what is a collateral assignment in construction

Collateral Assignment

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A collateral assignment involves granting a security interest in the asset or property to a lender. It is a lawful arrangement where the borrower promises an asset or property to the lender to guarantee the debt repayment or meet a financial obligation. Moreover, in a collateral assignment, the borrower maintains asset ownership, the lender holds the security interest, and the lender has the right to seize and sell the asset in event of default. This blog post will discuss a collateral assignment, its purpose, essential considerations, and more.

Key Purposes of a Collateral Assignment

Collateral assignment concerns allocating a property's ownership privileges, or a specific interest, to a lender as loan collateral. The lender retains a security interest in the asset until the borrower entirely settles the loan. If the borrower defaults on loan settlement, the lender can seize and market the collateral to recover the unpaid debt. Below are the key purposes of a collateral assignment.

Enhanced Lender Protection: The primary purpose of the collateral assignment is to provide lenders with an added layer of security and assurance. Also, by maintaining a claim on the borrower's properties, lenders lower their risk and improve the probability of loan settlement. In case of default, the lender can sell the collateral to recover the unpaid balance. This security authorizes lenders to offer loans with lower interest rates, as the threat associated with the loan is reduced.
Favorable Loan Terms: Collateral assignment allows borrowers to access financing on more favorable terms than unsecured loans . However, the terms of the loan will vary depending on the borrower’s creditworthiness and the value of the collateral. Generally, lenders are more willing to extend larger loan amounts and lower interest rates when they have collateral to fall back on. The presence of collateral reassures lenders that they have a viable means of recouping their investment, even in case of default. This increased confidence often leads to more competitive loan offers for borrowers.
Unlocking Asset Value: Collateral assignment enables borrowers to leverage the value of their assets, even if those assets are not readily convertible into cash. For instance, a business owner with valuable machinery can assign it as collateral to secure a business loan. This arrangement allows the borrower to continue utilizing the asset for operational purposes while accessing the necessary funds for expansion or working capital. Collateral assignment, thus, enables the efficient allocation of resources. However, the collateral will still be considered in determining the loan amount and terms.
Access to Higher Loan Amounts: When borrowers promise collateral against a loan, lenders can present greater loan amounts than for other unsecured loans. The worth of the collateral serves as a reassurance to lenders that they can recover their investment even if the borrower fails to settle the loan. Therefore, borrowers can obtain higher loans to finance important endeavors such as purchasing property, starting a business, or funding major projects.
Diversification of Collateral: Collateral assignment offers flexibility for borrowers by allowing them to diversify their collateral base. While real estate is commonly used as collateral, borrowers can utilize other valuable assets such as investment portfolios, life insurance policies, or valuable personal belongings. This diversification allows borrowers to access financing without limiting themselves to a single asset, thereby preserving their financial flexibility.

Steps to Execute a Collateral Assignment

A collateral assignment is a financial procedure that involves utilizing an asset as security for a loan or other responsibilities. Below are the essential steps involved in the collateral assignment process.

Assess the Need for Collateral Assignment. The initial step in collateral assignment is determining whether collateral is necessary. Lenders or creditors may require collateral to mitigate the risk of default or ensure repayment. Evaluating the value and marketability of the proposed collateral is crucial to ascertain if it meets the lender's requirements.
Select Appropriate Collateral. The next step involves choosing a suitable asset for collateral assignment. Common classifications of collateral comprise stocks, real estate, bonds, cash deposits, and other valuable assets. The collateral's value should be sufficient to cover the loan amount or the obligation being secured.
Understand Lawful and Regulatory Requirements. Before proceeding with collateral assignment, it is essential to comprehend the lawful and regulatory provisions specific to the jurisdiction where the transaction happens. Collateral assignment laws can vary, so seeking advice from legal professionals experienced in this area is advisable to ensure compliance.
Negotiate Provisions. Once the collateral is recognized, the collateral assignment provisions must be negotiated among the concerned parties. It includes specifying the loan amount, interest rates, repayment terms, and any further duties or limitations associated with the collateral assignment.
Prepare the Collateral Assignment Agreement. The collateral assignment agreement is a lawful document that typically includes details about the collateral, the loan or obligation being secured, and the rights and responsibilities of both parties. It is highly advised to engage the services of a legal specialist to prepare or review the contract.
Enforce the Collateral Assignment Agreement. After completing the collateral assignment agreement, it must be executed by all involved parties. This step ensures that all necessary signatures are obtained and copies of the agreement are distributed to each individual for record-keeping objectives.
Notify Relevant Parties. To ensure proper recognition and recording of the collateral assignment, it is important to notify all relevant parties. It may involve informing the lender or creditor, the custodian or holder of the collateral, and any other pertinent stakeholders. Sufficient documentation and communication will help prevent potential disputes or misunderstandings.
Record the Collateral Assignment. Depending on the nature of the collateral, it may be necessary to record the collateral assignment with the appropriate government authority or registry. This step provides public notice of the assignment and establishes priority rights in case of multiple claims on the same collateral. Seeking guidance from legal professionals or relevant authorities can determine if recording the collateral assignment is required.
Monitor and Maintain the Collateral. Throughout the collateral assignment term, it is crucial to monitor and maintain the value and condition of the collateral. This includes ensuring insurance coverage, property maintenance, and compliance with any ongoing obligations associated with the collateral. Regular communication between all parties involved is essential to address concerns or issues promptly.
Terminate the Collateral Assignment. Once the loan or obligation secured by the collateral is fully satisfied, the collateral assignment can be terminated. This involves releasing the collateral from the assignment, updating relevant records, and notifying all parties involved. It is important to follow proper procedures to ensure the appropriate handling of the legal and financial aspects of the termination.

Key Terms for Collateral Assignments

Security Interest: It is the legal right granted to a lender over the assigned collateral to protect their interests in case of borrower default.
Collateral Valuation: The process of determining the worth or market value of the assigned collateral to assess its adequacy in securing the loan.
Release of Collateral: The action taken by a lender to relinquish its claim over the assigned collateral after the borrower has fulfilled the loan obligations.
Subordination Agreement : A legal document that establishes the priority of multiple creditors' claims over the same collateral, typically in the case of refinancing or additional loans.
Lien : A legal claim or encumbrance on a property or asset, typically created through a collateral assignment, that allows a lender to seize and sell the collateral to recover the loan amount.

Final Thoughts on Collateral Assignments

A collateral assignment is a valuable instrument for borrowers and lenders in securing loans or obligations. It offers borrowers access to profitable terms and more extensive loan amounts while reducing the risk for lenders. Nevertheless, it is essential for borrowers to thoughtfully assess the terms and threats associated with collateral assignment before proceeding. Seeking professional guidance and understanding the contract can help ensure a successful and beneficial financial arrangement for all parties involved.

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Collateral warranties in construction contracts – the basics

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A collateral warranty is a contract under which a party involved in the works warrants to a third party beneficiary that it has fulfilled its obligations under its underlying building contract, subcontract or professional appointment (referred to as underlying contract in this article).

In this article we explore the purpose and typical content of a collateral warranty in the context of a construction project. We also briefly consider an alternative approach as provided by the Contracts (Rights of Third Parties) Act 1999.

In a simple construction project, an employer may contract with a contractor to carry out building works. Those two parties usually have a clear contractual relationship.

However, construction projects invariably involve a wide range of parties with an interest in the development (funders, purchasers, tenants for example) and also those involved in the works (contractors and consultants). Some of those parties will not have a direct contractual link or a commercial relationship of any sort.

Ordinarily, only a party to a contract is entitled to enforce said contract. Therefore, if a subcontractor were to commit a breach of its subcontract (with the contractor), and that breach adversely impacted on the employer (this could also be a funder/purchaser or tenant), an employer would be unable to enforce the same. That creates a problem for the employer particularly in a situation where the main contractor is insolvent.

In addition, if the employer identify defects in the subcontract works, in the absence of a collateral warranty the employer would have no realistic contractual recourse against any party in the example above.

In the absence of that contractual link, the employer would have to rely on a claim in negligence. This is not desirable as it would require the employer to establish that the subcontractor owed it a duty of care before its claim was even considered. Even if successful, the employer would also be limited as to what it could recover in negligence.

Collateral warranties are used to bridge the contractual gap and create a direct contractual link for the benefit of those parties that may otherwise have no recourse.

The step-in option

Some collateral warranties can also contain ‘step-in’ rights which effectively allow the beneficiary to step in to the underlying contract and issue instructions.

Should the main contractor of a project fall into insolvency the subcontractor will be under no contractual obligation to accept instructions from the employer to complete the works given there exists no contractual relationship. The use of a collateral warranty in this instance creates a direct contractual link allowing the employer to give instructions to the subcontractor, ensuring completion of the latter’s obligations is achieved.

