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what-are-acollateral-warrantiesIncreasingly contractors and consultants, particularly in the fields of architecture and engineering, are required to sign collateral warranties in connection with work they are undertaking but what is a collateral warranty, how does it affect the contractors responsibilities and how can you protect against losses under collateral warranties?

What is a collateral warranty?

By definition a collateral warranty is a legal undertaking by a party that runs alongside another contract. It is used to create a contractual responsibility where it would not otherwise exist.

What is the purpose of a collateral warranty?

When a contractor undertakes work for an employer they will have responsibility to that employer both under tort and under the law of contract. If the employer, a developer for instance, then hands over the project to a third party then there is no contract in force between the contractor and this party or parties. Consequently any action against the contractor would be limited to issues arising from tort as there is no contract in place between the two parties. In the case of Caparo vs Dickman (1990) any third party wishing to take an action in tort must show “forseeability, proximity and fairness” in order for a claim to succeed.

It is true that the third party may have an action under contract against the employer who may in term have an action in contract against the contractor but this is not always the case and following this path can be both expensive and fraught with difficulties.

The collateral warranty is a separate contract formed in order to a create a contractual liability that would not exist otherwise. The collateral warranty  should be designed to mirror the responsibilities of the contractor to the employer and extends those legal responsibilities to subsequent third parties. As in all contracts there must be a consideration in order for the contract to be valid and this will normally by a nominal fee, for example £1.

The responsibilities under a collateral warranty can vary greatly from the duty of exercising reasonable care to warranting that  their design be fit for purpose.  The warranty may also include liability for diminution in value, loss of rent and profits and other forms of economic loss. It may also to seek to extend the contractors period of responsibility for such losses beyond what would normally apply.

Anyone signing collateral warranties should work to ensure that their responsibility under the warranty is not wider than the duty owed under contract to the original employer although this is often the case.

It should be noted that collateral warranties are not a type of insurance product they are a contractual agreement entered into generally prior to the commencement of a main conttract for services.

Collateral Warranty Insurance

Protection against losses arising under collateral warranties falls into the category of professional liability insurance and can be catered for by a  professional indemnity insurance.

Prudent contractors will already have in place an appropriate level of liability insurance, whether this be professional indemnity insurance, public liability etc but is vital to note that any liability assumed under contract will be excluded from these policies as standard as as such the client may be taking on responsibilities that he believes he is insured for under his professional indemnity insurance but is in fact not.

Is insurance available for collateral warranties?

The insurance market does provide insurance in respect of the increased responsibilities assumed under collateral warranties but this is not automatic and the cover provided by may not be as broad as the scope of the warranty.

What are the potential problems with collateral warranty insurance?

As a class of business, professional indemnity insurance is underwritten on a claims made basis, that is to say that the policy responds to claims made against the insured whilst the policy is in force. This in itself provides problems for any contractor seeking to insure themselves against losses under a collateral warranty as whilst the cover may be available at an acceptable price at the outset of the contract there is no guarantee that an insurer will underwrite the warranty in future years or indeed at what price.

The terms of your collateral warranty may be so extensive that the insurer is not able to provide you with the full scope of cover that you require and you may be left exposed to claims that are not insured.

How do I buy collateral warranty insurance?

Your first port of call is to contact your existing professional indemnity insurance company to ask if they can provide you with the cover. If you do not currently hold professional indemnity insurance or you having difficulty obtaining the cover you need  you can contact us directly to discuss your needs with one of our specialist brokers.