Collateral Warranties - What Main Contractors Should Know

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Ian McCann

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Date: 10/10/08

We examine the main points main contractors should be aware of when they are under an obligation to grant collateral warranties and to provide sub-contractor collateral warranties.

These points are:

  • Parties
  • Limitations on liability
  • Consistency with the main contract
  • Step-in provisions
  • Obligation to provide sub-contractor collateral warranties
  • Amendments to sub-contractor collateral warranties

Parties
Firstly, the main contractor needs to be clear who they are required to grant collateral warranties to.

Limitations on liability
It is important for contractors to get as many limitations in the draft collateral warranty attached to the contract as possible i.e.

A 10 year shelf life,

A net contribution clause (don’t ask for this if it is design and build – it just won’t be accepted. The point behind design and build is that the contractor is liable for the lot and is not able to push liability off to one of the designers);

Caps on liability. Either an overall aggregate cap or a cap on consequential loss etc. Neither are popular with employers or funders for some reason but are useful for ensuring main contractors are clear as to their potential exposure;

Ensure that no greater duty is owed to the beneficiary under the warranty than that owed to the client under the contract; and

Ensure that any defences or limitations included in the contract can be used (but not necessarily in the warranty) in defence of any claim brought under the warranty – not set-off and counterclaim though.

Consistency with the main contract
The main clauses of the collateral warranties i.e.

  • Duty of care;
  • Deleterious materials;
  • Copyright; and
  • Professional indemnity insurance cover; etc
  • should mirror the clauses in the contract or at least be no more onerous.
  • Step-In Provisions

It is important to check which beneficiaries are entitled to exercise step-in rights and the periods of notice which must be served on them before employment can be terminated or suspended under the building contract.

If more than one party is granted these rights then a ranking clause is a good idea, to avoid a bun fight at the time.

Of course, if the step-in provisions allow for a nominee of the named beneficiary to exercise the rights instead of the beneficiary, the warranty should contain a specific statement that the named beneficiary will act as guarantor for any costs incurred as a result of the exercise of step-in rights.

In the past when I have acted for contractors, I have often asked that the bank provide a guarantee that it will pay any costs that may be incurred during the 21 – 28 day notice period that a bank has to decide if it wants to step-in if it eventually decides not to step-in.

If you don’t ask you don’t get.

Obligation to provide sub-contractor collateral warranties
Under the building contract, contractors may also be under an obligation to provide sub-contractor/consultant collateral warranties (where they have been novated or appointed directly in connection with a design and build project).

If this is the case:

As mentioned before, ensure that any obligation to provide collateral warranties from sub-contractors/consultants is not an absolute obligation - a reasonable endeavours obligation should be sufficient, whilst "absolute", "best endeavours" and, following recent case law, "all reasonable endeavours" are all too onerous - you need a degree of flexibility.

Unless specified in the schedule of amendments (and it would be unusual for this to be covered) non-provision of sub-contractor/consultants' collateral warranties will not be a default for which the employer is entitled to terminate the contract.

However, sometimes employers want to withhold a specified amount against the provision of these collateral warranties or even try and make practical completion conditional on provision of the collateral warranties.

If these provisions are accepted at main contract level, make sure they flow down to the relevant sub-contract.

Contractors need to be clear which sub-contractors have to provide collateral warranties. Usually it will be the designers. –Worst case scenario is where an employer wants collateral warranties from all your sub-contractors.

The time limit specified to obtain the collateral warranties should be realistic – it is highly unlikely that sub-contractors will turn a request around within 5 working days. Whatever time limit is noted in the building contract, a shorter period should be specified in the underlying sub-contract.

Ensure that there is a degree of flexibility in the terms of the collateral warranties - reasonable amendments must be acceptable. Sub-contractors, their professional indemnity insurance providers and their lawyers will all have amendments they require.

Amendments to sub-contractor collateral warranties
One further thing to consider when looking at the form of sub-contractor Collateral Warranties is whether the main contractor wants the employer or their funder is to have rights of step-in to sub-contracts.

These rights are often exercisable at will or in the event of a breach of the finance agreement. Do not accept a power to step-in to the sub-contracts in any circumstances other than if your employment of the main contractor under the main contract is to be determined.

Main contractors do not want to be in the position where they have accidentally ceded control of your own employees to a third party. 

In brief, main contractors need to know exactly what their obligations regarding collateral warranties actually are. - The employer will probably have contracted with funders, tenants and purchasers on the basis that collateral warranties will be provided to them before a specific date, and they will need these Collateral Warranties fromthe main contractor. 

It is essential that in the initial negotiations with the sub-contractors, the main contractor indicates that collateral warranties will be required in favour of the "usual suspects."

This will hopefully smooth the way later down the line and of course this requirement should clearly be reflected in the sub-contract.

 

 
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