Key contractual considerations

Effectively a collateral warranty is a shortened version of the underlying contract and so should reflect the obligations therein. We would expect to see direct provisions as to:

Principal covenant – The warrantor warrants to the beneficiary that it has and will fulfil its obligations under the underlying contract and perform its obligations with an appropriate level of skill and care.
Insurance - The level/basis of insurance the warrantor is obliged to maintain for the duration of the warrantor’s liability period.
Step-in rights - Gives the beneficiary the ability to step-in to the underlying contract in place of the instructing party in certain circumstances.
Intellectual property licence – A right for the beneficiary to reproduce and use the warrantor’s intellectual property.
Assignment - The ability to ‘pass on’ the benefit of the warranty to an alternative third party beneficiary.
Materials – That materials used or specified by the warranting party will be or were fit for use and not deleterious in nature.

Are parties required to provide collateral warranties?

This is dependent on the terms of the underlying contract. Providing a collateral warranty increases the potential scope of a provider’s liability, so careful thought should be given to the decision to do so.

If so required, a party may seek to limit the number of warranties it is obliged to provide, or limit the scope of the same by proposing an overall cap on its liability.

A warranting party (and its insurers) is unlikely to want to extend its obligations in a collateral warranty beyond those contained in its underlying contract. Such clauses are standard in the collateral warranties we see.

If entering into a collateral warranty, it is important to seek legal advice to ensure that the terms are acceptable for the required purpose, whether from the perspective of a beneficiary or the warranting party.

Third-party rights - An alternative approach?

A statutory exception to the doctrine of privity of contract was introduced by the Contracts (Rights of Third Parties) Act 1999 (the Act).

The Act allows a third party to enforce the terms of a contract where an express right has been granted or the contract confers a benefit on the third party. The contract should clearly identify any third party beneficiary by name or particular category (eg purchasers or tenants), with such beneficiaries typically set out in a rights schedule annexed to the underlying contract. Any such beneficiary will benefit from any remedy that would be available in an action for breach of contract as if they were a party to said contract.

Granting rights under the Act, particularly to members of a class, may result in the construction of a wide range of third party beneficiaries, which may place undue risk on the warrantor. While such rights are sometimes granted, contractors and consultants typically prefer to exclude them entirely by an express term of the contract, instead relying on collateral warranties.

Collateral warranties will continue to act as useful security in construction projects, allowing a beneficiary to avoid the issues associated with bringing a claim in negligence if issues arise.

Both collateral warranties and third-party rights can extend the scope of a warranting party’s liability beyond its direct employer, which may be beyond what was perhaps initially anticipated. While construction professionals generally accept that collateral warranties, or third-party rights, form part of a typical construction suite of contracts, the scope of additional liabilities to third-party beneficiaries should be factored in to the agreed price when negotiating an underlying contract.

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Collateral Assignment of Contracts, Licenses, Permits, and Plans (Construction Loan) | Practical Law

Collateral Assignment of Contracts, Licenses, Permits, and Plans (Construction Loan)

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Collateral warranties in construction contracts - the basics

In a simple construction project, an employer may contract with a contractor to carry out building works. Those two parties usually have a clear contractual relationship.

Collateral warranties are used to bridge the contractual gap and create a direct contractual link for the benefit of those parties that may otherwise have no recourse.

The step-in option

Some collateral warranties can also contain ‘step-in’ rights which effectively allow the beneficiary to step in to the underlying contract and issue instructions.

Key contractual considerations

Effectively a collateral warranty is a shortened version of the underlying contract and so should reflect the obligations therein. We would expect to see direct provisions as to:

Principal covenant – The warrantor warrants to the beneficiary that it has and will fulfil its obligations under the underlying contract and perform its obligations with an appropriate level of skill and care.
Insurance - The level/basis of insurance the warrantor is obliged to maintain for the duration of the warrantor’s liability period.
Step-in rights - Gives the beneficiary the ability to step-in to the underlying contract in place of the instructing party in certain circumstances.
Intellectual property licence – A right for the beneficiary to reproduce and use the warrantor’s intellectual property.
Assignment - The ability to ‘pass on’ the benefit of the warranty to an alternative third party beneficiary.
Materials – That materials used or specified by the warranting party will be or were fit for use and not deleterious in nature.

Are parties required to provide collateral warranties?

If so required, a party may seek to limit the number of warranties it is obliged to provide, or limit the scope of the same by proposing an overall cap on its liability.

Third-party rights - An alternative approach?

A statutory exception to the doctrine of privity of contract was introduced by the Contracts (Rights of Third Parties) Act 1999 (the Act).

Collateral warranties will continue to act as useful security in construction projects, allowing a beneficiary to avoid the issues associated with bringing a claim in negligence if issues arise.

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Guide to the use of collateral warranties in construction and engineering.

In this article, our experienced construction solicitors explain everything you need to know about collateral warranties, covering their purpose, length, who provides them, who benefits from them, and the common clauses used.

What is the purpose of a collateral warranty?

There are many parties involved in the delivery of a construction and engineering project and the contractual relationships between them are complex. Those parties include:

employers/developers;
main contractors;
construction professionals and consultants;
sub-contractors; and
suppliers.

Then there are those who may not be a party to the various contracts set up for the delivery of the project, but benefit from the construction project itself. These parties include:

employers/developers (in part);
funders and lenders; and
end users such as purchasers, landlords and tenants (together referred to as beneficiaries).

These third party beneficiaries are ultimately affected by any issues arising in or after the delivery of the project, most notably defects in the works. Collateral warranties play an important role in providing these third parties with contractual rights to make a claim that would otherwise not be available to them. To put it simply, without collateral warranties, only parties to a contract can enforce its terms, meaning that if a third party (such as a tenant or purchaser of a property) wants to make a claim against the contractor for defects in the construction work, they cannot do so as they were not party to the original contract. Collateral warranties provide a solution to this problem by creating a separate contract between the third party and the contractor, allowing the third party to enforce the terms of the original contract. This means that if defects arise, the third party can claim against the contractor, even though they were not a direct party to the original contract.

Collateral warranties serve to protect third parties with an interest in the construction project and help to ensure that the work is completed to a satisfactory standard.

Who provides a collateral warranty?

A collateral warranty is usually provided by a party (the warrantor) based on a requirement in the underlying contract.

It is common for a collateral warranty to be provided as a warrantor by the construction professionals and consultants, main contractors and sub-contractors with a material design responsibility. Although a collateral warranty can be provided by others involved in the delivery of the project.

A project may involve the provision of a separate collateral warranty by a warrantor to several parties.

What are the common clauses in a collateral warranty?

Common clauses include:

a warranty that the warrantor will comply or has complied with the terms of the underlying contract (the building and engineering contract, the form of appointment of the construction professional/consultant or the sub-contract, as appropriate);
a warranty that the warrantor has exercised or will exercise reasonable skill and care in the provision of its services, including design and management services as appropriate;
an obligation to maintain suitable professional indemnity insurance and to provide evidence of that insurance (see note below);
the granting to the beneficiary of a licence to copy and use material produced by the warrantor on the project;
a limitation on the ability of the party with the benefit of the collateral warranty (the beneficiary) to assign the benefit of the collateral warranty (usually on a set number of occasions and/or to associated parties);
terms that the warrantor will have no greater liability and will have equivalent rights of defence to those in the underlying contract;
a limitation on the liability of the warrantor to the beneficiary;
a time limit after which a claim cannot be commenced against the warrantor; and
(in the case of funders) the ability to step into the underlying contract.

A note on professional indemnity insurance (PII):

When it comes PII policies, there are two types of coverage:

'Each and every claim made' policies provide coverage for each individual claim that is made against the policy during the policy period. This means that the policy limit applies to each claim separately, regardless of how many claims are made during the policy period.
In the aggregate' policies provide coverage for all claims that are made against the policy during the policy period, up to the policy limit. This means that the policy limit applies to the total amount of all claims made during the policy period.

The main difference between the two types of policies is the way that they handle multiple claims during the same policy period. If a professional concern has made previous claims against its PII policy within the same claims year, an 'each and every claim made' policy can be more beneficial as it provides coverage for each individual claim made, up to the policy limit. In comparison, under an 'in the aggregate' policy, the policy limit applies to the total amount of all claims made during the policy period. This means that if multiple claims are made during the same policy period, the policy limit may be exhausted, leaving the professional concern with no further coverage for any subsequent claims.

It is important to consider the type of insurance cover the warrantor has, its potential exposure to claims and claims history in the same year (if the policy held is aggregate), because this can have a considerable impact on what can be recovered in the event of a claim.

Should I use a standard form of collateral warranty?

The quality of the protection provided by a collateral warranty depends on the terms of the underlying contract, and the terms of that underlying contract will have to be carefully considered to ensure that it provides the required security for the beneficiary.

Whilst there are some standard form collateral warranties available, it is usual for a bespoke collateral warranty to be included in the underlying contract.

Given that a beneficiary should consider the terms of the underlying contract, a beneficiary should seek a collateral warranty drafted with the requirements of the project in mind.

How much does a collateral warranty cost?

A collateral warranty on its own is not a long document and is not usually expensive or time-consuming to prepare, review and negotiate.

