This is a brief introduction to collateral warranties and covers the following common questions raised about them:
What are collateral warranties?
Why do they exist?
What are the common issued relating to collateral warranties?
Are there any alternatives?
We also set out below a checklist of things to consider when reviewing/entering into a collateral warranty.
What are Collateral Warranties?
A contract that is separate to and alongside (i.e. collateral to) the construction contact of the professional appointment.
They give third parties (such as funders of the project, purchasers and tenants) a contractual right to sue the provider of the warranty in circumstances where there would be no such contractual right.
They warrant that the professional has performed services (usually) by reference to the duty of care set out in their contract (and where the project has not yet finished, that they will continue to do so).
The professional usually receives nothing in return, and in order to make the warranty an enforceable contract, it is either executed under seal or there is a promise of nominal consideration from the other party (e.g. £10).
Give the Employer rights against the consultant which it would otherwise not have.
Under the collateral warranty, the duties and obligations owed by the consultant to the main contractor are replicated for the benefit of the employer. This gives extra protection to the employer as, for example, if the main contractor enters liquidation, the employer has a direct contractual link with the sub-contractor
Distinct From Novation:
Upon novation the main contractor steps into the shoes of the design team and assumes responsibility for outline design (typically in design and build contracts). The contract between the employer and the professional is 'novated' across to the contractor and the professional then owes future duties to the contractor rather than the employer. However, to ensure that the employer is still owed a duty, typically upon novation a collateral warranty will be entered into between the employer and professional.
Upon novation, and in the absence of a collateral warranty, the employer only has a contractual remedy against the contractor and not the professional.
Why do Collateral Warranties exist?
In the 1980s, the courts were reluctant to extend a professionals duty of care in tort to anyone other than to the client with whom the professional had contracted. This caused the client problems as prospective funders, purchasers and tenants could be taking over a potentially defective design without any recourse to the professional who may have been at fault.
Collateral warranties have evolved since the 1990s. Murphy v Brentwood, HL held that a tortuous claim for pure economic loss (i.e. damage to the thing itself) was irrecoverable. There then followed a complex series of cases in the House of Lords which produced three limited exceptions to that rule including an extension to the Hedley Byrne v Heller decision where a special relationship can be shown to exist.
Following the above, it is evident that where there are no clear contractual duties, there can be uncertainty as to whether an actionable duty in tort exists and recovery made. A collateral warranty obviates the need to establish such a duty in tort as it creates a direct contractual link between the funder, purchasers or tenants, on the one hand, and the professional on the other. The contractual link will provide certainty, whereas the tortuous duty will not.
Due to the pressure from the client side, collateral warranties have become the industry norm. However, there is no legal obligation on a professional to give a warranty (unless it is provided for in the main contract/appointment).
Whilst funders, purchasers or tenants may have rights under the Contracts (Rights of Third Parties) Act 1999 - these rights are often excluded in the appointment.
Whilst collateral warranties open a professional to exposure that they otherwise would not have, they can allow a professional to define and restrict the extent of its liability to the recipient by inclusion of a net contribution clause or limit of liability clause, subject to it being fair and reasonable. This can be preferable to relying on C(RTP) Act 1999.
What are the common issues relating to Collateral Warranties?
For Insurers, collateral warranties always increase potential exposure to liability for claims which, but for the collateral warranty, would probably not be pursued (or perhaps could not be pursued). by way of example, the HCCI Architects and Engineer Professional Multi-risks Insurance PMR AR EN Civil AOC 01 11 Policy wording contacts the following exclusion:
"The Insurer shall not be liable to indemnify the Insured against any claim arising directly or indirectly from any breach or alleged breach of any contractual duty or duty of care owed or alleged to have been owed by the Insured to any third party and which is more onerous than any duty that would otherwise be implied by common law or statute save for any liability arising out of the ordinary course of the Professional business in consequence of or arising from entering into any collateral warranty, duty of care agreement or any similar agreement, provided that, in so doing, the Insured does not make itself liable.”
a) to provide a level of service of produce a result beyond the scope of any duty that would otherwise be implied by common law or statute; or
b) to any greater extent or for any longer a period that is the case under the agreement with the person or party with whom the Insured originally contacted to perform the same work; or
c) under any financial guarantee, for any contractual penalty or for liquidated damages..."
Common issues for professionals and their insurers to consider therefore when entering into a collateral warranty or facing a claim that concerns a warranty include:
Firstly, care should be taken to limit the number of warranties required to be provided in the appointment document. Otherwise, the professional may open itself up to liability to a number of parties. This may be achieved by limiting the number to be provided, or by limiting the provision to, for example, first tenants and first purchasers only. Warranties must never be entered into before the appointment document is executed.
Onerous obligations, such as strict obligations or warranties for fitness for purpose should be avoided, otherwise they are likely to fall foul of the indemnity provided by the PI policy. Obligations under a collateral warranty need to be subject to the professionals duty of care i.e. to exercise reasonable skill and care.
The obligations imposed on the professional under the warranty must be no greater than those imposed in the appointment i.e. it should be back to back (sometimes referred to as mutatis mutandis).
