Collateral warranties

A collateral warranty is a contract which is ancillary or 'collateral' to a principal contract, such as a building contract, a subcontract or a consultant appointment. It is entered into between the person employed under the principal contract (e.g. a contractor) and a third party (known as the 'beneficiary') having or acquiring an interest in the development, such as a funder, a purchaser, a tenant or a management company. In a collateral warranty, the person employed under the principal contract ('the Warrantor') generally warrants to the third party that it has complied with its obligations under the principal contract.

Privity of contract

As a general rule, the doctrine of privity of contract states that only a party to a contract has the benefit of that contract or is subject to the obligations contained in it. Put simply, only a party to a contract can enforce the terms of that contract. Despite the existence of the Contracts (Rights of Third Parties) Act 1999 (discussed in more detail below) a collateral warranty remains the industry's preferred way to overcome the restrictions on remedies for third parties, created by the doctrine of privity of contract.

Why have collateral warranties?

The main purpose of collateral warranties is to provide contractual remedies for interested third parties against other parties from whom none would otherwise be available or against whom any remedies would be limited or uncertain under statute or under the tort of negligence.

The development of collateral warranties

The use of collateral warranties has increased in popularity over the last 15 to 20 years.

The current position where there is no contract between A and B is, generally, that in order for A to sustain a claim in the tort of negligence against B, the necessary 'damage' that is suffered must amount to actual, physical injury to person or to property other than the property which is the product of the negligence itself. Damage to the property itself is categorised as pure economic loss and is irrecoverable in tort.

So, in other words, the cost of putting right damage to the property caused by a defect in the property itself is irrecoverable except where A and B have a contract. Under current law, the only exception to this, where a claim for pure economic loss will succeed, is where the loss derives from a Hedley Byrne type situation (i.e. Hedley Byrne & Co Ltd v Heller & Partners Ltd [1964] AC 465 where there is a special relationship between the parties); where the defendant has assumed a responsibility to the claimant who suffers loss as a consequence of having relied on information supplied by the defendant.

The reason why you cannot recover in tort for defects in a property is set out in the House of Lords case of Murphy v Brentwood District Council [1991] AC 398. This case involved a claim for pure economic loss against a local authority that negligently failed to ensure that a building was designed in accordance with relevant building regulations. The court held that where a dangerous defect was discovered before it caused physical injury, the expense incurred by the building owner or occupier before the defect caused physical injury was the pure economic loss of putting the defect right.

This development in case law restricting claims to cases of physical damage to third party 'other' property (i.e. excluding loss sustained to the defective property itself) compounded the problem posed by the doctrine of privity of contract: that an entity cannot sue, or be sued, under a contract to which it is not a party.

The sum of these 2 principles was this: where the loss could be quantified only in financial terms (i.e. was purely economic) and the party who had suffered detriment was not contractually linked with the party that caused the loss, there was no remedy.

Collateral warranties are the preferred solution to fill this gap and are now considered a fundamental part of the documentation for most commercial developments.