To assess the protection provided by a collateral warranty, the underlying contract must be considered, and that exercise adds some expense.

The costs of a collateral warranty are not large when compared to the protection that a collateral warranty can provide.

How long does a collateral warranty last?

The period of liability under a collateral warranty is usually the same as that under the underlying contract, whether by reference to the express terms of the collateral warranty or by the warrantor having no greater liability (which would include any provision as to the time within which a claim must be commenced) than that under the underlying contract. Most collateral warranties are provided in relation to an underlying contract which has been executed as a deed and it is usual for a collateral warranty itself to be executed as a deed.

Limitation periods:

If the collateral warranty is executed as a deed, the relevant limitation period runs for 12 years, but if it is signed as a contract then it is 6 years

When does the limitation period begin?

For most collateral warranties, the limitation period commences from the date of Practical Completion of the Works (PC) rather than from the date on which the actual breach of the underlying contract occurred. This is preferrable, as it can be extremely difficult to pinpoint the exact date the breach occurred, and often leads to costly initial satellite litigation to determine the start date in the first instance, before the claim itself can be considered. It is common practice to use the date of PC (which is a defined date) as being the commencement of the limitation period, in order to avoid an argument as to when it commences.

Can collateral warranties be amended or transferred?

If all parties agree to it then amending the collateral warranty is straightforward. In practice, warrantors tend to resist making amendments to the agreed form of collateral warranty. If such resistance is met, and there are no other feasible solutions, beneficiaries may need to settle for a recital to the collateral warranty agreement stating the updated position.

A good example is where the warrantor changes its status or entity - for instance, converting from a partnership to an LLP. A beneficiary will rightly be concerned whether the new structure has assumed liability for the obligations under the collateral warranty. Ideally, the warrantor should change its name and update the relevant execution procedures on the collateral warranty document accordingly, but beneficiaries often find themselves with just recitals recording the same.

The general rule is that where a contract is silent on the topic, the benefit of the contract can be assigned without limit or consent. It is standard practice that the collateral warranty contract expressly deals with the issue of assignment or transfer of rights. The warranting party will seek to limit the number of assignments possible to control the number of third parties they are liable to. Normally, two assignments are allowed without restriction, while additional assignments require the warrantor's consent.

It is important to note that only the benefit under a contract can be assigned, not obligations. This means that contractual rights, such as the right to receive payment, may be assigned to another party but the obligation for the original contracting party to perform works or services cannot. To assign all the benefits and burdens of a contract, the original contracting parties will need to enter into what is known as a novation agreement with the new party.

Some beneficiaries, like funders, may request 'step in’ rights, allowing them to assume the role of the employer in specific situations, such as insolvency. The collateral warranty should specifically include details of these provisions including notification processes and circumstances triggering the step-in rights.

Are there any alternatives to collateral warranties?

Contracts (Rights of Third Parties) Act 1999

The Contracts (Rights of Third Parties) Act 1999 changes the concept of privity of contract by allowing a third party to enforce a contract made for its benefit in certain situations.

Adoption of third-party rights under the Act requires the original contract to explicitly confirm that a third party may enforce its rights under it. If this is the preferred route, it is important that the original contract contains several key items and provisions, referring to the clauses in the underlying contract that the third party may enforce, or a standalone schedule. Although a viable and sometimes less expensive alternative to collateral warranty contracts, in practice many building contracts (and contracts in general) seek to limit exposure and exclude third party rights.

Assigning rights from the original contract

The employer of the professional consultants or contractors could technically assign their building contract rights to the purchaser or tenant of the end development. In practice this may be unsuitable especially if the employer still owns the building – by assigning their rights to another party the employer will then have lost its ability to address any discovered defects in the works.

Structural insurance policy

Structural insurance, also known as latent defects insurance, safeguards investors, homeowners, occupants, and mortgagees against structural issues post-construction, typically spanning 10 to 12 years after completion. Insurance provides no fault protection, in that there is no need to prove negligence on the part of liable parties like contractors or architects. This means potentially avoiding a lengthy and costly court battle with defects claims. The insurer covers costs regardless of the solvency or insurance status of the contractor. Like with any insurance, the policy may contain exclusions and limits that could affect claims. Another key drawback with latent defects insurance is that it is limited to just the defects that cause damage, meaning that nonstructural issues and economic losses arising from the defect are not recoverable.

All new residential developments are covered by NHBC ‘Buildmark’ or a similar scheme for 10 years, which is in effect a form of latent defects insurance that kicks in after 2 years from the date of completion. As such, purchasers or tenants of new residential buildings do not need to purchase a separate structural insurance policy where NHBC exists. You should carefully review the terms and conditions of the policy, and understand its limitations.

Negligence claim

In UK law, a recourse to professional negligence claims exists as an alternative to contractual claims. Legal restrictions on recovering "pure economic loss" in tort claims pose a challenge in construction contexts. "Pure economic loss" refers to financial losses rather than physical harm to individuals or property. While damages resulting from harm to other property or personal injury are compensable in tort, the costs of fixing the defect itself are considered purely economic and are typically not recoverable. For instance, if a property defect leads to personal injury, the losses from the injury may be claimed in tort, but the expenses of rectifying the defect are unlikely to be recoverable through this avenue.

What happens if a party breaches a collateral warranty?

As with any contract, if a party breaches the collateral warranty the other party (or parties) can make a claim for breach of contract. Claiming damages from the breaching party is one well-known remedy available to aggrieved parties. Depending on the nature of the warranty and what has been breached, different approaches to calculating damages may apply (ie based on wasted expenditure or loss of profit). Where the breach is about quality or anticipated performance, a claimant if successful can elect to claim damages calculated by reference to its loss of profit, or losses incurred as a result of entering into the contract (whichever is higher). If the breach is about a negligent misstatement, for example, because of failure to take reasonable care when warranting any estimates given, then only wasted expenditure can be claimed, putting the aggrieved party in the same position as if the warranty was never made in the first place.

How can a party enforce a collateral warranty?

Although seeking damages is common where a breach of collateral warranty occurs, an aggrieved party may wish to enforce the warranty and compel the breaching party to specifically perform the contract. For example, to ensure the party completes the works or delivers proper quality / workmanship if issues arise. If a default is identified, you should first notify the warranting party, outlining the specific breach and formally request remedial action within a specified timeframe. Before taking legal action, it is advisable to attempt to resolve the issue through negotiation or alternative dispute resolution methods.

A collateral warranty is a key legal contract that protects third party interests, providing a route for those not directly involved in the project to claim against the contractor or consultants in case of defects or failures. It provides a link between third parties affected by the defects (lenders, finders, purchasers and tenants), and the contractors or professional consultants responsible for the construction and workmanship of the building. Without such a contractual link, third parties may be left with limited or inadequate means to recover their losses.

Since the warranty involves the warrantor promising to a third party that it has complied with its obligations under the underlying building contract, the strength of the collateral is largely dependent on the terms of the building contract. It is therefore essential to conduct a thorough review of the underlying contract before accepting the collateral warranty.

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What is Assignment in Construction Contracts?

A legal assignment is transferring an interest from one party, called the assignor, to another, the assignee. An assignment entitles the assignee to the performance of a particular contractual obligation conferring a benefit. It’s not usually possible to assign burdens, obligations or debts under a construction contract .

An example of the assignment of a benefit in a construction contract is transferring a collateral warranty to the tenant or purchaser of a building either during construction or after completion.

An employer can assign their right to have the building constructed and the subsequent right to sue the contractor if the works are not up to standard or delayed. Sometimes, financial investors want the developer to assign contractual rights as security for their investment.

To be legally valid, an assignment must satisfy the requirements of Section 136 of the Law of Property Act 1925. An assignment that doesn’t comply can still be effective as an equitable assignment, but it is harder to prove.

• Parties to construction contracts can only assign benefits and not obligations

• An assignment should comply with the provisions of Section 136 of the Law of Property Act 1925

• A construction contract may contain restrictions on the right to assign, so only permitting the assignment of certain rights or a limit on the number of assignments

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Collateral Warranties on Construction Projects

Joanne Perritt - Partner and Head of Commercial Property

A Guide to Collateral Warranties on Construction Projects

In this article, we consider collateral warranties, which are often used on construction projects, and we explain what they are, why they may be required, some alternatives to collateral warranties (such as third-party rights) and which parties are likely to give and receive collateral warranties.

What are Collateral Warranties?

In UK law, there is a doctrine of privity of contract which prevents a person who is not a party to a contract from enforcing a term of that contract.

The general rule is very simple: only the parties to a contract may sue on it or be sued for breach of its terms. In the context of construction projects, this means that only the employer is able to enforce the terms of the building contract or any professional appointments, for example, that of an architect or structural engineer.

However, other parties often have an interest in the works either during construction or once the works are completed, such as funders, lenders, purchasers, and tenants. It is also often the case that defects may not arise or be discovered until some time after the works have been completed, with the party that is actually affected by the defect being the person in occupation, i.e. the purchaser or tenant.

