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Collateral warranties – what are they and what recent development should you be aware of?

Collateral warranties – what are they and what recent development should you be aware of?

What is a collateral warranty?

Education institutions regularly use collateral warranties in the context of construction and development projects as an added form of commercial protection.

In short, a collateral warranty is an agreement between a member of the construction team (such as a building contractor or construction consultant) and a third party who we lawyers tend to call the “beneficiary” (such as a funder, employer, tenant or purchaser).

The problem is that the beneficiary is not typically a party to the underlying building contract, sub-contract or professional appointment. As such, the beneficiary doesn’t have any direct contractual link or therefore any contractual right of recourse against a building contractor, sub-contractor or consultant and could not pursue a claim for breach of contract.

Collateral warranties are used to solve this problem by creating a direct contractual relationship and extending the obligations of the building contractor, sub-contractor or consultant to a beneficiary.  In simple terms, it is an agreement in which a building contractor, sub-contractor or consultant warrants to a beneficiary that it has complied with the terms of the respective underlying building contract, sub-contract or professional appointment.

What recent developments should I be aware of?

In a recent case ¹ the court had to consider whether proceedings for a claim under a collateral warranty had been commenced in time.

In that case, Stewart Milne Group Limited (the Contractor) entered into a Design and Build Contract with a developer to produce a number of retail units.  Under the terms of the building contract, the Contractor was required to provide a collateral warranty to any end beneficiary of the units (such as a tenant or purchaser).

The building works were completed in 2009.  However, the site had flooded and as a result, a flooding report was commissioned in May 2013.

In June 2013, British Overseas Bank (the Beneficiary) acquired part of the development and was provided with collateral warranties from the Contractor dated June and August 2013.

The terms of the collateral warranty included the following common provisions:

  • A no greater liability provision stating that “the Contractor shall have no greater duty to the Beneficiary under this Agreement than it would have had if the Beneficiary had been named as the employer under the Building Contract”; and
  • An equivalent rights of defence provision which entitled the Contractor to “rely on any limitation in the Building Contract and to raise equivalent rights in defence of liability as it would have against the Employer under the Building Contract.”

The car park on the development flooded. Understandably, the Beneficiary pursued a claim against the Contractor for breach of the terms of the collateral warranty.  The Beneficiary’s case was that the Contractor had failed to exercise the requisite level of skill and care required under the collateral warranty, and that the design and the construction of the car park was defective.

The prescriptive period under the building contract expired 5 years after the date on which the Contractor became aware of the flooding. The ‘prescriptive period’ is a Scottish term.  In short, it is similar to the limitation period under English law i.e. the time you have to pursue a claim before it ‘times out’.

The Beneficiary started its court claim within 5 years of the granting of the collateral warranty but crucially, only after the expiry of the prescriptive period under the building contract.  The question that the Court had to decide was whether the Beneficiary had commenced proceedings in time?

Whilst you might think that the issue was simple, the fact is that the court had two attempts  at deciding the point!  On the first attempt, the court decided that the claim was started in time because the collateral warranty had a separate 5 year prescriptive period.  On the second attempt, however, the court changed its mind and decided that the claim was out of time because of the “no greater liability” and “equivalent rights of defence” provisions.  This is because these provisions show that the parties’ intention was to restrict the duties and obligations of the Contractor to those contained in the building contract.

The court pointed to the fact that such provisions indicate an intention to place the Contractor and the Beneficiary under the collateral warranty in the same position to that of the developer and Contractor under the building contract.  This means that the Beneficiary obtains the rights that the developer had against the Contractor, but subject to the defences and limitations that the Contractor would have against the developer under the building contract.

The need to know ‘top tips’ from the case

This is a decision of the Scottish Courts but the analysis may well be persuasive in the English courts. The legal principles involved are clearly relevant under the laws of England and Wales.

This case is a useful reminder of the importance of having a clearly drafted limitation period in a collateral warranty so that a beneficiary has certainty as to when it may pursue a claim under a collateral warranty.

Whether it is the in-house legal team or the estates team dealing with the collateral warranties on construction and development projects, here are our top tips arising out of the case:

  • For certainty, it is good practice to include an express limitation period in all construction documents, including collateral warranties. This way, the parties to the contract will be crystal clear as to the latest date by which they can start a claim if there is any breach of the terms of the contract.  It is worth noting that, if there is no express contractual limitation period noted in the collateral warranty, the limitation period will be implied into the contract by statute (Limitation Act 1980).
  • For the avoidance of any doubt, the limitation period across all construction documents including a building contract, sub-contract, professional appointment and any collateral warranty should, where possible, be the same. This means that there is only one relevant date for the purpose of contractual limitation and again, provides certainty for all parties as to the timeframe in which they are entitled to pursue a contractual claim.  Typically, you will often find that the limitation period is specified as being 6 or 12 years from the date of practical completion under the building contract (dependent upon whether the document has been signed as a simple contract or as a deed).
  • Be mindful of the effect of any “no greater liability” or “equivalent rights of defence” provisions contained within a collateral warranty. Regardless of whether there is an express contractual limitation period in the collateral warranty, “no greater liability” and “equivalent rights of defence” provisions serve to give effect to the limitation period contained within the underlying contract which the warranty is collateral to. Before incurring the legal costs of starting a claim under a collateral warranty, it would therefore be sensible to check that there are no limitations on a similar claim being brought under the terms of the underlying contract.

It is good practice for the legal team or the estates team to keep a record of the dates on which the contractual limitation period expires.  Diary reminders which pop up and remind you to assess whether or not there are any claims which need to be dealt with can help preserve the right to start a claim which is in time. No one wants to realise that they have a good claim if only it was still in time!

¹ British Overseas Bank Nominees Ltd and others v Stewart Milne Group Ltd ([2019] CSIH 47)