed to relying on collateral warranties, assignments, or the law of negligence. Some of these reasons are as follows:

• The construction industry is becoming increasingly familiar with third party rights and in particular how to handle the issues that may arise from the inclusion of third party rights within a construction contract.
• Third party rights can be incorporated into a contract or a professional appointment and therefore the parties do not have to create additional agreements to establish the rights. Effectively, this saves time and money.
• The law of negligence only allows for direct consequential loss and does not allow for pure economic loss. Therefore, a third party does not gain the same breadth of rights as those arising under a contract.
• Often there will be a bar on assignment of the benefit of the construction documents to a third party.

What are collateral warranties and why are they needed?

A collateral warranty is a contract in respect of which an individual involved in a construction project warrants to a third party that it has complied with its obligations pursuant to that project.

Parties may choose to use a collateral warranty rather than relying upon the Act, assignments, or the law of negligence because:

• The construction industry is historically comfortable with collateral warranties.
• The Act does not allow a third party to be put under a burden. The Third Party Rights Act 1999 allows a third party to enforce the benefit of the contract terms only.
• A collateral warranty is a separate contract between the parties to the collateral warranty. It may be enforced, and its benefit may be assigned on the terms set out in the collateral warranty.
• An assignment of the entire benefit of a construction document means that the assignor could not later make a claim under the construction document.
• An assignment would only assign the benefit of a construction document to one party. Separate collateral warranties can be given to more than one party.

Overall, it is clear that the protection of third party rights in respect of construction projects is crucial for the following reasons:

They provide security – if something goes wrong on a construction project, a party who has suffered a loss will want to be able to claim its losses directly from the person who caused the loss; and

Claims in negligence are less likely to succeed than claims in contract – the law of negligence does not allow claims for pure economic loss, and therefore parties need to be able to rely on a contract.

If you have any queries about any matters then please do not hesitate to contact Lewis Cohen on 07956964466 or email [email protected] .

This article is for general information only and does not constitute legal or professional advice.

Lewis Cohen Partner

[email protected] 07956 964 466

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Collateral Warranties: What to look for?

Collateral warranties are a key feature of the construction industry, and they enable beneficiaries such as funders, tenants or purchasers of a development to have a contractual link with the project team. whilst it is possible to utilise the third party rights act, this route is limited, as seen in the case of hurley palmer flatt limited v barclays bank plc [2014] and you can read our analysis here ..

Given the importance of collateral warranties, the focus of this article will be to provide a general overview on some of the clauses and limitations that appear in collateral warranties.

Clauses and their effects?

There are a range of clauses that are typical to collateral warranties, but the key ones highlighted here relate to deleterious materials, professional indemnity insurance, copyright, assignment and step-in rights.

• Deleterious materials – Such a clause will usually contain an obligation to confirm that no deleterious materials which may be damaging to health or the environment will be specified or used in the project. However, it is limited to the level of skill care and diligence required by the professional appointment or building contract.
• Professional indemnity insurance – This clause requires professional indemnity insurance, with reference to asbestos and contamination exclusions under the policy, to be maintained for a specific period of time (usually 12 years from practical completion of the project).
• Copyright licence and use of information – These clauses are commonly included to allow a third-party beneficiary to use design information generated by the project, but only in connection with the project. Copyright should be retained by the warrantor.
• Assignment – It is common for beneficiaries to be afforded the right to assign the benefit of the collateral warranty to a third party. This right to assign may be limited in number to restrict the number of assignments the beneficiary is entitled to.
• Step-in rights – These are often included to give the beneficiary (usually a funder) the right to take the place of an employer under the main contract if the employer were ever to commit a serious and un-remedied breach, that would otherwise enable the warrantor to terminate their contract with them. In practical terms, this right is beneficial to both the warrantor and the beneficiary as the project may continue to completion even though the employer has committed the serious breach, and so allowing the project value to be realised.