Liability should not be unlimited - collateral warranties should impose no greater liability than imposed on the professional under the appointment. Any liability which may arise under a collateral warranty must be limited under the terms of the warranty. There are three key ways to achieve this:
Equivalent rights of defence - this ties the warranty back to the appointment, however it only works if there is a limitation of liability clause in the contract of engagement.
Limitation of liability provision - this usually refers to the professionals liability being capped at a specific amount (though this will be subject to Unfair contract Terms Act 1977). this is often tied to the limit of indemnity under the professionals PI insurance and never more than provided in the appointment.
Net contribution clause - this limits the professionals liability to its share of liability. this can be useful in circumstances where the contractor shares some blame (e.g. through defective workmanship) and subsequently goes into liquidation. A net contribution clause severs the common law principle of joint and several liability but must be carefully worded.
Limit the time within which a claim can be made - this could tie in any claims to say, 6 years from the date of practical completion, depending on whether the collateral warranty is entered into under hand or by deed.
The number of times that the benefit of a collateral warranty can be assigned should be limited, or the right to assign should be excluded altogether.
The terms of the collateral warranty must be fair to the professional. Standard terms of collateral warranty have been published by the CIC, with this objective in mind. These standard terms are suitable for use on most commercial contracts.
Professionals should only agree to give collateral warranties to funders of the project or purchasers and tenants of the projects. Collateral warranties in novation situations should be carefully considered so as to avoid a conflict of interest.
Are there any alternatives?
Contracts (Rights of Third Parties) Act 1999.
This Act has had little impact in practice, but it works so as to confer an ability on a third party to enforce a term of the contract where the contract purports to confer a benefit on that third party. The third party must be expressly identified in the contract "by name, as a member of a class or as answering a particular description" for a benefit to be conferred. If a third party can bring a claim under the Act, the claim would be subject to the terms or the contract, just as if the claim was being brought by a party to the contract.
However, most standard construction contracts exclude third party rights and specifically the Act, with the parties typically preferring to execute collateral warranties instead. If a right is granted under the Act then the extent of its terms and effect must be very carefully worded.
The benefit of an agreement can be assigned, but not the obligations. This would not be suitable, for example, where numerous collateral warranties are required (such as in a building intended to be occupied by more than one tenant/purchaser).
1. Level of Skill and Care
Must not be more onerous in the warranty than in the contract.
Must not go beyond the 'reasonable skill and care' duty in negligence.
Advisable to include the following standard wording as follows:
"Nothing in this Collateral Warranty shall be deemed to impose any higher standard or care on the sub-contractor (or sub-consultant) than the reasonable care and skill to be expected of a properly qualified and competent contractor of the appropriate discipline carrying out works of a similar size, scope, nature, complexity and value as the sub-contract works."
2.Warranty must not be entered into before the main contract.
The Collateral Warranty should provide that it 'shall only be executed and will in any event only become binding when the main contract is executed'.
3. Deed of Simple Contract
Collateral Warranty obligations must not extend in time beyond main contract obligations.
If the main contract is not by deed (i.e. 6 years limitation), the Collateral Warranty must also not be by deed.
TheCollateral Warranty must not allow for more assignments than is permitted by the PI Policy.
5. Net Contribution Clause
Insert clause limiting liability to those losses/damages caused by the person giving the warranty.
"Inconsideration of the sum of One Pound (£1) paid to the sub-contractor (or sub-consultant) of which the sub-contractor (or sub-consultant) hereby acknowledges receipt the sub-contractor (or sub-consultant) warrants that it has exercised and will continue to exercise reasonable skill and care in the performance of its duties to the (Funder/Employer) under the Appointment. In the event of any breach of this warranty.
(a) The sub-contractor (or sub-consultant) shall be liable for the reasonable costs of repair, renewal and/or reinstatement of any part of parts of the Development to the extent that:
The Funder/Employer incurs such costs and/or;
The funder/Employer is or becomes liable directly or by way of financial contribution for such cost.
The sub-contractor (or sub-consultant) shall not be liable for other losses incurred by the Funder/Employer)
(b) The sub-contractor (or sub-consultant's) liability for costs under this Agreement shall be limited to that proportion of such costs which is would be just and equitable to require the sub-contractor (or sub-consultant) to pay having regard to the extent of the sub-contractor (or sub-consultant) responsibility for the same and on the basis that it shall be deemed to have provided contractual undertakings on terms no less onerous to the Funder/Employer) in respect of the performance of their duties in connection with the Development and shall be deemed to have paid the Funder/Employer such a proportion which it would be just and equitable for them to pay having regard to the extent of their responsibility.
(c) The sub-contractor (or sub-consultant) shall be entitled in any action or proceedings by the Funder/Employer to rely on any limitation in the Appointment and to raise the equivalent rights in defence of liability as it would have against the Contract under the Appointment.
6. PI Clause
The limit of cover under the warranty should not be any greater than the limit of cover required by main contract.
Liability under the Collateral Warranty and contractual documents should be consistent with and no greater than the level of PI cover held.
