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Last edited 12 Dec 2017
Practical considerations of collateral warranties
A great many practical issues are raised by those involved in collateral warranties:
- Does a warranty have to be given at all?
- What the tenant wants is unfair.
- Who is to pay the legal costs of negotiation of non-standard warranties?
- Do warranties have to be signed by the parties?
- How should the negotiations be conducted and how should professional indemnity insurers be involved?
- Should different terms be in the warranties depending on whether they are being given to funds, purchasers or tenants?
A warranty does not have to be given by anyone unless they are under a binding and certain contractual obligation to do so, subject, of course, to the commercial pressure that can be brought to bear. It follows that in the absence of such a binding and certain contractual obligation such as that, no warranty whatsoever has to be given. This is particularly so where after practical completion of a development, proposed tenants seek warranties from the architect, the engineer and the contractor. This gives rise to points that are the opposite sides of the same coin.
Firstly, building owners would be well advised to deal with the whole question of collateral warranties at the outset of the project and see that they have bound all the principal parties to the construction process, through their contracts, to give certain collateral warranties when required by the building owner; this should be the case even though the names of the fund/purchaser or tenants are unknown at that stage
Secondly, it may be unwise for architects, engineers and contractors to raise the question of warranties, prior to entering into their principal contracts, with a view to avoiding any binding obligation to enter into warranties.
 Contractual obligation to give warranties
Where such clauses are incorporated by the building owner into tender documents or proposed contract documents, then the tenderer would be well advised to check the provision particularly carefully, including the warranty itself. In contractors' organisations, the estimating department may not be best placed to pick up the risks of collateral warranties and/or their wording and the dangerous consequences that can flow from badly drafted warranties, or warranties that have been well drafted but with onerous conditions. Contractors' estimators would be well advised to have such provisions carefully vetted by in-house or external lawyers.
Where a binding contractual obligation has been entered into to give warranties, then it is likely that on the failure of that party to give the warranty, the other party to the principal contract could apply to the High Court for an order of specific performance requiring the warranty to be entered into.
For such an application to be successful, the wording of the contractual obligation will have to be clear and unambiguous, and the terms of the warranty will have to be certain in law. A provision that simply purports to require a warranty to be given, but on terms that are not described, will be insufficient to enable an application for specific performance to be successfully made to the court.
 Commercial pressure
In most cases, it is the commercial pressure to sign warranties that is one of the dominant factors in the decision as to whether or not they should be given. In other words, if warranties are not agreed to be given by a party, then that party may not obtain the project; at a much lower level, there may be such a good working relationship between the parties, with ongoing work, that the pressure to give warranties is entirely reasonable.
However, in the absence of a binding obligation, the party who is asked to sign warranties is in a much better negotiating position on the terms of the warranty and, perhaps, the extent of the parties to whom warranties are to be given.
There is little point in the party giving a warranty permitting commercial pressure to force then into a position where they enter into very onerous obligations, which are not collateral to the principal contract, or obligations that put at risk professional indemnity insurance cover or the future financial viability of their business.
 Commercial balance
The reality is that the purpose of a contract is to allocate risk between the parties; in theory, that allocation of risk is a matter of negotiation between the parties. Usually, in collateral warranties, there is not a balancing of risks - most of the risks are undertaken by the person giving the warranty and the negotiation is about the nature and extent of the risks that that person is prepared to undertake.
On lengthy non-standard collateral warranties, the legal costs involved in the original drafting and subsequent vetting, negotiation, re-drafting of and producing the final version can be heavy. Indeed, on smaller projects, or sub-contracts on larger projects, the legal costs can be out of all proportion to the value, in terms of profit, of the principal contract. There is no reason in law why the collateral warranty obligations should be given by a professional person or a contractor free of actual consideration in money.
Although it is unusual to agree such a 'signing fee', the reality is that the developer, fund and tenant are gaining real benefits through a warranty. A building will be more readily marketable with warranties. The commercial reality suggests a fairly substantial fee might be appropriate. Regard might be had to the financial benefit to the other party; what the premium might be on ten years non-cancellable building insurance (which might not be needed if there are collateral warranties); what the market will bear; the future liability risks and any increased professional indemnity insurance premiums, now and in the future by reason of collateral warranties.
If there is a contractual obligation to enter into a warranty, and there has been no prior agreement as to legal costs or some provisions set out in the obligation as to legal cost, then each party will have to bear their own legal costs in seeking advice. However, if there is no legal obligation to enter into a warranty, the person asked to give the warranty is in a rather better position.
If the commercial situation enables them to do so, they can say to the other party, I am not obliged to give you a warranty but if you wish me to consider giving one, then I must ask you to pay my reasonable legal costs that I will incur in dealing with it and a signing fee. The other party, particularly where it is a developer with prospective tenants who will take a lease if they are given warranties, may be susceptible to that kind of suggestion.
Such an agreement as to legal cost can speed the process to agreement of the warranty dramatically; when one party is picking up the legal costs of two parties, they are likely to be keen to see resolution with the minimum of time and therefore expenditure of costs.
