Understanding Collateral Warranties in Construction Projects, Exams of Construction

Download Understanding Collateral Warranties in Construction Projects and more Exams Construction in PDF only on Docsity! ACLN - Issue #37 t----------------- Contracts Collateral Warranties: The Mysteries Explained - Alison Hancock, Solicitor, Minter Ellison Morris Fletcher, Solicitors. 16 Mention the term "collateral warranty" during project negotiations and it is more than likely one will get a fairly cool reception. Unfortunately, there is a tendency to suspect that the other party is trying to put one over when suggesting that both parties sign a collateral warranty. The reality is that collateral warranties are not the nasty crea­ tures many people believe them to be. In fact, they can be important and useful contracting tools. Much of the bad press given to collateral warranties stems from a lack of understanding of their nature and possible uses. A collateral warranty is essentially an agreement that exists alongside, but separate from, another principal agreement. It may be made between the parties to the principal agreement only or it may involve third persons who are not parties to the principal agreement. Why Use Collateral Warranties? Collateral warranties are generally used either where there is an aspect of a particular transaction that is more appropriately dealt with in a separate agreement or where one party wishes to create a direct contractual relationship with a third party in circumstances where a contract would not otherwise exist between those two parties. In the construction industry, collateral warranties tend to be used more often for this second purpose. This article focuses on this kind of use. There are two main reasons why the parties involved in a project might seek to establish direct contractual relationships with other parties involved in the project. Firstly, collateral warranties can be used as a mechanism to keep a project running in case ofinsolvency ofone ofthe parties involved. Secondly, they can be used to enable a party to recover damages for loss caused by the actions of another party with whom there would otherwise be no contractual relationship. Ofcourse, the lack ofcontractual relationship between two parties does not prevent a claim based in negligence. However, the law of negligence can be fickle in granting remedies and many prefer to rely on what they see as the "certainty ofobligations" provided by a collateral warranty. Some of the more common uses of collateral warran­ ties are set out here. Project Financier - Head Contractor Where a project financier takes a mortgage over a proprietor's interest in a construction contract, the finan­ cier will often require a separate collateral agreement between it and the head contractor. The collateral agree­ ment will usually contain a promise by the head contractor not to terminate the construction contract in case of the proprietor's default without first giving the financier an opportunity to rectify the default. It will also usually allow the financier to take over the proprietor's rights and obli­ gations under the construction contract if the proprietor defaults under the finance facility. This type of collateral warranty assists both parties. It gives the financier the ability to step in and complete the project with as little delay as possible in the event of the proprietor's default. Conversely, it gives the head contrac­ tor peace of mind that, if the proprietor defaults and the financier wishes to complete the project itself, the head contractor will probably get paid for its work. Depending on the type ofproject and the risk involved, financiers may also seek collateral warranties from sub­ contractors and consultants for similar reasons. Proprietor - Subcontractor This is probably the most frequently used form of collateral warranty. Although this type of collateral war­ ranty is generally designed to benefit the proprietor, it can offer some advantages for a sub contractor. There are three main reasons why a proprietor might seek to enter into a collateral agreement with a sub-contractor. Firstly, a proprietor can agree with the sub-contractor that the sub contractor will consent to the assignment ofthe sub-contract to the proprietor or to a third party contractor if the head contractor defaults. This enables the proprietor to complete the project with as little delay and cost escala­ tion as possible. The sub-contractor also benefits: if the head contractor defaults and the proprietor wants to com­ plete the project, the sub-contractor is likely to get paid for its work. Secondly, a proprietor can obtain warranties about the quality of workmanship and materials directly from sub­ contractors and suppliers. This is useful where the propri­ etor cannot secure satisfactory guarantees and warranties from the head contractor or where significant parts of the works are to be performed by sub-contractors. Where a sub-contractor is to provide design services, these should also be included in the warranty. Thirdly, a collateral agreement involving the proprie­ tor, the head contractor and the sub-contractor allows each party to clearly state what its respective rights are in relation to unfixed goods and materials. In the event of insolvency of a head contractor, there are often disputes about the ownership ofunfixed goods and materials. Such disputes can be avoided by the parties entering into a tripartite agreement at the outset that clearly sets out who