Collateral Warranty
A collateral warranty is a separate legal agreement in construction giving a third party - such as a funder, tenant, or future purchaser - direct contractual rights against a contractor, subcontractor, or consultant if their work proves defective.
A collateral warranty creates a direct contractual link between a construction professional - contractor, subcontractor, or designer - and a party who is not a signatory to the original building contract. Without a collateral warranty, a third party such as a building's tenant, lender, or future owner has no direct recourse against the construction team if defects emerge after completion. The collateral warranty effectively extends the protection of the main contract to cover that third party's interest.
In practice, most commercial construction projects require collateral warranties as standard. A developer's lender will typically require warranties from the main contractor, key subcontractors, and the design team before releasing finance for a project. A prospective tenant taking a long lease on a newly completed building will request warranties from the same parties before exchanging on the lease. A future buyer of the completed building will need them for the same reason.
What a Collateral Warranty Typically Covers
The content of a collateral warranty generally mirrors the key obligations in the underlying contract. It includes a warranty that the warrantor has performed its obligations under the main contract and will continue to do so, confirmation that certain deleterious materials - materials known to be harmful or unsuitable, such as high-alumina cement or asbestos - have not been used, and obligations relating to professional indemnity insurance.
Collateral warranties often include step-in rights, which allow a funder to "step into" the employer's position and take over the contract if the employer becomes insolvent or defaults on its obligations. This protects the funder's investment in the project by ensuring the construction programme can continue even if the original developer fails.
Third Party Rights
An alternative mechanism to collateral warranties is a third party rights notice, available under the Contracts (Rights of Third Parties) Act 1999. Third party rights are quicker to administer and avoid the need to chase signatures from every subcontractor. However, collateral warranties remain the preferred approach for institutional funders and commercial landlords on significant projects because they are more familiar and easier to enforce.
Collateral Warranties and the Construction Supply Chain
Collateral warranty obligations typically run through the entire supply chain on a commercial development. The main contractor provides warranties to the employer, funders, and tenants. Key specialist subcontractors - structural engineers, mechanical and electrical contractors, and cladding specialists - are often required to provide their own warranties directly to the same beneficiaries.
Contractors should ensure their building contracts and subcontracts include clear obligations to provide collateral warranties when required. A failure to include these obligations - or a refusal by a subcontractor to provide them - can delay project handover and, on funded developments, prevent the developer from drawing down project finance.
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