Where there is an endorsement to the professional indemnity policy, the person giving the warranty must keep the scope of the warranty within the parameters set by the endorsement to the policy. Indeed, the fact that those parameters are so set by the policy is a very useful tool in negotiations by that party with the person seeking the warranty. They should argue that there is little point in entering into a collateral warranty that would take them outside the cover of their professional indemnity insurance policy - it is in the interests of all parties to warranties that insurance cover is available in the event of a claim.
It is no answer for a developer, fund, purchaser or tenant to say that insurance is a matter wholly for the person giving the warranty; whilst that is true as a matter of law, it flies in the face of the commercial reality in the event of a claim.
Where the insurance policy has no endorsement in relation to collateral warranties, or where a warranty cannot be agreed within the terms of the endorsement, then it is absolutely essential to refer all such warranties to insurers for approval prior to entering into them.
In order to minimise the workload on insurers, it is sensible to get a draft into its final form before putting it to insurers, rather than constantly referring all the interim drafts; insurers, when faced with such non-standard warranties, will either refuse cover, agree to cover without any extra premium, or agree to cover with extra premium payment.
The insured should clarify with the insurer whether that extra premium payment is a one-off in that year of insurance or whether the additional premium is likely to reflect in premiums for subsequent years of insurance; in any event, it is necessary to disclose warranties that fall outside any agreed endorsement to the policy to insurers at the time that insurance is being taken out and at any renewal, whether with the same insurer or a different insurer.
 Warranties must be executed
Unilateral promises, save where given under seal, are not binding in English law, although they can be in Scotland. In order, therefore, for there to be a binding collateral warranty, it must be signed and/or sealed by all the parties to it. Where there is a novation agreement, with three parties, then all three parties must sign and/or seal the warranty.
 The givers, receivers and contents of warranties
In setting up the collateral warranty arrangement for a project, it is essential to look first at what the developer's intentions are. Is there to be a fund providing finance for the project and what are their requirements as to collateral warranties, if any? Is there to be a provision for the possibility that the development might be sold during construction or on completion?
If it is to be sold during construction, then consideration should be given to inserting an obligation in all the principal contracts (e.g. architect, engineer, quantity surveyor and contractor) requiring that party to enter into a novation agreement, in the form of a draft that should be attached, in the event that the building owner so requires; this is in addition to considering warranties.
Is the building to be occupied by the building owner or let on full repairing leases to tenants or sold to a purchaser on completion for occupation or for letting to tenants of the purchaser? There is little point considering who should be required to give warranties, and on what terms, to whom without looking first at the way the project is to be dealt with.
Once the developer's intentions are established, it is a relatively simple task to prepare a list of the principal contract and collateral warranty arrangements that will be required. Sometimes this can be best explained by preparing a chart of the contractual arrangements in diagrammatic form. Before this can be done, however, it is necessary to look at the method of procurement of the project.
 Method of procurement
On these types of projects, the building owner will engage the architect and the engineer to provide the design. A main contractor will be engaged by the building owner to carry out the construction of the design provided by the architect and the engineer. There may be nominated sub-contractors who will carry out design for the building owner and who will carry out the construction of their work under a sub-contract with the main contractor.
Under this form of contract, the building owner sets out their requirements in a document which, in the contract, is called 'the Employers Requirements’ the design and build contractor puts forward proposals in a document called 'the Contractor's Proposals'. Both these documents taken together form the description of the work to be done for the purposes of the contract.
It follows that on the face of it, the contractor is undertaking all the design and all the construction work and only they should be required to give warranties. In practice, the contractor will usually sub-let the design to architects and engineers and in some cases (such as mechanical and electrical services) to sub-contractors. There may be a chain of contracts for liability through collateral warranties given by the contractor so that, for example, the tenant can sue the contractor who in turn can join in the architect or engineer or sub-contractor responsible.
However, if the contractor goes into liquidation, there will be a break in the chain of contracts and the tenant will be unable to proceed against the architect, the engineer or the sub-contractors in tort. It is for this reason that warranties may be required on design and build projects from the architect and engineer of the contractor, as well as some of the sub-contractors. Clearly a decision needs to be made as to which of the sub-contractors are to be required to give warranties.
Usually, the building owner will engage the architect and the engineer and the construction manager; each trade contractor will then enter into a contract with the building owner but on the basis that the construction manager has the right and obligation to supervise and direct the trade contractors. These projects are a potential breeding ground for collateral warranties.
Clearly, the architect and the engineer can be asked to give warranties in respect of design and other matters without too much difficulty. As to the trade contractors, it may be inappropriate to ask for warranties from all of them but clearly the major trade contractors may be asked to provide warranties.
As to whether or not a warranty should be taken from the construction manager, this will depend on the duties that they have under the construction management contract. If those duties include, for example, inspecting the work of trade contractors to ascertain that they are carrying out work in accordance with the trade contract then collateral warranties may well be appropriate.
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