How can Collateral Warranties in a Construction Contract protect my interests?

As the coronavirus pandemic and subsequent lockdown continues albeit with an end in sight, even with the success of the vaccine roll-out, it is an unfortunate consequence that not all companies will survive the coming months.  With Carillion still fresh in the memory for so many in the construction sector, it is important to consider measures that can limit exposure to companies going under.  If you happen to be in a construction contract with a company that goes into liquidation, this could leave your project in jeopardy. It is important that you have the necessary clauses in your construction contract that can protect you in a multitude of scenarios.

Andrew Cullyer, Litigation Executive specialising in construction disputes, reviews here how collateral warranties can help limit this exposure and highlights how relevant they are in the current climate, whether it is a warranty between the contractor and a purchaser or tenant, or between a sub-contractor and employer.

The doctrine of privity of contract

In English law there is a general rule that says the rights and liabilities granted by a construction contract are limited to the parties to it.  The basic rule of privity of contract can therefore be summarised as:

“A contract can only be enforced by the parties to it”.

It is due to this rule of privity of contract that collateral warranties are of such import.  Privity of contract is best explained looking at a particular scenario, for example, if you wish to bring a claim for defective work.  In this situation:

• if you (“A”);
• buy a house from a developer (“B”);
• but the house was in fact built by a contractor (“C”);

A will have no automatic right to make a claim against C, the contractor.  Your contract would be with B, the developer and, notwithstanding the fact that B and C will almost certainly have a contract between themselves, you cannot enforce the terms because you are not party to their contract.

In this example, your remedy would be to make a claim against the developer (B) who would then in turn make a claim against the contractor (C).  Although convoluted, this generally presents no problem unless or until party B ceases to exist, which usually happens if the company goes into liquidation either voluntarily or involuntarily.

Under privity of contract, unfortunately you (A) would have no-one to sue and effectively have no rights at all in respect of the defective work.  While defective work is a common issue that arises in construction, it is likely that the coming months may see potential claims of this nature hit a stumbling block if more companies close due to the economic impact of Covid-19. 

Rights of third parties in construction contracts

At this juncture, it is worth mentioning that the Government of the day did try and address this problem with the Contracts (Rights of Third Parties) Act, 1999 (“the Act”).

The Act provides in s1 that:

“(1)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.

(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.”

This initially may appear promising and in particular subsection 1(b).  Unfortunately, all of this work is undone by subsection (2).

Effectively, the parties to a contract can simply opt out of the Act and as this is an agreement between parties B and C in the provided scenario, party A has no effective means of preventing them.  This, generally speaking, renders the Act meaningless as it is more often than not opted out of.

What are collateral warranties?

Collateral warranties provide a way out of this scenario for party A.

A collateral warranty is a free standing agreement between parties A and C in which C agrees to perform its obligations under its contract with B.  This means that if there is defective work, A may seek damages from C on the basis of breach of the collateral warranty.  This, therefore, sidesteps both the doctrine of privity of contract and the issues with the Act.

Collateral warranties can be entered into at any time, but it is usually preferable to ensure they are in place when you are entering into the initial contract (the contract between A and B). 

Collateral warranties obviously represent additional risk for party C as it is increasing the number of people it is liable to in respect of its works. This risk is mitigated in a number of different ways:

1. Generally, a collateral warranty should grant no greater rights to A than B has under its contract with C.
2. C will want to limit the ability of A to assign any collateral warranty to others, as each assignment increases the potential number of people who could make a claim against C.

Provided that the collateral warranties follow these basic principles they are usually uncontroversial and whilst they represent some additional risk to party C, that risk is usually minor and can be obviated by ensuring the work is carried out properly and in accordance with the contract.

To have your questions answered on collateral warranties or if you wish to bring a claim against a party involved in your construction project, you can contact Andrew Cullyer today on 023 8071 7482 or email andrewcullyer@warnergoodman.co.uk.

For general Litigation or Dispute Resolution enquiries, contact Laura Blakemore on 023 8071 7412 or email laurablakemore@warnergoodman.co.uk.

ENDS

This is for information purposes only and is no substitute for, and should not be interpreted as, legal advice.  All content was correct at the time of publishing and we cannot be held responsible for any changes that may invalidate this article.