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Within a construction project, there exists a network of contracts. Generally speaking, at the centre is the employer/developer, who will typically enter a building contract with a main contractor. However, depending on the circumstances of the project, the developer/employer may also enter a financing agreement with a funder, professional appointments with consultants, and an agreement for lease or lease with a tenant.

Within this network of agreements, not every party with an interest in the construction project or in the site has a direct contract with every key party responsible for the design or construction of the project.

For example, the purchaser, tenant, or funder of a development relies on the completion of the project, but typically has no direct contractual relationship with the contractor, sub-contractors, or consultants responsible for the works. Moreover, the developer/employer may not have a direct contract with all important sub-contractors or consultants involved lower down the chain.

This leaves a legal gap for those purchasers, tenants, funders or developers who have financial and other interests in the development. As such, if something goes wrong with the project, they may not be able to bring claims against those contractors, sub-contractors or consultants in order to protect their interests and resolve any problems. Collateral warranties exist to bridge this gap, providing a method of extending contractual protection to interested third parties.

What is a collateral warranty?

A collateral warranty is a contract between:

  • A party who has or will acquire rights or interests in the construction project or the site on which it is built (the beneficiary), and
  • Another party which has duties and obligations relating to the construction, design or management of the project (the warrantor).

Under a collateral warranty, the warrantor gives contractual promises, known as warranties to the beneficiary. Typically, the main warranty given is that the warrantor has or will comply with the terms of their construction contract, sub-contract, or professional appointment.

Some examples of collateral warranties that may be entered into within a construction project are:

  • The contractor entering into a collateral warranty with the purchaser, tenant or funder, and
  • A sub-contractor or sub-consultant entering into a collateral warranty with the employer/developer.

Important terms in collateral warranties

Broadly speaking, collateral warranties commonly include certain key terms, for example:

  • Performance – the warrantor confirms that it has and will perform its duties and obligations under its contract properly.
  • Duty of care – where the warrantor has carried out design services, the warrantor confirms it has and will use reasonable skill, care and diligence in producing those designs and in selecting materials.
  • Intellectual property – the warrantor gives the beneficiary a licence to use or reproduce materials produced by the warrantor. Often there are limits on this licence, for example that use or reproduction of these materials relates to the project or the site only, and that the warrantor will not be liable if the materials are used for purposes that they were not intended for.
  • Insurance – again where there is design, the warrantor agrees it has and will maintain professional liability insurance at a certain monetary value (such as £5m) for an agreed period of time (often 12 years). There may also be other terms, like an obligation on the warrantor to provide evidence from time to time that this insurance is being maintained.
  • Excluded materials - the warrantor confirms it will not use (or permit the use of) materials or products that do not confirm with certain standards, or which could harm the health and safety of any persons or the development itself.
  • Step-in rights – these provide the beneficiary with the ability to step into the relevant contract in specific circumstances, and are particularly useful for development funders. For example, under the main building contract, the developer/employer and contractor usually have the right to terminate the contract due to the insolvency or breach of the other party. If the contractor has given the funder a collateral warranty with step-in rights, and the employer breaches the building contract in a way that gives the contractor the right to terminate, the funder can step into the developer/employer's shoes, taking over the project to ensure its completion. Step-in rights therefore maintain the continuity of the project, protect the funder's investment, and ensure that the project reaches its intended value on completion.

Another example is where step-in rights may also be found in collateral warranties favour of the developer/employer, giving it the contractual right to step-into the sub-contracts or sub-consultant appointments if it terminates main contract for the contractor's breach.

Collateral warranties are often "bespoke" (ie customised drafting), so the wording around these terms may vary, and other clauses may be included to tailor the collateral warranty to the parties or the project. 

Final thoughts

Collateral warranties play an important role in construction projects, first by closing the contractual gaps inherent in complex project structures, and second by providing additional rights and protections to the beneficiaries of the warranties through the wording of the collateral warranty itself.

As such, they not only ensure contractual protection for interested third parties, but also mitigate development risk and, where relevant, can be used to preserve the continuity of development projects.

This article is part of our series of Construction Introduction series. For more, see:

This article was also authored by Hayley Trickett, Trainee Solicitor at Womble Bond Dickinson.

This article is for general information only and reflects the position at the date of publication. It does not constitute legal advice.