How common are collateral warranties in favour of joint/multiple beneficiaries?

Collateral warranties help safeguard those involved in construction projects, from developers to funders, providing the ability to take legal action against parties who have carried out or designed works, such as contractors and consultants. In some cases, collateral warranties are required for multiple beneficiaries (funders, tenants, property management companies), which must be carefully managed to avoid overlapping liabilities, competing enforcement demands, and more.

In this article, Zi Chuen Gwi, solicitor in our construction team, explains why having a collateral warranty in favour of joint/multiple beneficiaries is not a standard approach, examining the recent case of Darchem v Bouygues.

What is a collateral warranty?

A collateral warranty is a contract that is “collateral” to the relevant underlying primary contract, such as a building contract or professional appointment. It‘s normally given to a third-party beneficiary who has an interest in the project to create a direct contractual relationship between the relevant contractor or consultant. This enables the third-party beneficiary to bring a breach of contract claim against a contractor or consultant if problems arise.

A standard collateral warranty is usually in favour of a single beneficiary, and it’s a stand-alone contract.

Why is it a standard approach to provide/receive a separate collateral warranty?

More often than not, each third-party beneficiary will have a different interest in the project and because of that, the nature and extent of loss (if any) suffered by them due to the warrantor's defective work may not be the same. This means that the nature and extent of the claim that each beneficiary may bring against the warrantor will differ, creating risks such as conflicting legal interpretations of the issue.

In addition, the terms of the collateral warranty in favour of each beneficiary may be different. For example, a tenant will not normally require step-in rights in their collateral warranty (which allows the third-party beneficiary to “step in” to the underlying contract in the event the Client becomes insolvent), but a funder or buyer might.

As such, it’s normal for warrantors to enter into a separate collateral warranty with each third-party beneficiary so risks and complications are mitigated where possible.

So, what if I am asked to enter into a collateral warranty in favour of joint/multiple beneficiaries?

It’s not the standard approach and there are several points you must consider before entering into a collateral warranty in favour of joint/multiple beneficiaries.

For example, will all beneficiaries to the collateral warranty have step-in rights and if so, who has the priority of step-in? This will require further drafting in the collateral warranty to set out whether one or all of the beneficiaries have step-in rights and who will have priority.

In addition, if there are multiple third-party beneficiaries under a single standard collateral warranty, the third-party beneficiaries typically share a single and collective right under the collateral warranty. Therefore, unless the wording of the collateral warranty expressly provides that each beneficiary has several or joint and several liability, all beneficiaries under the collateral warranty must act together to bring a claim, which might be difficult if one of the beneficiaries decides not to pursue the claim.

Collateral warranties in the Darchem v Bouygues case

In the Darchem v Bouygues case, the claimant was an unincorporated joint venture of Darchem and Framatome, and Darchem, in its own name, wanted to enforce an adjudicator's decision for payment of £23.9 million by way of summary judgment. The Technology and Construction Court refused to enforce the decision on the basis that Darchem, as one of two participants in an unincorporated joint venture, was not a party to the sub-contract and therefore could not commence adjudication proceedings unilaterally in its own name.

The court will typically treat the joint venture (this means all constituent parties that are involved) as the only party that can bring a claim and simply stating that the constituent parties are acting jointly and severally is not good enough. This shows the importance of clear wording in a contract to authorise one company to act on behalf of the joint venture, if that is the parties' intention.

The same principle applies to a collateral warranty. For a collateral warranty to have two or more beneficiaries, each third-party beneficiary must be expressly identified as a distinct party to the warranty. Under the terms of the collateral warranty, it should also be assumed that each third-party beneficiary is separate. If the parties are unable to amend the terms of the collateral warranty, each third-party beneficiary should receive a separate collateral warranty.

Legal support with collateral warranties

To avoid complications such as conflicting liabilities and differing legal interpretations, it's important to understand the right approach to collateral warranties, and this starts with seeking the right legal advice.

For support with collateral warranties or construction law generally, please contact Zi Chuen Gwi, via [email protected] or 0191 211 7837.