Episode 41:

Hello and Welcome to the Part3 with me podcast, 

The show that helps part 3 students jump start into their careers as qualified architects and also to provide refresher episodes for practicing architects. I am your host Maria Skoutari and this week we will be talking about Collateral Warranties— PC3 of the Part 3 Criteria.

What is a Collateral Warranty:

A Collateral Warranty is a form of contract which runs alongside and is supplementary to another contract. A collateral warranty in essence creates a contractual relationship between two parties where none would otherwise exist. It typically takes the form of a contract between the party under contract who is providing the services and a third party who has an interest in the proper performance of that contract, for example creating a contractual relationship between the architect and funder, purchaser or tenant. The contract will the need to be signed by the Parties, which is typically signed as a deed. A key thing to note here is that the relationship created between the parties using a collateral warranty doesn’t extend further and there should be clause stating that ‘nothing in the agreement is intended to confer any benefit or right to any third party pursuant to the Contracts (Rights of Third Parties) Act’.

Why are Third Parties so interested in entering into collateral warranties:

Because of the privity that exists with contracts as we mentioned in the previous episode, law of Contract, only the persons who are parties to a contract can sue for breaches of the contractural obligations. So an architect for example can only be sued by the client for breach of the architects appointment, so a third party who takes an interest in a completed building such as a tenant, can’t sue the architect, so if the building is defective these third parties will want to recover pure economic loss, that’s why interested third parties will insist that the client provides a contractual route for recovery of such potential losses from the contractor, design team and sub-contractors.

So how and why are architects required to enter into collateral warranties:

Architects may be required to enter into a collateral warranty in favour of a funder, tenant or prospective purchaser when engaged by the client or in favour of the client when engaged by the contractor. In order for architects to be able to enter into collateral warranties, their appointment must include a clause that explicitly obligates them to provide collateral warranties to particular parties or in specific circumstances.  

It is typically recommended that an architect entering into such a contract extend their scope of liability to third parties and insert a net contribution clause so that the architect is only financially liable to the extent that they have caused the problem. Although clients will typically be reluctant to include such clauses, PI insurers will only pay out the extent that the architect was liable for. So the architects right to contribution can be protected by including a clause stating that claims made under the warranty will only be valid provided all consultants have entered warranties at the same time in similar terms. 

A few key issues and watchpoints the architect should consider before signing a collateral warranty, would be: 

• the terms within the collateral warranty being more onerous that the original contract, 
• the wording of the collateral warranty will need to be approved by the architects PII, 
• the architects need to make sure the other consultants and contractor have also entered into collateral warranties
• And that the collateral is limited to an agreed number of subsequent tenants.

So as indicated from what I’ve mentioned so far, clients on large-scale commercial projects are typically the ones that will require collateral warranties in favour of future purchasers and tenants in order to increase the marketability of their development. The future purchasers or funders will require the collateral warranties to provide them the ability to ‘step in’ to the shoes of the client and take over the appointment of the architects, other consultants and contractor to complete the development in case the client is removed from the project for whatever reason. 

Now, there are a few formats a collateral warranty can be worded under:

The collateral warranty forms have typically two main standards forms they use that an architect may be asked to enter into. One is drafted by the Construction Industry Council and is known as CIC/ConsWa and the other form is drafted by the British Property Federation and is known as BPF/CoWa. These two forms are typically insurable and provide limitations on liability to protect the architects position but there are instances where clients will propose their own bespoke forms. 

But in any case, with any form, the architect should check with their PI insurers to confirm they are satisfied with the policy cover and the collateral warranty wording. A key thing to note in any instance is if a specific obligation is included in a professional appointment. The architect will therefore be expected to warrant that in respect of their professional services under the appointment that they have complied with the terms of the appointment and have and will exercise reasonable skill, care and diligence, in the absence of any other wording, the standard of care for an architects will be that of the ordinary skilled architects. If client tries to request something higher, the architect should resist as PII covers tend to contain an exclusion of cover for any contractual performance warranties in excess of the warranty of reasonable skill and care. 

Some bespoke forms of collateral warranty require the architect to acknowledge that at the date of the collateral warranty the professional appointment remains in full force and effect and the client has paid all sums due. The intention of this is to prevent the architect from raising any set-offs in relation to claims by the collateral warrant beneficiary, e.g. funder. It may also include wording for the architect to acknowledge that the beneficiary has relied and will rely on the satisfactory performance by the architects of their obligations under the appointment. This wording should be accepted by architects.

Now lets refer back to the ability of the future purchasers or funders to ‘step in’ to the appointment with the architects:

So in a collateral warranty, the funder or party who has agreed purchase the whole of the project will require to have ‘step in’ rights to avoid any potential implications with the architects appointment for example, so by having the ‘step in’ opportunity with the architects appointment they can ‘step in’ to the clients position for certain circumstances. The funder will most probable expect to have reactive and/or proactive ‘step in’ rights to enable them to act if for example the original client has stopped paying the architects fees and the architect gives notice to terminate their appointment, in such an instance the funder will be able to step in and give notice to the architect requiring them to carry on with the funder becoming responsible for all payment of fees on stepping in - this process would be classed as reactive. The funder may proactively step in when the funder/client relationship for example has broken down and the funder wishes to build out the project and remove the original client to protect their investment. 

The step in clause operates to restrict the architects ability to terminate their own appointment for breach of the client obligation to make payments but this is acceptable in principle given the other party agrees to take over and pay outstanding fees and the fees moving forward.   

In terms of the architects appointment and relevance to third parties:

Typically, a third party rights clause is entered into the architects appointment identifying the potential beneficiary by name or particular class to description. Once the beneficiary has been identified, the client will give notice to the architect that their third party rights obligations will extend to this particular party. The architect of course does have the right to deny signing such an agreement and they cannot be forced to do so. PI insurers tend to prefer the architect to enter into a collateral warranty with another party rather than granting third party rights. 

So to sum up what I discussed today:

• A collateral warranty is a form of contract which runs alongside the main contract and it creates a contractual relationship between two parties where none would otherwise exist.
• A collateral warranty is a contract between the party to the main underlying contract who is providing services or carrying out the work and a third party who has an interest in the proper performance of the contract.
• Collateral warranties can be executed as a simple contract or as a deed setting the relevant limitation period of either 6 or 12 years respectively. 
• Collateral warranties have become so important because they are the only means of protection for third parties in recovering losses suffered due to defective building work. 
• The main parties that benefit from collateral warranties are the client, purchaser, tenant, funder and other third parties such as a neighbouring landowner to ensure any damage that occurs on their property is safeguarded. 
• It is important to note that the warranty only extends to reasonable skill and care.
• It is recommended that an architect entering into such a contract extend their scope of liability to third parties and insert a net contribution clause so that the architect is only financially liable to the extent that they have caused the problem.
• A warranty can have a ‘step in’ clause enabling a funder for example to step into the clients shoes if for any reason the client cannot fulfil or continue with their duties.