Collateral Warranties Explained

Starting a large-scale construction project? You may need a collateral warranty. Here at Eximia, we’re well-placed to advise you on this. After all, we’re expert construction insurance brokers who have an in-depth understanding of collateral warranties, professional indemnity insurance and public liability insurance. 

Unsure what collateral warranties are and why you might need one? Well, in this post, we reveal everything there is to know about collateral warranty insurance. 

What is a Collateral Warranty? 

In construction, a collateral warranty is a contract between a professional consultant (such as an architect, engineer or building contractor) and a third party (such as a bank, purchaser or tenant).

The warranty assures the third party that certain obligations will be fulfilled. These obligations typically relate to the quality of the work carried out, compliance with regulations and future performance. Crucially, the warranty also gives contractual rights to the third party. 

In simple terms, a collateral warranty acts as a bridge between parties that may not have a direct relationship under the main contract. It creates a legal link between a party involved in the original contract, such as a contractor or consultant, and a third party, such as a funder, purchaser, or tenant.

A collateral warranty is important because, without one, the third party would have no direct legal recourse against a contractor if something went wrong. Ultimately, a collateral warranty gives the beneficiary the right to claim for losses that would otherwise not be recoverable.

Common Clauses Included in a Collateral Warranty 

A collateral warranty includes various clauses that shape the warranty’s contractual and legal framework. Common clauses include: 

• An indemnity clause that requires the warrantor to indemnify the beneficiary from specific losses or liabilities.
• A duty of care clause that sets the standard of care expected from the warrantor in executing their obligations, emphasising reasonable skill, care and diligence. 
• A limitation of liability clause that curtails the warrantor’s liability for certain damages or losses, often capping the amount to a multiple of contract value or fees.

Added to this, other clauses, such as notices, assignment, governing law and jurisdiction, severability and termination help to establish procedural guidelines, address assignment permissions, designate legal jurisdictions, ensure contract coherence and delineate termination circumstances.

Collateral Warranties: A Practical Example 

The above may seem a little abstract to you, so let’s take a look at a way in which a collateral warranty would apply on a practical level… 

Let’s say you’re engaging a developer who will help your company build a new apartment block. That developer will then appoint a contractor who will carry out the building work. The relationship between the two will then likely be governed by a building contract. 

However, in this scenario, you have no direct contract in place with the contractor, as their contract is with the developer rather than you. For this reason, you essentially become a third party to the building contract. 

This means that, if you incur losses due to a defect in the completed work (either due to a design or construction error), then you have little to no protection in law. 

In this scenario, a collateral warranty bridges the gap between the employer (you) and the contractor who was employed by the developer. The warranty gives you the right to enforce the original building contract and means that you can claim any losses directly from the contractor that caused them.

It’s also important to state that an eventual tenant in one of the apartments also wouldn’t have a direct contract with the builder. As a result, they would suffer the same lack of contractual protection against defective workmanship. However, a collateral warranty could also provide them with protection from losses in the same way.

How Does A Collateral Warranty Tie in With Insurance? 

Usually, in the construction industry, a party requesting a collateral warranty will specify the insurance requirements that contractors and consultants must have in place in order to fulfil their obligations under the warranty. This may include specific limits of both professional indemnity and public liability cover. This then ensures that contractors and consultants have adequate financial protection against potential liabilities.

Added to this, the collateral warranty may also stipulate how long this level of cover needs to be in place for. This may exceed the duration of the original contract. 

In the construction industry specifically, it’s not uncommon for a collateral warranty to require a contractor to maintain a specific level of insurance for up to 12 years. This means that all parties that rely on the collateral warranty have recourse to insurance coverage for any defects or issues that may arise well into the future.

Get In Touch to Learn More

Interested in learning more about collateral warranties and how they’re suited to protecting you? Get in touch with our experts today. Simply call us on 0114 345 10 20 or email info@eximiabroking.co.uk.