A collateral warranty is a document in which a party to a contract warrants to a third party who is not a party to that contract that they have complied (or will comply) with their contractual obligations. It creates a direct contractual link between a party to a contract and a third party. 

Background 

One of the key principles of contract law is the principle of privity of contract. This principle states that only the parties to a contract can enforce the terms in that contract. This is the case even if it is clear that the contract in question was put in place for the specific reason of benefitting a particular third party – that third party would still not have a right to sue to enforce any of the terms under that contract. That could potentially seem counter-intuitive on one hand, but when the inverse is considered,  such a contract also cannot impose any obligations on a third party.  

Where is the link to construction?  

Construction projects are a melting pot of different parties with different interests. There are employers/clients, who are often the parties that are putting the project in place, funders; consultants who are responsible, design and contractors; to do the actual building work. Between these parties, there will be multiple contracts; a funding agreement between the client and its funder, a consultancy appointment between the client and its architect/engineer, a subcontract between the contractor and subcontractors it may employ to carry out parts of the works, and so on.  

The issue is that some parties have interests in contracts that they are not party to. Perhaps the leading example is that funders have a clear interest in the building works going well and reaching completion hitch-free. As discussed, this leaves the funder in a bind if the contractor performs negligently.  

Enter Collateral Warranties 

In order to allow the funder to enforce the terms of the building contract against the contractor (to sue the contractor), a collateral warranty can be used in which the contractor warrants to the funder that it has complied with its obligations under the building contract. Therefore, in the unfortunate event that a funder needs to sue the contractor, it has a direct right to.  

The benefit is clear; without a collateral warranty, the funder (or any other relevant third party) would have no right of recourse against the contractor (or any other relevant contracting party). The collateral warranty gives a degree of comfort to the third party that it has options if things do not go according to plan. Collateral warranties are often a funding prerequisite, as funders will be unwilling to be involved in a project without the client procuring collateral warranties from its supply chain.  

As a result of the various interests that need to be protected in construction projects, collateral warranties have become a regular feature in the industry. While they are not the only method through which a third party can gain direct interest in a contract – the other method being through the activation of the contracts (Rights of Third Parties) Act 1999 – they are arguably the primary method.  

In summary, collateral warranties are an essential feature of construction projects and constantly prove their value. In an industry that continues to feature a variety of parties and growing levels of investment, the collateral warranty does not seem to be going anywhere.  

How Capsticks can help 

Our construction lawyers provide expert legal advice and end to end tailored support for clients who are involved in delivering construction projects across both public and private sectors. If you have any questions related to this insight and how Capsticks can help, please contact Catherine Kay.  

This insight is co-authored by Sore Odunsi, Associate in our Corporate & Commercial team.