Collateral warranties in construction: Do you need one from a sub-sub-contractor?
William Marlow, solicitor in our construction team, looks at the importance of collateral warranties in construction and what employers need to know.
When undertaking a construction project, employers want assurance that they can seek recourse if things go wrong, especially when multiple layers of contractors, sub-contractors, and sub-sub-contractors are involved.
One way to achieve this is through collateral warranties; agreements that create a direct contractual relationship between the employer and parties further down the supply chain. They stand alongside a main agreement or contract which carries full contractual obligations and rights. Warranties carry varying degrees of these obligations and rights which are repeated in favour of a third-party beneficiary.
Understanding contractual liability in construction projects
Typically, the main contractor is responsible for delivering the entire scope of works, even if it sub-contracts parts of the project to other parties.
This means that:
- The main contractor is liable to the employer for the performance of the works.
- A sub-contractor remains responsible for its portion of the works, even if it further sub-contracts part of that work.
- A sub-sub-contractor is accountable to the sub-contractor, but not directly to the employer.
Under standard contract structures, the employer does not have a direct contractual relationship with a sub-contractor or sub-sub-contractor and ensures that liability for defective work or design is passed up the chain.
Collateral warranties are used to provide legal recourse by the employer under the main contract to the Professional Indemnity Insurance of the sub-contractors, or other parties which have material design liability.
Recent changes mean that it is increasingly difficult to get Contractors to agree to procure sub-sub-contractor warranties unless this material and key design liability exists.
Checking your contracts
Before deciding whether to seek a collateral warranty from a sub-sub-contractor, employers should first examine the building contract and sub-contracts to confirm that this structure is in place.
This is particularly important where design obligations are involved, as professional design services often introduce additional risks.
If the contracts do not create a clear chain of responsibility, an employer may need to consider alternative legal protections, such as direct warranties or third-party rights.
When are collateral warranties needed?
Collateral warranties provide a legal link between the employer and subcontractors or sub-sub-contractors in case something goes wrong with the project, offering protection in the event of breach of contract or failure to perform as required.
They help create a safety net for the employer by allowing them to pursue claims directly against contractors further down the supply chain.
If the main contractor becomes insolvent, the employer’s ability to seek redress directly from the main contractor is severely limited. In this case, having a collateral warranty from the sub-contractor gives the employer an alternative route to recover damages or ensure completion of the works. Similarly, if the sub-contractor becomes insolvent, the employer might need to rely on the sub-sub-contractor’s warranty to enforce obligations or seek damages.
One of the challenges employers face is the number of parties involved in a large construction project. In large projects, there may be dozens or even hundreds of sub-contractors and sub-sub-contractors, making it difficult to negotiate individual warranties.
Despite these challenges, collateral warranties are crucial for managing risks such as poor workmanship, faulty design, or delayed project completion. Employers should carefully weigh the administrative burden of obtaining warranties against the potential costs of failure in the chain of responsibility.
Assessing risk
Deciding whether to require a collateral warranty from a sub-sub-contractor involves weighing various factors, primarily revolving around risk management and the specific needs of the project.
Here are the key points to consider when assessing whether it’s appropriate:
- The importance of the sub-sub-contractor’s role
If the sub-sub-contractor plays a critical role in the project, such as providing key design services or carrying out specialised, high-risk work, the employer may want additional protection.
- Financial stability of key parties
If the main contractor and sub-contractor is in a financially precarious position, the employer might need to consider obtaining warranties from sub-sub-contractors as a contingency plan. Collateral warranties provide a way to pursue claims if the main contractor or sub-contractor becomes insolvent.
- Employer’s attitude to risk
Some employers are more risk-averse and prefer to secure as many collateral warranties as possible to mitigate potential issues. Others might be willing to accept the risks associated with relying on the main contractor and sub-contractor alone, particularly if they have a strong financial position and the risk of insolvency is low.
Key considerations for structuring collateral warranties
Here are the key considerations for creating effective and enforceable collateral warranties that provide real protection for the employer:
- Establishing a direct contractual link
A collateral warranty enables the employer to pursue legal action for breach of contract or failure to meet obligations, even if the warrantor is not a party to the main contract.
In these circumstances, the sub-sub-contractor would be the warrantor, and the employer would be the beneficiary. The key goal is to ensure that the sub-sub-contractor’s obligations are clearly outlined and enforceable, should the need arise.
- Step-in rights and additional parties
A common reason for involving additional parties in a collateral warranty is to provide step-in rights. These rights allow a third party, often the funder, employer or other relevant party, to step in and take over responsibilities if the sub-contractor or sub-sub-contractor fails to meet their obligations.
In many cases, the contractor may also be a party to the collateral warranty, particularly where step-in provisions are included. This ensures that the contractor has the authority to take over if a sub-contractor or sub-sub-contractor fails to deliver.
- Standard contractual provisions
Most collateral warranties include standard terms regarding the scope of obligations, limitations of liability, and duration of the warranty. These terms help protect both the employer and the warrantor by clearly defining the responsibilities and remedies available.
Conclusion
When assessing the need for collateral warranties, employers should:
- Understand the contract chain: It’s essential to ensure that the contractual responsibilities between the employer, contractor, sub-contractor, and sub-sub-contractor are clear. This will help determine whether a collateral warranty is necessary.
- Assess the risks: Consider the nature of the sub-sub-contractor’s work, their financial stability, and your own attitude to risk when deciding whether to require a collateral warranty from them.
- Weigh the burden of procurement: While collateral warranties provide significant protection, they can be time-consuming to negotiate and procure, especially with multiple sub-contractors. Weigh the administrative burden against the potential risks of insolvency and failure.
- Structure your warranties carefully: Make sure the collateral warranties create direct links between the employer and the sub-sub-contractor and consider whether step-in provisions or additional parties might be necessary.
Ultimately, collateral warranties are an important tool for risk management in construction, offering a safety net in the event of contractor insolvency or other failures. By understanding how they work and when they are needed, employers can ensure their projects remain protected.
If you have any questions surrounding collateral warranties, then please get in touch with our construction team on 01772 258321.