If those third parties suffer a loss, such as lost income, or they have to incur the costs of rectifying the defect, then they will be the persons who will need the ability to pursue a claim against the contractor or the professional consultant responsible for the defect. However, since they are not a party to the building contract or professional appointment, they will be unable to pursue a contractual claim under the building contract or professional appointment.

An alternative to a contractual claim is to bring a claim in tort as a result of negligence. However, in UK law, there are legal limitations on the ability to recover what lawyers refer to as “pure economic loss” in claims in tort, which causes a particular issue in the context of construction claims.

Economic loss is effectively a financial loss as opposed to damage to a person or property.

For example, if the defect causes damage to other property or personal injury, then that damage would be recoverable in tort, but the problem is that the costs to rectify the defect itself are purely economic and are unlikely to be recoverable in tort. So if a property has been constructed improperly and it injures an occupier, a claim for the losses arising from the personal injury would be recoverable in tort (subject to satisfying the other requirements for a claim in tort), but the costs to rectify the defect would most likely not.

Since there is unlikely to be an ability to bring a claim for the costs to rectify the defect in either contract or tort, the interested third parties need another route, and this is where collateral warranties come in. A collateral warranty creates a contractual link between the third party and the contractor or professional consultant.

A collateral warranty is a contract that sits alongside the underlying contract, such as a building contract or consultant appointment, and grants rights to a third party which can be sued upon.

A collateral warranty is much shorter than the underlying contract because, to a large extent, it relies upon the terms of the underlying contract. In the collateral warranty, the warrantor will warrant to the third party that it has performed its duties and obligations in accordance with the underlying contract. Therefore, if there is a breach of the underlying contract, that will usually trigger a collateral warranty breach. This is a key point to note in relation to a claim under a collateral warranty. It is effectively a claim for a breach of the promise to comply with the underlying contract.

The limitations regarding “pure economic loss” mentioned previously do not apply to contractual claims, so the costs of rectifying the defect would be recoverable as well as any other pure economic losses such as lost income or profit.

In order to obtain collateral warranties, the underlying building contract, appointment or sub-contract will need to expressly provide that the contractor, consultant or sub-contractor is required to provide collateral warranties to third parties. Collateral warranties may be provided to third parties during the course of the works or after completion.

When a collateral warranty is provided, it is essential to ensure that it has been signed correctly by the right people. Any failure to execute a warranty correctly can affect its validity.

There are some standard forms of collateral warranty, such as those published by JCT and the CIC, but these forms contain several limits on the liability of the person providing the warranty, and they may not be acceptable to the third party. In practice, most employers will usually use their own bespoke forms of collateral warranty.

Are there any alternatives to collateral warranties?

There are some alternative ways to grant rights to the interested third rights in construction projects.

The Contracts (Rights of Third Parties) Act 1999 alters the doctrine of privity of contract and, in certain circumstances, allows a third party to enforce the terms of a contract made between other parties for its benefit.

The granting of rights in this way is a viable alternative, but the underlying contract often excludes third party rights, and many parties still prefer to receive collateral warranties. If third party rights under The Contracts (Rights of Third Parties) Act 1999 are to be adopted, then this has to be dealt with in the underlying contracts at the outset, which is still a fairly rare occurrence.

Another way to grant rights to third parties is by assigning the rights under the original contract, but this is not always appropriate. For example, an employer could assign its rights under the building contract to an incoming tenant.

However, if the employer still owns the completed building, it will need to retain its rights in case it needs to claim itself in respect of defects in the works.

Another alternative to a collateral warranty can be a letter of reliance. This is a letter giving a third party the right to rely upon a report prepared by a professional consultant, typically used in site investigations, ground condition reports, and surveys.

These are not usually used where there is an underlying contract or appointment; there is an ongoing role in relation to the performance of services and duties or where it relates to design or construction.

Who should give a collateral warranty?

Parties that regularly provide collateral warranties to third parties on a construction project include main contractors, consultants (usually those with responsibility for design including the architect and engineers and also those with no design responsibility, e.g. project manager) and sub-contractors (although sub-contractors with responsibility for design are more likely to provide them than non-designers).

Who should receive a collateral warranty?

Parties that frequently require collateral warranties from the construction and design team on a construction project include:

Funders - banks and other lenders funding construction works who are taking a charge over the property, rather than purchasing it, will require collateral warranties. This protects the funder if the borrower defaults under the finance agreement and the funder has to recover its loss by selling the development. The funder will require the ability to make a claim against the construction and design team if there are defects in the works that reduce the value. The funder will also require step-in rights in its collateral warranties, allowing it to step into the employer’s role in the underlying building contract and procure the completion of the development.

Purchasers - a party that buys the development (either before or during construction as a ‘forward purchaser’ or after completion) will acquire a long-term interest in the building, even if they do not intend to occupy the building themselves, they may suffer a loss as a result of defects in the works. A purchaser will therefore require rights against the construction and design team so that they can claim against them in the event of defects arising.

Tenants - a tenant will often have a lease on a fully insuring and repairing basis. They will therefore require collateral warranties to allow them to claim against the construction and design team in the event they need to pay for the rectification of a defect. On projects where there are a number of tenants, it is usual for only those taking a lease of a substantial part of the development to receive a warranty. The obligation on the construction and design team to provide warranties to tenants is often limited to the first tenants of the property.

Employers - the employer will not require a collateral warranty from the main contractor and the consultants as it has a direct contractual link to them already by way of the building contract and professional consultant appointments. However, the employer is likely to require collateral warranties from sub-contractors engaged by the contractor. Otherwise, it cannot bring a claim against them, particularly if the main contractor becomes insolvent. In addition, where the project is procured using the design and build route, it is usual practice for the appointments of the design consultants to be novated to the contractor. As a result, the employer loses its direct contractual link to the design consultants and so will require a collateral warranty back from the novated consultants to maintain its rights against them.

There are also other parties who might also require a collateral warranty on some projects where they have an interest in the works, such as a local authority or freeholder. On large multi-let developments, the management company might require a collateral warranty, or if a tenant of an existing property is carrying out the works, the landlord may require a collateral warranty.

Here to help

At Myerson, our Construction Team can offer advice on all aspects of contentious and non-contentious matters. We regularly advise and draft collateral warranties for construction projects on behalf of employers or third parties. For more information on the range of legal services we provide, please contact our Construction Team below.

You can contact us below if you have any more questions or would like more information.

0161 941 4000

Joanne Perritt

Partner and head of commercial property.

Joanne has over 20 years of experience acting as a Commercial Property solicitor. Joanne has specialist expertise in commercial property matters, including acquisitions and disposals of business premises, commercial leases (acting for both landlord and tenant) and secured lending.

Home » News & publications » Latest news » Collateral warranties: an overview

Collateral warranties: an overview

Posted: 04/01/2013

Everyone involved in the construction industry will be aware of the traditional contractual relationships that exist in the basic structure of most construction projects. That is, the employer contracts with the contractor, who in turn contracts with any sub-contractors and/or sub-consultants. This arrangement leaves the employer with no contractual relationship with any of the sub-contractors or sub-consultants.

This is not normally a problem provided the employer appoints a financially robust and competent contractor. In fact, in many instances the employer often prefers to have a contractual relationship with only one party because it creates a single point of responsibility. This means that should problems arise during construction, or, should a defect arise during the liability period, or later, the employer merely has to turn to the contractor to resolve it or to pay up.

However, there may be situations where this lack of contractual relationship with sub-contractors or sub-consultants could be problematic. These typically arise on contractor insolvency, whether during the construction or post completion. Here, if the employer’s only contract is with the contractor, the employer has no contract on which to seek damages and the doctrine of privity of contract prevents him using any agreement between the contractor and sub-contractor or sub-consultant as a means of redress.

Further, the employer is likely to face difficulties in bringing a tortious claim against sub-contractor/sub-consultant because of the restrictions places on the recovery of pure economic loss and because of the difficulty in establishing that a sub-contractor/sub-consultant owes a sufficient duty of care to a distant employer.

In order to address these problems, the employer can require the sub-contractor/sub-consultant to enter into a collateral warranty with them. This creates a direct contractual relationship between the two parties.

Key clauses

Collateral warranties typically follow a standard approach. Some are now standard form documents but many bespoke collateral warranties exist and they need to be read closely to fully understand their effect. The following are examples of the most common clauses. However, more complex projects will likely require tailored collateral warranties.

Consideration : collateral warranties are normally executed as a deed and so do not require consideration. However, sometimes the parties choose to include some nominal consideration just in case the deed is not executed properly. The collateral warranty will then take effect as a contract.

Principal covenant : this is where the sub-contractor/sub-consultant warrants that they have complied with the terms of their sub-contract/appointment. If they have a design responsibility they will also warrant that they have performed this duty with the skill, care and diligence to be expected from a person of the relevant profession.

Employers beware: the principal covenant is only as strong as the sub-contract/appointment. Employers should ensure the sub-contract/appointment includes all key terms and requires the sub-contractor/sub-consultant to exercise a good degree of care. If not, the value of a collateral warranty will inevitably be limited.

