Collateral Warranties - Check Your Policy Before and After you Sign

It is well-established that for newly built properties to be marketable to funders, purchasers and tenants those parties will require to be granted contractual rights of recourse against those responsible for the design and construction of the property.

Whilst contractors and professionals in the construction industry appreciate this is a commercial reality and are generally prepared to enter into the necessary collateral warranty agreements, careful consideration should be given to the terms of the particular contract documents to be entered into with those third parties.

The general purpose of these agreements is to extend the same duty of care owed by the granter to its employer or client to the third party beneficiary. However the forms of these warranties, whilst generally brief and following recognised content headings, by the wording used will often increase the potential liability of the granter.

One of the key clauses will relate to the maintenance of relevant professional indemnity insurance cover for the period of the collateral warranty agreement (normally 10 or 12 years) by the granter where it has provided a professional service or is a contractor with design responsibility.

It is important to the beneficiary of a warranty that recovery for any potential claim is supported by insurance cover. It will be even more important to the granter that its liability to a third party is insured against. Whilst granters may have taken “commercial views” on the terms of their original appointments or contracts where these were in consideration of the payment of fees they will be concerned to ensure that any liability under a warranty does not go beyond its insurance cover.

As a matter of course granters should give notice to their insurer of any collateral warranty agreement to be entered into. It will likely be a term of insurance that cover only extends to notified contracts. Insurers may provide commentary on the terms of a warranty but will not approve and generally will only confirm that it is noted and cover is subject to policy conditions.

It is common for insurance policies to contain particular conditions and restrictions on cover for claims related to collateral warranty agreements entered into by the insured. Parties should ensure that these are understood and reflected in any collateral warranty agreements they enter into. By way of example insurers will often provide that cover is only available in respect of agreements which provide for a restricted number of assignations by the beneficiary.

We regularly advise contractors and consultants on the particular terms of collateral warranty agreements and also on the terms of insurance cover. The current insurance market is a hard one and we have seen in a short space of time contractors having undertaken to maintain particular levels of cover only to be able to obtain reduced levels at economic rates for their businesses and on more restricted terms of cover such as excluding cover for liability for collateral warranty claims where a warranty agreement is assigned more than once.

Where professional indemnity insurance cover is on a claims made basis so that it is the cover which is in place at the time of a claim which applies it is important that any decision on cover takes account of the potential liability for claims under collateral warranty agreements already entered into in previous years. Whilst new agreements can be altered to take account of the restrictions of current cover the risk that cover will be excluded for previous agreements has to be recognised.

It may be that the United Kingdom construction industry will have to identify alternative mechanisms to ensure marketability of new build properties but for the moment the expectation of funders and end users is that collateral warranty agreements will be available and supported by appropriate insurance.