Collateral warranties are common in the construction sector and can contain additional terms that impose higher levels of liability than under the initial appointment. Consequently, the beneficiary could bring a claim for a wider range of issues and for more costly damages against the construction firm. These costs may not be covered by the professional indemnity insurance (PII) and could therefore impact the business' finances.
Some market participants still view collateral warranties as a formality and as a result don't give them the same attention that they give the main appointment contract. Many employers or end clients are including their own form of collateral warranties in appointments or novations and a template collateral warranty will more likely than not already be set out in the appointment contract a construction firm enters before beginning work. The collateral warranty establishes a new contractual link and may contain additional terms that impose higher standards than under the initial appointment. In a lot of cases, these do not appear to be written on the same basis as the appointment.
Purpose of collateral warranties
When a construction firm enters an appointment with a client, the firm will agree to not only carry out the work, but to do so to a certain standard – ideally exercising reasonable skill and care. If the construction firm fails to carry out the work to that standard, the client has a legal right to make a claim against the construction firm via the original appointment document. As the appointment is just between the construction firm and the client, usually the firm would owe no obligation to any other party under it.
The problem is that other parties will have an interest in the work. For example, a company that purchases a building after it has been constructed will want to be certain that the job has been done correctly and will otherwise want to be able to bring a claim against the construction firm.
The purpose of a collateral warranty is therefore to create a contractual relationship between the construction firm and a third party who would otherwise have no contractual right to bring a claim. This collateral warranty is intended to sit 'collateral' to the main appointment with the client.
PII vs. collateral warranties
Professional indemnity insurance policies will typically provide coverage for collateral warranties, but only where the collateral warranty does not create greater or longer lasting liabilities than the original appointment.
As a result, if the collateral warranty creates any additional liability or obligation on a firm, there is a risk that this will not be covered by the PII.
Review services
In order to ensure that a construction firm is minimising any gaps between the collateral warranty and the insurance policy, any collateral warranty should be reviewed (including any draft collateral warranties appended to an appointment), to ensure that it is not imposing any additional obligations or potential liabilities on the firm compared to what has been agreed to under the appointment. These would ideally be agreed at appointment stage.
To assist with this process, Lockton offers its clients a contract review service to help identify potential gaps between collateral warranties and their Professional Indemnity Insurance policy. To find out more, please contact your dedicated account executive.