Non use of deleterious materials : the sub-contractor/sub-consultant warrants to the employer that he will not use or specify materials that will be deleterious to any part of the works.

Step in rights : these can be very important. They allow the employer to ‘step into the shoes’ of the contractor if the contractor becomes unable to complete the construction – typically through insolvency. In the current economic climate where contractor insolvency is all too common, this clause can be of great importance. However, the sub-contract/appointment should be drafted to make the exercise of these rights optional: for example, the employer may not wish to insist on stepping in as this may not be financially prudent for the employer depending upon the overall financial position of the sub-contract/appointment.

Copyright : many collateral warranties will contain a copyright clause allowing the employer to use any design documents the sub-contractor/sub-consultant prepares. The licence should be royalty free, irrevocable, non-exclusive and include the right to assign.

PI insurance : if the sub-contractor/sub-consultant has design responsibility, the collateral warranty will require that PII is kept in place for the full length of the warranty, typically 12 years if in deed form or six years if in contract form.

Liability period : this will again be 12 years if the collateral warranty is executed as a deed and six if a contract. Employers should seek a liability period equal to the liability period under the building contract.

Assignment : there is usually a restriction on the employer’s ability to assign; often the collateral warranty will provide that two assignments are allowed. Subject to the nature of the works, and whether or not they are likely to be sold often, the warranty may need to expressly provide for assignment more than twice throughout the 12 year period.

Limitations

The sub-contractor/sub-consultant will want to try and limit his liability under the collateral warranty. The most common method of doing this is the use of “no greater duty” and “equivalent rights defence” clauses. These state, respectively, that the sub-contractor/sub-consultant owes no greater duty to the employer than he does to the contractor under the professional sub-contract/appointment and that the sub-contractor/sub-consultant may use any defence available under the sub-contract/appointment when defending any claim under the collateral warranty. In addition, the sub-contractor/sub-consultant will try to limit what can be recovered to make repairs or take remedial action. For example, if consequential trading losses can be claimed, this may be prohibitively expensive.

The sub-contractor/sub-consultant may also try to use a net contribution clause, though the use of these is fairly controversial and usually a matter for negotiation. As often, commercial bargaining power will probably determine who triumphs.

The effect of a net contribution clause is to adjust the default position of joint and several liability. That is, normally, the employer would be able to recover all losses from just one sub-contractor/sub-consultant. The responsibility would then be on that particular sub-contractor/sub-consultant to recover the money he has paid out over and above his ‘fair share’ (i.e.: the proportion of damages attributable to his breach) from the other sub-contractors/sub-consultants by reference to the Civil Liability (Contribution) Act 1978. However, a net contribution clause limits the employers recovery from each sub-contractor/sub-consultant to that which is “just and equitable.” In such circumstance the employer therefore needs to sue all sub-contractors/sub-consultants individually and demonstrate the amount of their contribution. All of this can be significantly harder for an employer than simply demonstrating that damages are due from any one of the sub-contractors/sub-consultants.

Sub-contractors/sub-consultants often push for such net contribution clauses because they push the risk of another sub-contractor’s/sub-consultant’s insolvency and the risk of litigation onto the employer. Employers will wish to resist them for the same reasons.

In the current economic climate when everyone is aware of the increased likelihood of contractor insolvency, the allocation of this risk is often hotly negotiated.

Court’s view

It is perhaps surprising given their prevalence but cases concerning collateral warranties before the English courts are not large in numbers. However, where they have been discussed, it appears the court supports the commercial principle behind collateral warranties; How Engineering Services Ltd v Southern Insulation (Medway) Ltd [2010] and Linklaters Business Services v McAlpine Ltd and others [2010].

Cases concerning net contribution clauses are rarer still. However, the Scottish courts have stated that, even though they seek to limit liability, the clauses do not fall foul of the Unfair Contract Terms Act 1977 ( Langstane Housing Association Ltd v Riverside Construction Aberdeen Ltd & Ors [2009] ScotCS CSOH 52). Whilst this view is not widely supported by legal practitioners, it is by institutions such as RIBA and ACE.

Alternatives

Alternative options to the use of collateral warranties are assignment and third party rights. Neither have proved particularly popular. The trouble with an assignment is that it can only be used once and the Employer may also want to keep part of the benefit. Third party rights are potentially more useful. In fact, they may be more efficient, requiring modified drafting to only one document. However, although use of third party rights has been available since the Contracts (rights of Third Parties) Act 1999 came in to force in November 1999 these have not been widely used and few within the construction industry after familiar with them.

Other requests

Other involved parties may also request collateral warranties. These include any future tenant or purchaser of the property, and freehold owner or any funder of the project.

Arranging and securing fully executed collateral warranties can be hugely time consuming. Many involved in the construction industry are not fans of collateral warranties for this reason. However, those who are putting up the money for projects, whether they be employers or funders, fully recognise the value of securing well drafted collateral warranties and collateral warranties are likely to be around for some time to come.

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Out-Law Guide 5 min. read

Collateral warranties

01 Sep 2012, 3:51 pm

This guide provides a basic outline of the main issues to consider in relation to collateral warranties, and should be read in conjunction with our guide to Professional appointments

Why are collateral warranties necessary?

Only the parties to a contract can generally sue to enforce the rights and obligations under it. This means that parties do not have to worry about unexpected claims from third parties. However, it can mean that where a third party has an interest in a construction project – for example, a funder or a tenant – then that third party may not be able to bring a contractual claim against the person who is at fault, as he has no rights under the relevant contract.

(Please also see "The Contracts (Rights of Third Parties) Act 1999" below.)

What does a collateral warranty do?

This is where the collateral warranty comes in. A collateral warranty is an additional contract between, commonly, a (1) contractor, consultant or subcontractor (warrantor) and (2) an interested third party (beneficiary) giving that third party the right to sue the warrantor. It is a useful contractual bridge which creates a direct contractual link which may not otherwise exist. This helps to provide an additional level of security for other stakeholders in a construction project who are not directly appointing the parties delivering it.

Collateral warranties are given in PPP projects for example by the professional team (for more detail please see Professional appointments in favour of the procuring authority, funders and special purpose vehicle. For more detail on PPP projects please see Public Private Partnerships . They are also given by key sub-contractors.

It is important that a collateral warranty is consistent with the underlying contract it relates to.

What does a collateral warranty contain?

Principal covenant: that the warrantor will fulfil its obligations under the underlying contract and, without prejudice to that covenant, that it will carry out any design with reasonable skill and care;
copyright and use of information: third parties acquiring interests in construction projects will require the right to use the design information generated by the project. It's common to include clauses to allow for that right which often restrict the use of design documents to purposes connected with the relevant project;
assignment: without restrictions, the benefit of a warranty can be assigned in the same way as any contractual benefit. Warrantors sometimes request limits on the number of permitted assignments of collateral warranties to seek to limit the number of third parties they may become liable to; For more detail on assignment and novation in construction contracts please see Assignment and novation :
step-in rights: these are a common feature of warranties and are often given to beneficiaries who have an interest in the project before it is completed (eg they have provided funding). They give the beneficiary the right to take the place of the employer under the underlying contract, to ensure that it and the project continue, where the employer gets into difficulties that threaten the project. The beneficiary will take responsibility for any past and future unpaid sums under the contract. Step-in provisions often try to postpone the exercise of the warrantor's rights to terminate the underlying contract. This is to give funders time to react to the relevant issue and to make sure that they can exercise the step-in rights. If two or more parties have step-in rights under different collateral warranties (for instance funders and procuring authorities in PPP projects), there should be agreement on whose rights will take priority on step in;
no greater liability clause: the warrantor seeks to ensure that it takes on no greater risk as a result of giving a collateral warranty than it has under the primary contract;
equivalent rights of defence clause: the warrantor seeks to ensure that it has all the same rights of defence against claims under the collateral warranty as it does under the underlying contract;
economic and consequential loss: These types of exclusions are resisted by beneficiaries, and their appropriateness will depend on the project-specific issues;
if two warrantors are each liable to a beneficiary for the same defective work, the beneficiary could seek to recover 100% of its damages from warrantor 1, despite the joint liability of warrantor 1 and warrantor 2 in relation to the relevant defects. Warrantor 1 could then seek to recover a share of those damages from Warrantor 2 through the Civil Liability (Contribution) Act 1978 ;
a net contribution clause can take various forms. However, it will often state that where two or more warrantors involved in a construction project are each jointly liable for the same defect, the liability of each warrantor will be limited to the amount which would be just and reasonable (having regard to their contribution to the problem). This means that a beneficiary has to pursue each warrantor who may have contributed to the defect. Effectively this transfers the burden of pursuing the other defaulting parties for their contribution from the warrantor to the beneficiary and can be problematic if the one of those defaulting parties is insolvent. This is why net contribution clauses are often resisted by beneficiaries.

