A client survey highlights the problems in practice with Collateral Warranties in construction projects. However, a solution lies on the horizon for Scottish projects in the form of a new Contract (Third Party Rights) (Scotland) Bill.

Collateral Warranties: two words that are all too familiar in the construction industry today but not necessarily for the right reasons as a recent survey demonstrates. At our Winter Seminar Series, we asked a wide variety of construction professionals:

1: Have you ever not given/received a collateral warranty that you should have given/received?

41% said yes.

2: Have you ever given/received a collateral warranty that contained incomplete information, mistakes or had execution issues?

79% said yes.

Obtaining a suite of multiple collateral warranties is an integral part of the legal framework of a construction project in Scotland, yet the responses to our survey highlight a recurring theme which is that obtaining them (particularly in the correct form) can in practice be problematic.

What is a Collateral Warranty?

A collateral warranty is a contract that creates contractual rights between two parties that would not otherwise exist. It is collateral to a principal contract and therefore the terms of the principal contract can be as important as the collateral warranty itself. They are widely used within the construction sector where there are multiple interested parties who require contractual duties of care from people who they do not have a direct contractual relationship with e.g. an employer from a sub-contractor appointed by the main contractor or a funder from the main contractor who is appointed by the borrower.

What is the problem?

There are three common problems:

  1. Collateral Warranties are poorly drafted which diminishes their value;
  2. Collateral Warranties are incorrectly signed which may in fact mean they have no value; and
  3. Collateral Warranties are simply never delivered at all notwithstanding an agreement to produce the warranty on demand.

Resolving these problems takes time both from a legal and practical perspective and delay has become a common occurrence. There is also often a cost implication in sorting these issues which can become sizeable, particularly on large scale projects with multiple collateral warranties for different interested third parties across the different tiers of construction professional.

One thing is for sure, the construction industry (including the lawyers!) are spending far too much time trying to resolve these issues.

Is there a new solution?

In England, the Contract (Rights of Third Parties) Act 1999 enables parties to grant enforceable rights to third parties without the use of collateral warranties. However, in practice, the construction industry has been slow to adopt this route (although there are signs that this is now changing). An equivalent Scottish Act could, if embraced by all those involved in a construction project (in particular any funders), potentially eliminate the need for collateral warranties altogether. The Contract (Third Party Rights) (Scotland) Bill has just been introduced into the Scottish Parliament under a fast track parliamentary procedure.

Only time will tell whether such an Act will replace the need for collateral warranties completely in the Scottish construction market. The collateral warranty may still prove popular in time given the potential right to adjudicate under a collateral warranty, something which would not necessarily be available via third party rights. In any event, there will certainly be a period of adjustment. However, at a minimum, the Act will provide an alternative route for protecting the interests of third parties in the construction projects of the future.

As the saying goes, “Time is Money” and the time and expense endured by the construction industry creating, chasing and correcting Collateral Warranties may be better spent elsewhere.

In our next Blog, we will be considering the new legislation in more detail. In the meantime, the Contract (Third Party Rights) (Scotland) Bill can be viewed on the Scottish Parliament website.