Collateral warranties

The key clauses found in a collateral warranty, whether they are industry standard forms or bespoke forms, are: 

• duty of care;
• copyright;
• prohibited materials;
• professional indemnity insurance;
• assignment; and
• step-in rights. 

Primary covenant/duty of care

The primary covenant, or the duty of care clause is a promise by the warrantor that they have carried out and will continue to carry out their obligations and duties in accordance with the principal contract (e.g. building contract, appointment, etc). A consultant will promise that they have performed their services in accordance with the terms of their appointment exercising the requisite level of skill and care. A contractor will promise that they have carried out the works in accordance with the terms of the building contract (the duty of care imposed upon the contractor pursuant to clause 2.1 of JCT SBC 2005 is to carry out the in a proper and workmanlike manner).

Where a warranty is provided before the completion by the warrantor of their duties and obligations in the principal contract, it is important that the primary covenant is sufficiently broad to cover work carried out both before and after the collateral warranty was entered into.

Where a contractor also has design obligations, in order to reflect the terms of their professional indemnity insurance policy, the contractor will want to make clear that their duty in respect of the design and selection of material is that of a professional designer (exercising the requisite standard of skill and care), rather than a contractor, upon whom a fitness for purpose obligation in respect of their design would otherwise be implied at common law.

It is usual that the warrantor's standard of care is commensurate with that of a similarly experienced consultant or contractor of the relevant discipline experienced in carrying out services on developments of a similar size, scope and complexity to the particular development in question. While this is arguably a higher standard than that implied by common law, if a consultant or contractor is a specialist experienced in large and complex projects, and the employer is paying for that experience, it is reasonable that this should be reflected in the standard by which the consultant's or contractor's performance is judged.

There is often argument as to whether the warrantor should undertake its obligations with 'diligence' (i.e. within a reasonable time or with attentiveness). Again, this is arguably a higher standard than the duty imposed by common law, but generally, a contractor or consultant's insurers accept the inclusion of this term without too much argument.

In a duty of care clause, it is important to clarify which obligations in the warranty are subject to the exercise of reasonable skill and care, and which are absolute. For example, for a consultant, the requirement to procure professional indemnity insurance should be an absolute obligation, while the professional services should be only subject to exercising reasonable skill and care.

Copyright

A warrantor usually grants to each beneficiary of a collateral warranty a licence to use its designs, drawings specifications and other intellectual property.

As each beneficiary of a collateral warranty will require a licence, the warrantor must retain copyright in the various documents produced by them. This is achieved by making sure that:

• only a beneficiary a licence is granted (and not an assignment of the copyright); and
• an exclusive licence is not given to the first beneficiary of a collateral warranty.

The licence granted is thus deliberately expressed to be 'non-exclusive' to ensure this, as otherwise the warrantor could find that they have to obtain consent from the first licensee before it could grant further licences to other beneficiaries of their warranties.

A typical copyright clause will allow the use of such material by the beneficiary (and any other third party to whom an equally non-exclusive licence is granted) for any purpose in connection with that project; however, it will usually contain a limitation making clear that the licence is not granted in respect of any 'extension' of the development and is not transferable to a new development unless the warrantor is paid for the privilege of its design being re-used. Such a limitation is normally reasonable.

Consultants in particular often try to amend the copyright clause to make the licence revocable in the event of non-payment of that consultant's fees. In practice, such an amendment is rarely reasonable as, quite rightly, a beneficiary of a collateral warranty will not want its copyright licence to be conditional upon payment by someone else (i.e. the employer) to the consultant.

Prohibited materials

It is common practice that a collateral warranty will contain a provision from the warrantor confirming that certain types of material will not or have not been specified for or used in the construction of a project.

Where a principal contract already contains a list of prohibited materials, a similar clause in a collateral warranty is unnecessary as the primary covenant in the collateral warranty will already cover this. It is more logical to specify the quality of materials to be used in the construction of a development in the specification that forms part of the principal contract, not in a contract that is collateral to it.

The exception to this would be where the beneficiary requires a specific prohibition on certain materials which are not mentioned in the underlying principal contract. It is rare for a clause in a collateral warranty to develop or expand upon the terms of the underlying principal contract (a 'no greater liability clause' will prohibit this).

The inclusion of a list (of what were once referred to as 'deleterious materials') was once common practice. The danger of including a list is that the list might be construed as exhaustive; moreover, the variety of available materials and technologies may evolve to include the potential for use of products not even contemplated at the time the warranty was given.

Rather than list out the prohibited materials, the preferred position today is to include a provision which states that materials have been selected in accordance with the guidelines contained in Part 2 of Ove Arup's publication 'Good Practice in the Selection of Construction Materials' (for example, the JCT standard form collateral warranties contain such a provision).