The Contracts (Rights of Third Parties) Act 1999

The Contracts (Rights of Third Parties) Act 1999 was primarily aimed at the construction industry, to do away with the need for collateral warranties on each construction project. In broad terms, the Act provides that a person who is not a party to the contract may enforce a term of the contract if:

the contract expressly provides that he may; or
the contract term purports to confer a benefit on him.

The Act has not had as big an impact as originally thought, and is often expressly excluded in contracts. The fear was largely driven by the insurance industry, that the Act might inadvertently give rise to additional liability on contracting parties and increased claims against them by third parties. There is still little case law on the operation of third party rights and collateral warranties remain the most common mechanism to give third parties contractual rights of recovery in relation to construction projects.

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"Supreme Court Rules Most Collateral Warranties Are Not Construction Contracts" in Abbey Healthcare v Simply [2024] UKSC 23

On 9 July 2024, the Supreme Court unanimously held that collateral warranties deriving from or reflective of the primary building contract, and merely promising continued construction, are not generally considered agreements “ for…the carrying out of construction operations ” as defined under s.104(1) of the Housing Grants, Construction and Regeneration Act 1996 (the “Construction Act” ).

This overturns the Court of Appeal’s decision from June 2022, thereby providing certainty on the definition of a construction contract and the subsequent availability of adjudication as a method to resolve disputes under collateral warranties.

Legal background – adjudication and collateral warranties

Adjudication

Adjudication is a private form of dispute resolution whereby a dispute, rather than being heard by a court judge, is referred to a trained independent adjudicator for determination. The adjudicator, who has 28 days from the provision of the referral document to reach a decision, will tend to be a construction specialist. The process results in a legally enforceable decision, which is binding on parties on an interim basis until final determination by arbitration, litigation or agreement.

An obvious advantage of adjudication as compared to litigation is its expediency which, in turn, keeps costs down and improves cash flow. A further advantage is that, regardless of the outcome, both parties bear their own costs meaning that the costs’ risk for the referring party is very different to that in litigation or arbitration.

Under s.108 of the Construction Act, there is a statutory right for disputes under a “construction contract” to be decided on an interim basis by adjudication even in the absence of express adjudication provisions. In turn, s.104(1) of the Construction Act defines a construction contract as an agreement “for… the carrying out of construction operations”.

Collateral Warranties

A collateral warranty is a contract under which a party involved in construction works warrants to a third-party beneficiary that it has fulfilled its obligations under the original building contract. This type of agreement is common in the industry.

Under the original building contract, an employer contracts with a contractor to carry out the works. There is a clear contractual relationship through which either the employer or contractor may bring a claim. However, the rule of privity of contract means that an interested third party (such as a tenant, or a funder) cannot enforce the terms of the contract as they are not a party to it.

In the absence of that contractual link, a third party would have to rely on a claim in negligence. This is far from desirable given that (i) a duty of care would need to be established and (ii) recovery in negligence is somewhat more limited thanks to the decision in Murphy v Brentwood . 1

For this reason, collateral warranties are used to bridge the gap and create a direct contractual link for the benefit of those parties that may otherwise have no recourse.

Can parties to a collateral warranty refer a dispute to adjudication?

Absent an express provision providing for recourse to adjudication, s.108 of the Construction Act, parties to a collateral warranty will only be able to refer a dispute to adjudication if the collateral warranty is considered a “construction contract” within the meaning of s.104(1).

Parkwood (2013)2

Eleven years ago, Akenhead J ruled in Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd (“ Parkwood ”) that whether a given contract was a “ construction contract ” had to be determined by reference to the terms of the contract itself. 3 This meant that a collateral warranty could be a construction contract in certain situations, with the determining factor being the express wording used in the collateral warranty.

Akenhead J stated that “ a very strong pointer ” in favour of the collateral warranty being a construction contract would be whether the relevant contractor is “ undertaking to the beneficiary of the warranty to carry out such operations ”, while “ [a] pointer against may be that all the works are completed and that the contractor is simply warranting a past state of affairs as reaching a certain level, quality or standard ”. 4

To this end, it was found that the use of the words “warrants, acknowledges and undertakes” as opposed to “ warrants ” alone pointed towards the warranty being a construction contract. Akenhead J suggested that “ these three verbs, whilst intended to be mutually complementary, have different meanings. A warranty often relates to a state of affairs (past or future); a warranty relating to a motor car will often be to the effect that it is fit for purpose. An acknowledgement usually seeks to confirm something. An undertaking often involves an obligation to do something ”. 5 As a result, he found that the collateral warranty in Parkwood , which contained this wording, was a contract for the carrying out of construction operations because it was not merely warranting or guaranteeing a past state of affairs but providing an undertaking that the contractor would actually carry out and complete the Work.

In light of this decision, parties negotiating collateral warranties could use careful drafting to either include or avoid an automatic right to adjudicate.

Nevertheless, the broader and more fundamental question remained: Are collateral warranties generally construction contracts? This question would be addressed head on in the Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP litigation.

Abbey v Simply (2021-2024)

Factual background

Simply Construct (UK) LLP (“ Simply ”) had entered into a JCT Design & Build Contract for the construction of a care home in London, pursuant to which Simply were obligated to provide collateral warranties to purchasers and tenants. Simply provided a collateral warranty in favour of its tenant, Abbey Healthcare (Mill Hill) Limited (“ Abbey ”) (the “ Abbey Collateral Warranty ”), some five years after the principal building contract was entered into. It is important to note at this juncture that the Abbey Collateral Warranty only used the word “ warrants ”.

As a result of fire safety defects and associated remedial works, Abbey commenced adjudication proceedings against Simply. The Adjudicator awarded Abbey £908,495.98. Simply refused to pay these costs, resulting in Abbey’s commencing enforcement proceedings before the TCC. Simply contended that the Abbey Collateral Warranty, which did not contain express adjudication provisions, was not a “ construction contract ” as defined in s.104 of the Construction Act and therefore could not be referred to adjudication by operation of s.108.

TCC decision (2021) 6

The TCC judge, Bowdery QC, refused to enforce the adjudication decision made against Simply on the grounds that the Abbey Collateral Warranty was not a “ construction contract ” within the meaning of s.104(1) of the Construction Act and therefore the adjudicator had lacked jurisdiction. Specifically, Bowdery QC deemed it significant that the Abbey Collateral Warranty had been executed four years after construction works under the principal building contract had been completed, and a number of months after rectification of the defective works had taken place. Resultantly, he considered that, at the time of execution, the Abbey Collateral Warranty was akin to a warranty as to a state of affairs, both past and future, rather than a contract “ for…the carrying out of construction operations ” under s.104(1).

This decision suggested that there were instances, tempered by the drafting or time of the collateral warranty, in which a collateral warranty could avoid the Parkwood decision.

Court of Appeal decision (2022) 7

The Court of Appeal, however, granted an appeal against the TCC decision and found, following Parkwood , that a collateral warranty could be a “ construction contract ” within the meaning of s.104(1) of the Construction Act. In particular, he found that the Abbey Collateral Warranty itself was a construction contract.

In his judgement, Coulson LJ, wanting to confer the benefit of adjudication onto more parties, determined that s.104(1) of the Construction Act should be construed broadly considering that it was a statutory purpose of the Construction Act to enable parties to two different construction contracts to refer disputes involving the same or similar underlying factual issues to the same adjudicator. Parliament, he believed, deliberately left the definition of “ construction contract ” wide such that there could be multiple construction contracts for one set of arrangements.

He also considered that s.104(5), which is concerned with hybrid contracts and uses the wider phrase “ relates to construction operations ”, informs a broad meaning of “ construction contract ” generally. However, this view was not shared by all of the Court of Appeal judges.

The Court of Appeal disagreed with the TCC finding that the timing of the execution of the Abbey Collateral Warranty was material or determinative of the question of whether it was in fact a “ construction contract ”. All three judges agreed that a collateral warranty is capable of having retrospective effect, meaning the date of the Abbey Collateral Warranty’s execution was irrelevant.

According to the Court, the wording of a collateral warranty itself would determine whether it was, in fact, a construction contract:

if a collateral warranty is just a fixed promise/guarantee to a past state of affairs, then it is unlikely to be a “ construction contract ”; whereas
if a collateral warranty provides that the “ contractor was carrying out and would continue to carry out construction operations ”, then this could be considered a contract “ for the carrying out of construction operations ” (i.e. a “ construction contract ”). 8 The rationale is that the warranty in this instance is a promise (at least in part) which regulates the ongoing carrying out of construction operations.

It was determined by the majority that the Abbey Collateral Warranty itself contained a warranty of future performance of the construction operations such that “ not only have [Simply] carried out the construction operations in accordance with the building contract, but they will continue to do so to carry out the construction operations in the future ”. 9 As the warranty was not to a fixed or past state of affairs, but was promising future performance, the Court of Appeal held that the Abbey Collateral Warranty was a “ construction contract ”.