Stephen James

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Limitations for the party granting the collateral warranty

A wide range of limitation and exclusion of liability clauses will be relevant when a collateral warranty is being negotiated. These include:

• No greater liability – If this clause is included, then it confirms that the warrantor will take on no greater risk under a collateral warranty than under the main contract; meaning that they cannot be made to pay more than they would be liable for under the original contract.
• Equivalent rights of defence – Such a clause stipulates that all the same rights of defence under the main contract will be available to the warrantor under the collateral warranty, ensuring that the contracts are back-to-back.
• Limitation to the claim period of a beneficiary – This clause limits the period during which a claim can be made by a beneficiary against the warrantor; this is often 12 years from practical completion.
• Net contribution – This clause apportions liability between each party liable for the same loss or damage and are used to limit the warrantor’s liability to a fair and reasonable amount.

These limitations all should take into account the parties’ bargaining positions and the nature/value of the project.

In considering these clauses and limitations, the essence of a collateral warranty is that it is ‘collateral’ to the professional appointment or building contract. In practice, collateral warranties may be harder to enforce if the equivalent provisions in the underlying contract are not the same.

Therefore, collateral warranties are only as good as the underlying contract, and so special attention must be paid to ensuring that they are fully ‘back-to-back’ with the underlying contract.

About this article

• Subject Collateral Warranties: What to look for?
• Author Stephen James
• Expertise Construction
• Published 07 November 2017

Disclaimer This information is for guidance purposes only and should not be regarded as a substitute for taking legal advice. Please refer to the full General Notices on our website.

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A Guide to Collateral Warranties on Construction Projects

Published 12 January 2022  |  Myerson Solicitors

Blogs || Construction || 8 minutes reading time

In this article, we consider collateral warranties, which are often used on construction projects, and we explain what they are, why they may be required, some alternatives to collateral warranties (such as third-party rights) and which parties are likely to give and receive collateral warranties.

What are Collateral Warranties?

In UK law, there is a doctrine of privity of contract which prevents a person who is not a party to a contract from enforcing a term of that contract. The general rule is very simple: only the parties to a contract may sue on it or be sued for breach of its terms. In the context of construction projects, this means that only the employer is able to enforce the terms of the building contract or any professional appointments, for example, that of an architect or structural engineer.

However, other parties often have an interest in the works either during construction or once the works are completed, such as funders, lenders, purchasers, and tenants. It is also often the case that defects may not arise or be discovered until some time after the works have been completed, with the party that is actually affected by the defect being the person in occupation, i.e. the purchaser or tenant.  

If those third parties suffer a loss, such as lost income, or they have to incur the costs of rectifying the defect, then they will be the persons who will need the ability to pursue a claim against the contractor or the professional consultant responsible for the defect. However, since they are not a party to the building contract or professional appointment, they will be unable to pursue a contractual claim under the building contract or professional appointment.  

An alternative to a contractual claim is to bring a claim in tort as a result of negligence. However, in UK law, there are legal limitations on the ability to recover what lawyers refer to as “pure economic loss” in claims in tort, which causes a particular issue in the context of construction claims.  

Economic loss is effectively a financial loss as opposed to damage to a person or property. 

For example, if the defect causes damage to other property or personal injury, then that damage would be recoverable in tort, but the problem is that the costs to rectify the defect itself are purely economic and are unlikely to be recoverable in tort. So if a property has been constructed improperly and it injures an occupier, a claim for the losses arising from the personal injury would be recoverable in tort (subject to satisfying the other requirements for a claim in tort), but the costs to rectify the defect would most likely not.

Since there is unlikely to be an ability to bring a claim for the costs to rectify the defect in either contract or tort, the interested third parties need another route, and this is where collateral warranties come in. A collateral warranty creates a contractual link between the third party and the contractor or professional consultant.

A collateral warranty is a contract that sits alongside the underlying contract, such as a building contract or consultant appointment, and grants rights to a third party which can be sued upon. 