As most materials are subject to British Standard Specifications and all building materials are regulated by Building Regulations and the Construction Products Regulations it should be sufficient for the beneficiary of a collateral warranty to rely on a warrantor's covenant to use reasonable skill and care and to design the works in accordance with Building Regulations. However, it is generally accepted that a beneficiary will also require the comfort of having a prohibited materials clause in its collateral warranty.

Professional indemnity insurance

The strength of a collateral warranty is only as good as the underlying insurance policy supporting it. Few professional practices have sufficient financial assets to meet a large scale claim brought against them, consequently, it is imperative that a collateral warranty contains an appropriate obligation to maintain professional indemnity insurance.

Professional indemnity insurance is a form of liability insurance taken out by contractors, consultants and subcontractors involved in the 'design' of a project to indemnify themselves against their liability to others for damages arising out of a claim against them for breach of their professional duties. The most common risk which the insurance is intended to cover is negligent design.

A collateral warranty will contain a clause whereby the warrantor confirms that professional indemnity insurance is in place at the time of the warrantor's involvement in the project and promises to maintain such insurance for a set period (usually 12 years) following practical completion.

The obligation to maintain such insurance post practical completion may be limited to where the insurance remains available on commercially viable terms. This reflects the fluctuating nature of the professional indemnity insurance market.

Further, a beneficiary of a warranty will require that professional indemnity insurance is held on an 'each and every' basis (i.e. no limit on the number of claims that can be made in any one year), rather than in the 'aggregate' (i.e. a maximum value of claims allowed in any one year) as some consultants and subcontractors would prefer to offer. Before agreeing to professional indemnity insurance in the aggregate, an employer should investigate the warrantor's claims record by asking them to provide written confirm of the number and value of any current and pending claims being made against them.

Assignment

Those providing collateral warranties often seek to restrict future assignment of them, either by a maximum number of permitted assignments or by the type of recipient.

Arguments advanced by warrantors for limiting the number of assignments are that their professional indemnity insurance only permits a limited number of assignments - usually 2 in the case of a funder and 1 for all other types of beneficiary.

Arguments advanced by warrantors for limiting the type of recipient are that the character of certain assignees and the use to which they put the building may potentially be more adverse to the warrantor (with an increased risk of a claim) than the original beneficiary or the original use.

The reality is that funders inevitably resist any attempt to cap the number of times they can assign their warranty by way of security.

The most commonly agreed position is to allow unlimited assignment by any entity providing funding for the project (and to any company related to such a beneficiary, e.g. holding companies or subsidiaries) and to limit assignment by any other party to 2 assignments. Most professional indemnity insurance policies permit this.

If a warranty is to include a requirement for the warrantor to consent to an assignment, it is wise to qualify this with words stipulating that the consent must not be unreasonably withheld or delayed.

Where a warranty is silent on assignment, the benefit of the warranty is freely assignable at common law.

Step-in rights

So called 'step-in' provisions are usually provided to funders and, less frequently, to forward sale purchasers (e.g. a purchaser of the whole of the project, who agrees to make payments during its construction, as opposed to upon completion of the construction only). Step-in applies only where the warranties are given prior to practical completion. Once the building works have reached the stage of practical completion, there is nothing for the beneficiary to step into and so step-in rights are not necessary.

The purpose of step-in provisions is to allow a beneficiary to step into the role of the employer to ensure that the project is completed. The completion of the project would, of course, be in the interest of any forward sale purchaser. Normally, step-in rights may be exercised in circumstances where the employer has defaulted under its funding agreement or alternatively where the employer has defaulted under the terms of its principal contract with the warrantor to the extent that the warrantor has the right to terminate the principal contract.

Where a warrantor becomes entitled to terminate its contract with the employer, it is usual that the warrantor is obliged to give the beneficiary 'X days' notice' of its intention to do so and to specify the grounds for the proposed termination. During this notice period, the beneficiary is given the opportunity to consider whether it wishes to exercise its step-in rights.

It is important that the step-in provisions make clear that in the event of the beneficiary exercising its step-in rights. The warrantor is obliged to treat the beneficiary as its employer in place of the original employer, otherwise the warrantor would be in breach of its obligations to its original employer under the principal contract. This is achieved by adding the employer as a third party to the collateral warranty in which the employer acknowledges that the Warrantor is not in breach of its obligations under the principal contract where step-in is exercised and it acts upon the instructions of the beneficiary.

Where there are multiple beneficiaries of warranties, each containing step-in rights the warranty will need to provide for step-in rights which are ranked according to each beneficiary's position of priority.

If the funder exercises its step-in rights, it does so, usually, subject to the obligations of that position, e.g. paying the warrantor any sums properly due under the contract and undertaking responsibility to settle any outstanding claims.