Given that the Abbey Collateral Warranty only used the word “ warrants ”, this stopped practitioners from distinguishing or avoiding Parkwood with drafting alone. It appeared as though the position was clear and immovable: Collateral warranties were construction contracts which necessarily attracted the statutory right of adjudication.

Like Parkwood , this decision was met with mixed reviews. Indeed, the Court’s decision itself was not unanimous, with Stuart-Smith LJ disagreeing that the Abbey Collateral Warranty was a construction contract. It came as little surprise that there was a further appeal.

Supreme Court decision (2024) 10

In a landmark decision made on 9 July 2024, the Supreme Court unanimously allowed the appeal against the majority decision of the Court of Appeal and expressly overruled Parkwood , deciding that “most collateral warranties will not be construction contracts” , 11 including the Abbey Collateral Warranty itself.

Central to the Supreme Court’s decision was the word “for” in the s.104(1) definition of a construction contract. Lord Hamblen reasoned, “a collateral warranty will not be an agreement “for” the carrying out of construction operations for the purposes of section 104(1) if it merely promises to perform obligations owed to someone else under the building contract. There needs to be a separate or distinct obligation to carry out construction operations for the beneficiary; not one which is merely derivative and reflective of obligations owed under the building contract”. 12

It was wrong, the Court found, to equate contracts “ for ” construction operations as contracts “ in respect of ” construction operations.

Lord Hamblen suggested that the natural meaning of the word “ for ” denotes function and purpose. As such, the key question would be “ whether the object or purpose of the agreement is the carrying out of construction operations ” . 13 With respect to collateral warranties, he commented that, “ [a]s a generality, it is difficult to see how the object or purpose of a collateral warranty is the carrying out of construction operations. The main object or purpose of such a warranty is to afford a right of action in respect of defectively carried out construction work, not the carrying out of such work ”. 14 In short, a contract “ for ” construction operations “ must…give rise to the carrying out of such operations ” . 15 A mere promise that construction operations will be done is not sufficient.

Consequently, the Supreme Court found that the Abbey Collateral Warranty could only be interpreted as a “ promise to carry out the works ” which amounted to an “ entirely derivative promise ”. 16 Nothing was promised in the Abbey Collateral Warranty that was not already promised under the original building contract. There was no separate construction obligation, and so the Abbey Collateral Warranty was not a construction contract.

Moreover, the Supreme Court considered that collateral warranties were never intended to fall within the scope of the Construction Act. One of the key statutory purposes of the Construction Act was to improve cashflows in the industry; however, none of the payment provisions are applicable to collateral warranties (as consideration is usually only nominal). Consequently this purpose was not furthered by applying the Construction Act to collateral warranties.

Implications of the Supreme Court’s decision

The Supreme Court’s decision in Abbey v Simply is naturally a significant one given that it directly addresses a fundamental question about the scope of the construction industry’s key piece of legislation – the Construction Act. To this end, the decision appears to finally put an end to an eleven year tug of war over the position of collateral warranties within the definition of a “ construction contract ” under that piece of legislation.

Given its significance, the Court’s ruling has broad ramifications.

Direct implications

Certainty . The decision, for now at least, puts the debate to bed and provides certainty that collateral warranties are not construction contracts for the purposes of the Construction Act (unless there is an express, distinct construction obligation – see point two below). In the words of Hamblen LJ, “ collateral warranties are generally outside the 1996 Act rather than everything being dependent on the wording of the particular collateral warranty in issue ”. 17 As a result, the statutory right to adjudication is not automatically available to parties to a collateral warranty. This certainty will be welcomed by those operating in the construction industry and construction practitioners.
including an express provision for a dispute to be referred to adjudication; or
drafting the collateral warranty such that the warrantor owes a distinct and separate construction obligation to the beneficiary.

This raises the possibility that express adjudication clauses will now become boiler plate in collateral warranties given the efficiency, cost and cash-flow benefits of adjudication discussed above (see Adjudication section).

Indirect implications

Possible recall of sums paid pursuant to concluded adjudications . An immediate impact of the decision is that collateral warranty adjudication decisions made under the Parkwood /Court of Appeal approach would, if made today, be invalid for lack of jurisdiction. Parties who have paid out in light of these decisions may therefore consider calling on the return of these sums.
Existing disputes will be litigated, not adjudicated . Parties to a collateral warranty wishing to resolve existing disputes will now need to litigate such disputes rather than being able to refer them to adjudication. Although this may be criticised on efficiency and even access to justice grounds, there is the possibility that a dispute concerning, for example, defects will soon be resolved in the courts as opposed to the private forum of adjudication meaning that an accepted principle may be established which could avoid further disputes being adjudicated, as they could be settled in line with judicial principle instead.
Funding . Most project funders have a right to receive an assignment of the original building contract as a condition of funding. The Abbey decision did not deal with arrangements other than collateral warranties that may provide access to adjudication, however, the decision may have implications for how such funding arrangements are treated. A novation of the original building contract to the funder, or an assignment of the rights under a construction contract (particularly any construction rights/obligations, or specific assignment of the adjudication rights), could mean that a funding arrangement is considered a construction contract, or at least an assignment of the right to refer a dispute to adjudication under the original construction contract. In this way, assignment and novation may be an effective means of keeping the automatic right to adjudicate alive by effectively rendering a third-party funder a party to the original building contract.

Theoretical implications

The Supreme Court has signalled a retreat from an all-inclusive approach to s.104 of the Construction Act which tried to shoehorn all peripherally related construction disputes into the adjudication system. As Hamblen LJ noted in his decision, “ [p]rior to Parkwood the general understanding in the construction industry appears to have been that the 1996 Act did not apply to collateral warranties and we have been shown no textbook or commentary at that time which suggested otherwise. This is why the decision is said to have been a surprise ”. 18

The position now, however, is that automatic adjudication should not be all encompassing; a definitive dividing line has been drawn between “ collateral warranties which merely replicate undertakings given in the building contract and those which give rise to separate or distinct undertakings for the carrying out of construction operations ”. 19

Although Parkwood and the Court of Appeal in Abbey muddied the waters for 11 years, those waters now seem clear again and we are left with a simple and workable approach which practitioners can apply.

1 Murphy v Brentwood District Council [1991] 1 AC 398.

2 Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd [2013] EWHC 2665 (TCC).

3 Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd [2013] EWHC 2665 (TCC).

4 Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd [2013] EWHC 2665 (TCC), at paragraph 28.

5 Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd [2013] EWHC 2665 (TCC), at paragraph 27.

6 Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2021] EWHC 2110 (TCC).

7 Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2021] EWCA Civ 823.

8 Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2021] EWCA Civ 823, at paragraph 31.

9 Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2021] EWCA Civ 823, at paragraph 62.

10 Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2024] UKSC 23.

11 Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2024] UKSC 23, at paragraph 77.

12 Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2024] UKSC 23, at paragraph 70.

13 Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2024] UKSC 23, at paragraph 64.

14 Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2024] UKSC 23, at paragraph 65.

15 Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2024] UKSC 23, at paragraph 66.

16 Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2024] UKSC 23, at paragraph 72.

17 Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2024] UKSC 23, at paragraph 78.

18 Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2024] UKSC 23, at paragraph 82.

19 Abbey Healthcare (Mill Hill) Limited v Augusta 2008 LLP (formerly Simply Construct (UK) LLP [2024] UKSC 23, at paragraph 76

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Assignment, novation and construction contracts - What is your objective?

Consider a not too hypothetical situation where the parties to a construction project (employer, contractor and sub-contractor) enter into a Deed of Assignment intending that the employer, having lost confidence in the contractor, would directly engage the sub-contractor to complete the sub-contract works. But what if no assignment has taken place? What are the terms of the contract under which the sub-contractor carries out the works for the employer?

Potential risks with assignment

In construction projects, main contractors often assign the benefit of their key sub-contracts to the employer in the event of contractor default and consequent termination of the main contract. The employer can then enforce the rights in the sub-contract against the sub-contractor, including rectification of the works and the performance of particular obligations.

However, there are potential risks associated with assignment in these situations as the Technology and Construction Court’s decision in Energy Works (Hull) Ltd v MW High Tech Projects UK Ltd demonstrated. We discussed this decision in Assigning a sub-contract on termination: which rights is the contractor giving up? In this case, the nature of the assignment meant that the main contractor could not pursue claims made by the employer against its sub-contractor under the sub-contract. This limited the main contractor’s ability to ‘pass on’ any liability it had under the main contract to the sub-contractor.

But what if the Deed of Assignment does not take effect as an assignment?

Assignment v novation

Both assignment and novation are forms of transferring an interest under a contract from one party to another. However, they are very different and in their effect. An assignment transfers the benefit of a contract from one party to another, but only the benefit, not the burden. In contrast, a novation will transfer both the benefit and the burden of a contract from one party to another. A novation creates a new contractual relationship - a ‘new’ contract is entered into.

Another key difference with novation is that the consent of all parties concerned must be obtained, which is why novation is almost always effected through a tripartite agreement. In the case of an assignment, it is not always necessary to obtain consent, subject to what the specific terms of the contract provide.