"The sub-contractor (or sub-consultant) shall maintain professional indemnity insurance in an amount of not less than (insert figure not greater than the policy limit) in respect of each and every claim for a period of (twelve/six) years from the date of Practical Completion of the Project for the purposes of the Appointment, provided always that such type of insurance is available to professional persons acting in the capacity of the Appointment at commercially reasonable rates. The sub-contractor (or sub-consultant) shall immediately inform the Funder/Employer if such insurance ceases to be available at commercially reasonable rates in order that the Funder/Employer and the sub-contractor (or sub-consultant) can discuss the means of best protecting the respective positions of the Funder/Employer and the sub-contractor (or sub-consultant) in respect of the Project in the absence of such insurance. As and when it is reasonable requested to do so by the Funder/Employer, the s shall produce for inspection documentary evidence that its professional indemnity insurance is being maintained".
7. Novation / 'Step In' Rights
Ensures a contractor/developer party to the Collateral Warranty agrees to drop out of the picture completely if a funder steps into the developers shoes.
Ensure that the 'step in' rights or a third party (i.e. funder) are consistent with 'step out' obligations for the main contractor.
Ensure that the Collateral Warranty provides for copyright in the warrantors drawings/designs to remain with the warrantor, but for a licence to be granted to the beneficiary under the Collateral Warranty for limited purposes.
Ensure governed by laws of England and Wales (assuming that is the intention)
Top five causes of claims against Engineers
A recent across the board survey of claims handled by the Technology and Construction Court (TCC) provided a useful categorisation of the types of dispute that are the most prevalent. the top 5 were i) defect claims (18%), ii) payment issues (13%), iii) miscellaneous professional negligence (13%), iv) property damages (13%), v) design issues (12%).
Although precise figures are not available for the engineering sector in isolation, no doubt engineers feature in professional negligence claims. We discuss below five common dispute areas from our experience of handling claims against engineers, together with some basic risk management advice.
1. Inadequate Design
Design mistakes or calculation errors are an obvious area or risk for engineers. Such mistakes can arise in circumstances where the engineer has agreed to fees that are too low for the demands of the project. This may lead to the engineer deploying inappropriate resourcing/supervision, in order to fulfil its own profit requirements. Another cause of error is when the engineer agrees to deliver the design to unrealistically swift timescales, which means that designs have to be issued in circumstances where they have not been afforded due consideration. To avoid such pitfalls, careful thought should be given to realistic pricing, resourcing and suitable peer review provisions at the outset of a project.
2. Changes in Client requirements
During the course of a project, the scope of services required from the engineer is often broadened by the client. This can lead to problems in circumstances where either the engineer is overstretched or does not have the requisite expertise or sufficient time to work through the additional tasks. Claims can arise against the engineer for failure to comply with the extended brief. We advise engineers to include appropriate contractual provisions in their initial retainer terms to determine how altering the scope of duties is to be dealt with during a project that provides clarity for both parties. It must be open to the engineer to decline to perform additional services when it is not appropriate to do so. It is also prudent for engineers not to assume additional responsibility and risks by carrying out tasks beyond the agreed scope of their duties.
3. Inadequate Project documentation
Expended scope of services can lead to a situation where the engineer is unable to document the project as it should. For example, contemporaneous notes of site meetings can fall by the wayside, as can the recoding of rationale for engineering decisions. At the end of the project, 'as built' drawings may be omitted. This leaves the engineer vulnerable to a range of allegations, since it may lack documentary evidence in support of its actions. To protect their position, engineers should have in place an adequate system and make every effort to keep accurate and up to date records during the course of a project.
Late provision of design information is another common area for claims, since that can affect the works programme and the critical construction path. Under the NEC3 form of contract, the client can notify the engineer of delay constituting a compensation event during the project. That sets in motion a series of measures designed to avoid claims at the end of a projects, which may or may not successfully resolve matters. However, many contracts do not contain such a provision, in which case there is a greater prospect of a dispute and delay claim arising after completion.
5. Fees disputes leading to counterclaims
We frequently deal with counter claims that are made in response to unpaid fees claims from engineers at the end of a job. This emphasises the need for clarity about the engineers fees at the outset. In addition, when making an unpaid fees claim, engineers should at least be fully alert of the danger of a counterclaim being made and the potentially significant management time that will be taken up dealing with it. Put simply, before making a fees claim the engineer should be relatively comfortable that its conduct on the matter is not open to criticism
To recap, here is a list of key practical risk management tips:
Contracts need to be finalised as do retainer terms.
Contractual documents should only be signed in full cognisance of the meaning of the terms and conditions. In other words, such documents should be read carefully before being signed off.
Do not go beyond contractual obligations and risk assuming a duty of care for tasks outside your retainer.
If inspecting during course of works, set out parameters and frequency of inspections carefully.
Keep written records and photos of all inspections and generally.
Do not over-rely upon contractor competence.
Check written minutes and amend if necessary.
Keep to deadlines or provide written explanation as to why not possible.
If terminating a contract take legal advice on mechanism for doing so first
If in doubt about a problem issue, speak with your broker and consider notifying Insurers.
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