A tool to manage performance and defects

Monday, November 18th, 2013

We have been guiding a client through a procurement process involving construction. The issue of Collateral Warranties arose. The subsequent debate and negotiations have persuaded us that a briefing note will help our clients and visitors to our website.

A collateral warranty can be defined as

“an agreement associated with another primary contract”

The warranty is usually executed as a deed and no consideration is required to render the warranty enforceable. The limitation period is 12 years. It is used to define an agreement ancillary to another principal contract. For a third party, it imposes an extended duty of care and a broader liability on two separate parties involved in a contract.

A tool to manage performance and defects

Collateral warranties do not have a long history and there isn’t an extensive legal case history. Such warranties can be traced back to the 1980’s noting the Shanklin Pier case in 1951 (see later).

Essentially only parties to a contract can claim losses for breach of the contract. Particularly in construction, it is often necessary to establish contractual relationships between, for example, architects, builders, funders, developers and tenants. The collateral warranty is the legal document which creates the contractual relationship.

We need now to issue a “health warning”. You MUST seek professional and legal advice IF you wish to pursue collateral warranties in a future deal(s).

You may wish to consider (amongst other things) the following:

  • An undertaking to meet the obligations of the warrantor under the primary contract
  • The maintenance of insurance to cover off the risks – Professional Indemnity
  • Exclusions or limitations on liability (if applicable)
  • Permission to assign the warranty
  • Step-in rights for the funder to take on the employer’s role
  • “No greater liability” clause to ensure the warrantor is under no greater liability than the primary contract
  • Copyright which allows the Employer to use design documents the Sub-contractor/Sub-consultant prepares.

A test case worth reading is How Engineering Services Ltd and Southern Insulation (Medway) Ltd [2010] EWHC (TCC).  As always these cases are never straightforward. Developers engaged “McAlpine” as the main contractor who sub-contracted the mechanical and electrical (including the air-conditioning) services to “How” who then sub-sub-contracted to “Southern”. “Southern did the work of insulating the steel pipework which was to carry chilled water around the building for air conditioning purposes. Problems arose which led to the replacement of pipework at a cost of some £3.5m.The development was occupied by Linklaters (solicitors) as lessees. Linklaters issued proceedings against McAlpine which had provided to Linklaters a written collateral warranty. How gave to Linklaters a Collateral Warranty a collateral warranty to the effect that How would carry out its sub-contract works in accordance with the sub-contract it had entered into with McAlpine. Cutting a very long story short, the judgment supported the use and efficacy of collateral warranties.

Addleshaw Goddard comment on the “No greater liability” clause as follows.

“An issue that has dogged collateral warranties is the penchant for insurers for insisting on the inclusion of so-called no greater liability clauses. The inspiration for such provisions is thought to be that PI policies commonly exclude, in one way or another, cover for claims under any collateral warranty which imposes any obligations which are more onerous or longer-lasting than any related liability under the principal contract”.

There is no shortage of draft collateral warranties on the internet but you must exercise due care before recommending their use or “adapting” them for your use. A useful example is a University of Leeds Deed, attributed to Eversheds LLP (dated 24 September 2007). There are 13 clauses namely:

  • Consideration
  • Contractor’s Warranties
  • Intellectual Property Rights
  • Notices
  • Assignment
  • Other Rights and Remedies
  • No approval
  • Prohibited Materials
  • Limitation
  • Governing Law and Interpretation
  • Third Party Rights
  • Professional Indemnity Insurance
  • Step-in Rights

We referred earlier to the Shanklin Pier Ltd V Detel Products Ltd [1951] 2 All ER 471, Kings Bench case. McNair J commented “This case raises an interesting and comparatively novel question whether or not an enforceable warranty can arise as between parties other than those parties to the main contract for the sale of the article in respect of which the warranty is alleged to have been given.” Shanklin Pier contracted with George M Carter (Erectors) Ltd., to repair and re-paint the pier. Separately Shanklin Pier contracted with Detal Products, the paint known as “DMU” which Detel warranted would have a life of seven to ten years and would prevent corrosion and creeping of rust. Carters were instructed to use the “DMU” product. Its life was of very short duration. Note that there was no contract between Shanklin Pier and Detel. Nevertheless McNair J  held that there was a collateral warranty provided by Detel and Shanklin Pier and Detel were ordered to pay the cost of the corrective work.

A tool to manage performance and defects

The take-away: Collateral warranties are a useful tool to manage performance and defects…but ensure you take advice before entering into agreements with your suppliers.

 

About Brian Farrington

Brian Farrington is one of the world’s longest established procurement and supply chain consultancy and executive training specialists. 33 of the current FTSE100 have retained our services, as well as leading organisations in the UK, North America, southern Africa and Asia. Established in 1978, we have proven expertise and experience in strategic procurement and risk management.

Brian Farrington solutions and services are formed through  consultancy, training & development, coaching – all underpinned by proprietary technology . Our four core areas of procurement risk management capability are:

•Strategic review and commercial governance

•Performance delivery and transition

•Major project support including managing contractual risk

•Learning & development in support of organisational aims.

For more details about procurement risk management and Procurisk® Ray Gambell can be reached at on 01744 20698 and r.gambell@brianfarrington.com