The provision of a collateral warranty increases a construction professional’s financial exposure. Each issued warranty potentially creates another claimant against the construction professional, and it is therefore in their interest to limit the number of warranties issued on a project. Importantly, collateral warranties can create uninsured liability. To avoid facing an uninsured claim, professionals must be very careful and precise with wordings in third-party contracts.

Collateral warranties are common in the construction sector. Obligations to provide collateral warranties to identified classes of beneficiaries are often found in construction professionals’ appointments, or even in collateral warranties to be issued to employers and funders. They act to extend a construction professional’s liability to a third party.

Two legal cases show how unprecise contract wordings can lead to uninsured claims:

1. Liberty Mercian v Cuddy Civil Engineering Ltd

In the English law case of Liberty Mercian v Cuddy Civil Engineering Ltd (2014) the court was asked to consider an order for specific performance that the professional issue a collateral warranty in the form attached to their appointment. The professional’s position was that the content of the warranty had not been agreed, and that the appointment had been entered into on the basis that the warranty was still to be negotiated between the parties.

However, the parties in that case had not amended the appointment to make it clear that the warranty was subject to agreement, and the professional had entered into the appointment. The appointment stated that the professional would provide the warranty in the form attached to the appointment, and the court was willing to give an order for specific performance accordingly.

Key takeaway

The case shows the danger of a professional being obliged to provide a warranty which creates the potential for an uninsured loss against them (especially if the demand for the collateral warranty was prompted by an actual loss and desire to make a claim against the professional). As such, the case emphasises the importance of agreeing the form of any collateral warranty before entering into an appointment, or at least being very clear that the warranty is still to be negotiated and that any obligation to provide such warranty is subject to the same.

2. The Engine Yard Edinburgh Limited and Allenbuild Limited v Bayne Stevenson Associates Limited

In the Scottish law case The Engine Yard Edinburgh Limited and Allenbuild Limited v Bayne Stevenson Associates Limited (2024), the structural engineer in this project entered into a contract which required them to provide collateral warranties within 7 days of a request by the contractor for the employer or a funder or a lessee or a purchaser.

This was a contract in which the law of Scotland applied, and therefore negative prescription of 5 years potentially applied. No request for provision of the warranty was received by the engineers in the 5 years since the appointment was executed.

However, a claim arose, and the Engine Yard and Allenbuild claimed that the appointment created third party rights and/or that the engineer was obliged to provide the warranty.

On the question of third-party rights, the court took the commonsense approach that the explicit use of collateral warranties pointed away from any intent to create third party rights. It noted explicit exclusions of third-party rights in some of the project contracts as further evidence of the intent of the parties.

On the question of a contractual obligation to provide the warranty, the court upheld the prescription position. They considered that as the right was immediately available to the other party to the appointment, the clock had started to run and that as five years had passed, legal actions based on the right were now prescribed.

Key takeaway

The court case shows that the legal right to collateral warranties is itself subject to the limitation or prescription position. This observation has different relevance depending on the nature of participation in the project. Employers, contractors and development purchasers for example will need to be conscious of the need to gather in collateral warranties prior to the effective expiry of their right to do so. Conversely, professionals may want to be conscious of the passage of time and the potential to resist an inappropriate request for a collateral warranty (perhaps if it could be anticipated that the warranty would subsequently be assigned to another party who was not entitled to a warranty).

It should be noted that the Engine Yard case involved a contract which predated the coming into force of the Contract (Third Party Rights) (Scotland) Act 2017. However, the above observations remain relevant for other contracts predating the coming into force of this Act, or contracts where the Act is expressed not to apply in favour of the use of collateral warranties.

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