A collateral warranty is much shorter than the underlying contract because, to a large extent, it relies upon the terms of the underlying contract. In the collateral warranty, the warrantor will warrant to the third party that it has performed its duties and obligations in accordance with the underlying contract. Therefore, if there is a breach of the underlying contract, that will usually trigger a collateral warranty breach. This is a key point to note in relation to a claim under a collateral warranty. It is effectively a claim for a breach of the promise to comply with the underlying contract.  

The limitations regarding “pure economic loss” mentioned previously do not apply to contractual claims, so the costs of rectifying the defect would be recoverable as well as any other pure economic losses such as lost income or profit. 

In order to obtain collateral warranties, the underlying building contract, appointment or sub-contract will need to expressly provide that the contractor, consultant or sub-contractor is required to provide collateral warranties to third parties. Collateral warranties may be provided to third parties during the course of the works or after completion.

When a collateral warranty is provided, it is essential to ensure that it has been signed correctly by the right people. Any failure to execute a warranty correctly can affect its validity.

There are some standard forms of collateral warranty, such as those published by JCT and the CIC, but these forms contain several limits on the liability of the person providing the warranty, and they may not be acceptable to the third party. In practice, most employers will usually use their own bespoke forms of collateral warranty.

Are there any alternatives to collateral warranties?

There are some alternative ways to grant rights to the interested third rights in construction projects.  

The Contracts (Rights of Third Parties) Act 1999 alters the doctrine of privity of contract and, in certain circumstances, allows a third party to enforce the terms of a contract made between other parties for its benefit.  

The granting of rights in this way is a viable alternative, but the underlying contract often excludes third party rights, and many parties still prefer to receive collateral warranties. If third party rights under The Contracts (Rights of Third Parties) Act 1999 are to be adopted, then this has to be dealt with in the underlying contracts at the outset, which is still a fairly rare occurrence.

Another way to grant rights to third parties is by assigning the rights under the original contract, but this is not always appropriate. For example, an employer could assign its rights under the building contract to an incoming tenant. 

However, if the employer still owns the completed building, it will need to retain its rights in case it needs to claim itself in respect of defects in the works. 

Another alternative to a collateral warranty can be a letter of reliance. This is a letter giving a third party the right to rely upon a report prepared by a professional consultant, typically used in site investigations, ground condition reports, and surveys. 

These are not usually used where there is an underlying contract or appointment; there is an ongoing role in relation to the performance of services and duties or where it relates to design or construction. 

Who should give a collateral warranty?

Parties that regularly provide collateral warranties to third parties on a construction project include main contractors, consultants (usually those with responsibility for design including the architect and engineers and also those with no design responsibility, e.g. project manager) and sub-contractors (although sub-contractors with responsibility for design are more likely to provide them than non-designers).

Who should receive a collateral warranty?

Parties that frequently require collateral warranties from the construction and design team on a construction project include:

Funders -   banks and other lenders funding construction works who are taking a charge over the property, rather than purchasing it, will require collateral warranties. This protects the funder if the borrower defaults under the finance agreement and the funder has to recover its loss by selling the development. The funder will require the ability to make a claim against the construction and design team if there are defects in the works that reduce the value. The funder will also require step-in rights in its collateral warranties, allowing it to step into the employer’s role in the underlying building contract and procure the completion of the development. 

Purchasers - a party that buys the development (either before or during construction as a ‘forward purchaser’ or after completion) will acquire a long-term interest in the building, even if they do not intend to occupy the building themselves, they may suffer a loss as a result of defects in the works. A purchaser will therefore require rights against the construction and design team so that they can claim against them in the event of defects arising.

Tenants -   a tenant will often have a lease on a fully insuring and repairing basis. They will therefore require collateral warranties to allow them to claim against the construction and design team in the event they need to pay for the rectification of a defect. On projects where there are a number of tenants, it is usual for only those taking a lease of a substantial part of the development to receive a warranty. The obligation on the construction and design team to provide warranties to tenants is often limited to the first tenants of the property.