When deciding whether to assign or novate, parties should consider (i) whether there is in fact a burden to novate, (ii) whether the novatee will be willing to take on the burden, (iii) whether all parties will consent to the novation and indeed enter into the agreement. If there is no burden under the contract to transfer, then an assignment is likely to be the most appropriate way to transfer the interests.

Is the Deed for an assignment or a novation?

Although a document may be labelled a Deed of Assignment, if it has references to the transfer of ‘ responsibilities and obligations ’ and is a tripartite agreement these are characteristic of a novation as opposed to an assignment.

A key issue in such circumstances is to ascertain whether making use of the words ‘ assigning ’ and ‘ assignment ’ actually affects the characteristics of the document.

There has been some consideration of this characterisation issue by the courts. In the case of Burdana v Leeds Teaching Hospitals NHS Trust [2017] EWCA Civ 1980, by majority the Court of Appeal decided that on the facts of the case, although the Deed of Assignment in question referred to an ‘ assignment ’ of the benefit and burden, on proper analysis there was indeed a novation.

Furthermore, in the case of Langston Group Corporation v Cardiff City FC [2008] EWHC 535, Briggs J made it evident that even though the variation agreement in question did not use the word ‘ novation ’ and did not describe itself as such, the circumstances and effect of the agreement was indeed a novation and a new contract had been created.

It may be the case that even if a document does not describe itself as a novation, yet has the key characteristics of one, then as a matter of interpretation the courts would accept that the document takes effect as a novation.

Key characteristics of a novation

If entering into a document that purports to be a Deed of Assignment, tread carefully as it may well take effect as a novation, particularly if the following characteristics are present:

It is a tripartite agreement;
All the parties give their consent;
The novator has been released from its obligations;
There has been an acceptance of the terms of the novation on the part of the novatee and the substituted party; and
There is a vesting of remedies.

What is your objective?

Although a document may well be labelled as an assignment, it may have the characteristics of and take effect as novation. Parties need to be cautious and consider what they want to achieve when assessing whether to assign rights or to novate them along with obligations.

This article was written by Anna Sowerby and Eveline Strecker. For more information, please contact Anna or your usual Charles Russell Speechlys contact.

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Collateral Warranties & Construction Contracts

Collateral warranties & construction contracts   .

Collateral warranties essentially bridge the contractual gap between parties upstream and downstream of a middle party, such as employers and sub-contractors separated by the contractor, or funders and contractors separated by the employer.    

This article considers when a collateral warranty might be considered a construction contract for the purposes of the HGCRA and thus gives parties to that contract the right to adjudicate. This article will also consider what options are available if no right to adjudication exists.

Collateral Warranty, what is it?

The rule of privity of contract applies in English jurisdiction, meaning that a third party cannot enforce the terms of a contract.  As such, an Employer cannot enforce the terms of a sub-contract between a contractor and sub-contractor.   This was recently confirmed in  Multiplex Construction Europe Limited w here the Court restated its reluctance to impose a duty of care in respect of pure economic loss where parties do not have a contractual relationship. Hence, collateral warranties are a useful contracting tool.

A collateral warranty is a kind of side agreement between parties without a direct contractual link, for a warrantor to perform the work required of its direct contractual agreement.  In this side agreement the beneficiary (the party receiving the warranty) is afforded the ability to claim against the warrantor (the party giving the warranty) should it not perform its obligations.     

When it comes to construction contracts, a construction professional, such as a consultant, contractor or subcontractor will usually provide such a warranty to a main contractor, employer or funder.  In doing so, it establishes a direct contractual relationship between it and the beneficiary which is an extension of its obligations to its immediate contract party.   

Construction contracts & the right to adjudicate    

Section 104(1) of the HGCRA provides that a “ construction contract ” is:   

“ An agreement for carrying out construction operations, arranging the carrying out of construction operations by others or providing labour or the labour of others for carrying out of construction operations, amounts to a construction contract .”    

Where a construction contract fits the definition of a “ construction contract ” under the HGCRA it will afford the parties the statutory right to refer disputes arising from this contract to adjudication. Under section 108,  parties to a construction contract have a statutory right to adjudicate any dispute in connection with the construction contract. The right to adjudicate is often desirable for parties as it is a commercially pragmatic and relatively quick 28-day process. Adjudication helps to maintain cashflow as it aims to remove the need to undertake lengthy and extensive court proceedings to recover damages.

When is a collateral warranty a construction contract?   

The decision in  Parkwood Leisure Ltd (2013) demonstrated how the wording and relevant contractual background are fundamental factors when deciding if a collateral warranty amounts to a “ construction contract ”:  

“ One needs primarily to determine in the light of the wording and of the relevant factual background each such warranty to see whether, properly construed, it is such a construction contract for the carrying out of construction operations”.     

The Court found the collateral warranty in  Parkwood  to be a “ construction contract ” for the following reasons:   

i) The underlying contract was a construction contract;  

ii) The language in the warranty mirrored that of the underlying construction contract. It was  “for the design, carrying out and completion of the construction of a pool development”;   

iii) The words  “warrants”, “acknowledges” and “undertakes ” were included in the contract.   The warranty included an undertaking to carry out and complete works under the construction contract;  and

iv) The fact that the contract was retrospective was no bar to it being a construction contract.    

This meant that the protections of the HGCRA applied, including the statutory right to adjudicate and thus the adjudicator’s award was enforced. 

When is a collateral warranty not a construction contract?

The Court in  Parkwood  made it clear that not all collateral warranties will fit the definition of a “ construction contract ”. The decision in  Toppan Holdings Ltd (2021) provided an application of the  Parkwood  principles to a collateral

warranty to conclude that the collateral warranty in question was not a construction contract.    

A dispute arose from a collateral warranty between the parties which was referred to adjudication.  Toppan and the second claimant were both awarded damages in excess of £850,000 each and interest in respect of remedial works, professional fees and loss of trading profit.  S imply refused to comply with the decision and Toppan began enforcement proceedings. Simply contended that the adjudicator lacked jurisdiction as the collateral warranty was not a construction contract for the purposes of the HGCRA. 

The TCC agreed with Simply’s position for the following reasons:   

i) The language of  “acknowledges” ,  “warrants”  or  “undertakes”   found in the  Parkwood  contract was omitted from the  Toppan  contract.  This language is key to finding that a construction contract exists as the contractor undertakes to carry out and complete the works; and

ii) The warranty was executed four years after practical completion of the works and months after defects were rectified -  “…  by the time the [collateral warranty] was executed, it was a warranty of a state of affairs past or future akin to a manufacturer’s product warranty.”   

Quigg Golden Comment

Parkwood would indicate that most collateral warranties which relate to construction contracts would meet the criteria established to also be “ construction contracts ”. As such, parties should be aware that disputes arising under these agreements can be referred to adjudication and may also be afforded other protections / obligations of the HGCRA.

Toppan made it clear than an agreement to stand over previous works is not a construction contract, even if those previous works were construction operations. This is a developing area of law, and more situations may arise where a collateral warranty is not a construction contract.

Where a collateral warranty does not meet the Parkwood criteria, a statutory right to refer the dispute to adjudication will not exist. As such, it would be necessary to pursue claims in accordance with pre-action protocols. In such instances, it may be appropriate for the parties to consider including their own Alternative Dispute Resolution (“ ADR ”) provisions in the agreement which may include adjudication to potentially avoid the expense of litigation.

Contracting parties in Ireland should note that this issue has not yet come before the Irish Courts. The Construction Contracts Act 2013, which is the Irish equivalent of the HGCRA, defines “ construction contract ” similarly to the HGCRA. As such, the UK body of case law may prove persuasive in the Republic of Ireland on this issue.

Quigg Golden are the market leaders in construction and procurement law in the UK. Should any of the above issues affect you or your business, Quigg Golden can provide expert advice.

Do not hesitate to contact us.

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Assignment of a collateral warranty

Published by a lexisnexis construction expert.

This Practice Note focuses on the assignment of collateral warranties (see Practice Note: What are collateral warranties?). For more detailed guidance on assignment in general, see Practice Notes: Assignment in construction contracts and Legal and equitable assignment in construction contracts. Although this Practice Note refers to collateral warranties, the principles also apply where third party rights are used as an alternative to collateral warranties, see: Contracts (Rights of Third Parties) Act 1999 in construction—overview.

Assignment provisions in collateral warranties

The general rule is that if a contract is silent on the issue of assignment, this means that the benefit of the contract can be assigned without limit or without requiring consent (as permitted by law under section 136(1) of the Law of Property Act 1925 (LPA 1925))—there is no requirement to obtain the consent of the obligor to any proposed assignment. See Practice Note: Restrictions on the assignment of rights in construction contracts.

Most construction contracts contain express assignment clauses to clarify the rights of each of the parties in respect of assignment and this is also usually the

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Related legal acts:

Contracts (Rights of Third Parties) Act 1999 (1999 c 31)
Law of Property Act 1925 (1925 c 20)

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