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09 June 2021

A Guide To Collateral Warranties (and your Professional Indemnity Insurance)

Introduction

If you are a business working in the building and construction industry, you will almost certainly have been asked to sign various agreements and warranties at some point in order to win contracts. This requires a completely different set of skills – the ability to wade through pages of small print written in a language that only lawyers understand.

In the eagerness to win projects you may be tempted to skip over the small print. This is not advisable for obvious reasons. You might be agreeing to something you don’t fully understand which could come back and harm you at a later date.

So please take some time to read this guide. The notes should help draw attention to certain warranties and clauses you should be wary of – not least because they may invalidate your professional indemnity insurance. If, after reading them, you want further advice, please contact us on .

What is a Collateral Warranty

If you are asked to sign a Collateral Warranty agreement then you need to think very carefully. Entering into such an agreement can expose you to significant additional risks which may not be covered by your professional indemnity insurance policy.

Collateral Warranties are supplementary agreements over and above the agreement you have with your immediate client. For example, you may sign an agreement with the main contractor and then find yourself being asked to extend that agreement by means of a Collateral Warranty to include a third party such as a financier, purchaser, tenant, a consultant or another contractor.

If you sign the Collateral Warranty agreement you will be entering into a legal relationship with a third party and creating a fresh contractual link, that would not have otherwise existed. This means you are accepting an additional duty of care to that third party on completion of the project. You may then find that, although you have satisfied the terms of your agreement with your direct client, the third party makes a claim directly against you for failing to meet the terms of the Collateral Warranty.

Are you covered by Professional Indemnity Insurance

By signing such an agreement, you are exposing yourself to a wider range of liabilities than those inherent in the main agreement and therefore increasing your risks.

This in itself should concern you. But there’s another issue to consider. These risks may not be covered by your existing professional indemnity insurance. So, if you sign a Collateral Warranty assuming your professional indemnity insurance will protect you should that third party make a claim, then you might be in for a nasty surprise.

‘Noted, subject to policy terms and conditions’

Most professional indemnity insurers agree, in principle, to provide cover for any claim that arises as a consequence of you entering into a warranty. However, you’ll almost certainly find this is not the case if the duty of care owed to the third party is more onerous and/or of a longer duration than that owed to your direct client as part of your original agreement with them.

If you send the warranty to your insurer (via your broker) to approve, they may respond with the term ‘Noted, subject to the policy terms and conditions’. This simply means they are aware of the warranty, but it is still subject to the existing policy terms and conditions

In other words, if there are clauses within the Collateral Warranty that increase the extent of your liability, and/or extend the period of that liability beyond the terms of the contract with your direct client, then this will probably invalidate the cover provided by your current policy.

These clauses are not easy to spot or understand, so we strongly advise you to contact your solicitors or a use, before you sign.

Do you really have to sign?

You are not legally obliged to sign a Collateral Warranty unless you agreed to do so under the terms of the original agreement with your client. Go back to your original agreement and check whether you agreed to enter into a Collateral Warranty (a copy of which should be attached to that agreement).

However, even if signing such a warranty was not stipulated in your original agreement, your client may come back and put commercial pressure on you to do so. In this case, you have to make a judgement whether you are happy to sign or not.

If you are obliged to sign the Collateral Warranty because you agreed to do so under the terms of your original agreement, or because you are being pressured to do so and decide to comply, then there are two big points you need to consider:

  • The Collateral Warranty should only refer to those parties specifically included in your original agreement – such as the first purchaser and the first tenant of the development, as well as the funder and any consultants involved.
  • The Collateral Warranty should be a version produced by one of the following organisations:  the British Property Federation, CIC Collateral Warranty or the National Housing Federation. This is important because their terms are readily accepted by most insurers.

Other things to consider before you sign

  • Be clear about the fact that signing a Collateral Warranty will increase your potential liability by adding to the list of potential claimants who are entitled to bring a claim against you.
  • Before you sign a Collateral Warranty notify your broker, who will inform your insurer. If you fail to do this it may invalidate your current Professional Indemnity policy.
  • Because you are increasing your risk you may have to extend your professional indemnity insurance. You’ll need to do this immediately, and the cover must last as long as you are bound by the terms of the warranty. This is generally for a period of 12 years.
  • You’ll need cover up to the value of the Collateral Warranty.
  • Extending your cover will probably increase your premium.
  • If you are planning to retire or cease trading you must purchase run off cover to comply with the terms of the Collateral Warranty you are agreeing to. Failure to do this could expose the partners or directors to personal liabilities after a business ceases trading.

Clause for concern – wording you need to watch out for in your original agreement or the Collateral Warranty

As we’ve already explained, your existing professional indemnity policy will only cover you for certain specified risks and if you expose yourself to additional risks you may find that your policy is invalid with regard to these extra liabilities have accepted. So before signing an agreement with a client, and before also signing any Collateral Warranty, you need to understand every single clause, as some of them may take you beyond the protection of your policy. In particular, you should look out for the following clauses, treat them with caution, and check with your broker or provider before signing.

Adjudication clauses

Your professional indemnity insurance policy is probably provided on the condition that you do not agree to accept any clause in a warranty which states that you agree to accept the decision of an adjudicator, with no further reference to legal proceedings, arbitration or alternative dispute resolution, in the event of a dispute. If you agree to accept any such clause your insurer may be entitled to refuse cover under your policy for such a dispute.

Indemnity Clauses

These clauses seek to make you liable to pay compensation to your client for all losses, claims, damages, expenses and costs caused by a breach of contract or duty on your part when providing your services.  These clauses considerably widen the scope of what your client can recover from you – they go beyond what is normally recoverable at common law.

If you see such clauses you should ask to have them removed from the agreement.  Removal does not disadvantage your client. They can still bring a claim for a breach of contract in the ordinary way.  What’s more, your client will be protected by the fact that you are covered by the professional indemnity insurance that you are required to maintain as part of the agreement.

If your client refuses to remove the indemnity clause, then ask to amend the clause so that recoverable losses are defined as “all reasonably foreseeable, legally recoverable and fully mitigated losses, claims, damages etc.”

Deleterious Materials Clauses

Check the wording of such clauses to make sure you are only obliged to avoid specifying materials considered deleterious by your profession.  If the wording obliges you to avoid specifying materials considered deleterious within the construction industry as a whole, or by consultants generally, then this extends your liability and may therefore prejudice the cover provided by your policy.  Ask to have the wording changed so that your liability is limited and you are covered.

Fitness for purpose and Express Guarantee Clauses

These clauses are extremely onerous and should be avoided. They impose upon you a duty that goes way beyond the standard terms of “exercising reasonable skill and care” in the performance of your services.

If you accept such clauses, your current professional indemnity insurance policy will not cover you for any contractual liability you incur as a result – so ask for them to be removed.

Likewise, your policy will not cover you for any contractual liability you incur as a result of giving any express guarantee relating to the satisfaction of a performance specification, or that the period of a project or project budget will be achieved, within the terms of your agreement – again, such clauses should not be accepted.

Liquidated Damages and Penalty Clauses

These clauses relate to what happens if there is a breach of contract.  Your professional indemnity insurance policy will not cover you for any contractual liability you incur as a result of agreeing to such clauses and again they should be avoided at all costs.

Need some clarification? We can help.


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