Employers -   the employer will not require a collateral warranty from the main contractor and the consultants as it has a direct contractual link to them already by way of the building contract and professional consultant appointments. However, the employer is likely to require collateral warranties from sub-contractors engaged by the contractor. Otherwise, it cannot bring a claim against them, particularly if the main contractor becomes insolvent. In addition, where the project is procured using the design and build route, it is usual practice for the appointments of the design consultants to be novated to the contractor. As a result, the employer loses its direct contractual link to the design consultants and so will require a collateral warranty back from the novated consultants to maintain its rights against them.

There are also other parties who might also require a collateral warranty on some projects where they have an interest in the works, such as a local authority or freeholder. On large multi-let developments, the management company might require a collateral warranty, or if a tenant of an existing property is carrying out the works, the landlord may require a collateral warranty. 

Here to help

At Myerson, our Construction Team can offer advice on all aspects of contentious and non-contentious matters. We regularly advise and draft collateral warranties for construction projects on behalf of employers or third parties. For more information on the range of legal services we provide, please contact our Construction Team below.

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Why assignment provisions in construction contracts can make all the difference to lenders

Contributors.

Sarah Wales-Canning

Assignment provisions are often found in construction contracts, including collateral warranties, and they are used to transfer the benefit of a construction contract from one party to another. When providing development and real estate finance, there are a number of issues lenders need to consider in relation to assignment of construction documents as part of their overall security package.

Benefits for a lender

If the benefit of a construction contract is assigned from a borrower to a lender, the obligations of the contractor or consultant are then owed to the lender and the lender can demand performance of the contractor's or consultant's obligations under those contracts. Assignment also allows the lender to enforce the terms of the relevant contract or pursue a claim against the contractor or consultant where they are in breach.

The lender may have the benefit of collateral warranties which creates a contractual link between the lender and the contractor or consultants. However, these will not usually enable the lender to enforce the terms of the underlying contract unless the lender formally "steps-in" and uses express rights and meets express conditions in the collateral warranties.

Assignment therefore makes enforcement more streamlined.

Legal assignment versus equitable assignment

The law recognises two different types of assignment – legal or equitable.

A legal assignment must be in writing, absolute and notice must be given to the other parties. An equitable assignment is not subject to the same requirements.

The main difference between the two types of assignment is that an equitable assignee (who benefits from the assignment) must join the assignor (the person who assigns their right) in any action against the contractor or consultant. A legal assignee can bring an action themselves.

In practice, equitable assignment is often preferred by lenders as it can be achieved in the debenture or facility agreement without the need for a separate deed of assignment and notices to the contractor or consultant. It also allows the borrower to retain the benefit of the construction documents so that they can continue to have the right to enforce the terms.

Charge versus security

Where a lender takes a charge over a contract, this gives the lender a right over the benefit of the contract instead of assigning it the benefit of the contract.

If the benefit of a contract is assigned by way of security, the benefit is transferred to the lender. On redemption of the loan, the lender will need to re-assign the benefit of the contract back to the borrower. This can be problematic where there is a limit on the number of permitted assignments and no carve out for assignment in this manner.

Further considerations

Where a contract contains an express assignment provision, common issues include:

• Assignment being restricted to absolute legal assignment, which means that equitable assignments are not permitted, including granting a charge
• Limits on the number of permitted assignments, which could have been wholly or partly used up already
• No carve out for assignments by way of security and reassignment on redemption which means that both assignments will count towards the permitted number, and will often use them up entirely.

It's important for lenders to understand what assignment options are available for construction contracts and assess whether they allow for sufficient security.

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• Practical Law

Assignment of construction documents

Practical law uk practice note 3-314-7960  (approx. 32 pages).

• Collateral Warranties and Third Parties
• Collateral warranties and third parties
• Construction and engineering contracts