Collateral Warranties, Construction Bonds, Guarantees and Third Party Rights

When undertaking a construction project, you will likely have been asked to provide security documents such as a collateral warranty (or probably more than one). These might also include construction bonds, third party rights, and parent company guarantees. It’s important to understand what these are and what risks could be involved.

Use of collateral warranties, performance guarantees and bonds has become widespread in construction contracts. It is increasingly rare to see contracts and sub-contracts that do not require them.

If entering into a collateral warranty or performance guarantee or bond of any sort, or providing third party rights, it is important that you are not exposing yourself to unnecessary risk.

What is a collateral warranty?

A collateral warranty is a separate contract – an agreement to give a third party rights under a contract that they are not a party to.

Construction projects routinely involve more parties than simply an employer and a contractor. Parties with an interest in the development could include consultants, funders, purchasers, and tenants.

As some of those parties will not have a direct contractual link they would not be able to sue under the construction contract. They will however be directly affected if things go wrong. This means that the rights given under a collateral warranty can be an extremely important part of the arrangements made for construction projects.

Third Party Rights

The Contracts (Rights of Third Parties) Act 1999 enables third party rights to be created by a contract. Third party rights are similar to rights granted under a collateral warranty because they allow a third party to enforce rights under a contract which it is not party to.

Rather than a separate collateral warranty being required, third party rights can be granted in a contract itself. Or a contract might provide that notices of third party rights can be issued. These notices state that a third party is entitled to enforce those rights.

A contract which provides for third party rights will usually contain a schedule of third party rights.

We are increasingly seeing contracts which grant third party rights instead of requiring collateral warranties. This avoids the need to negotiate and enter into separate collateral warranties.

Significance of collateral warranty and third party rights

It is helpful to think of a practical example of where a collateral warranty comes into play. If the work of a specialist sub-contractor is defective, the employer can sue the contractor. The contractor can then seek to recover from the sub-contractor.

The employer cannot however sue the sub-contractor under the sub-contract between the contractor and the sub-contractor. This is because the employer is not party to it.

A collateral warranty from the sub-contractor to the employer, or third party rights under the sub-contract, allows the employer to sue the sub-contractor directly. In cases where the contractor has become insolvent, a collateral warranty or third party rights become very valuable.

Construction bonds and performance guarantees

Construction bonds and performance guarantees provide additional security. They are issued as security against the failure of one of the parties involved (usually a contractor or a sub-contractor) to meet contractual obligations.

There are technical differences between construction bonds and performance guarantees. The protection that they offer can differ greatly depending on the precise wording used. This is where using an experienced construction consultant can really help your construction project.

Parent company guarantees

Parent company guarantees are used to provide security from the parent company (the ultimate or holding company) of a party. Where a contractor that has given a parent company guarantee defaults on its obligations, its parent may be required to remedy the breach. Or it might be required to carry out the contractor’s obligations or make good the losses caused. Sub-contractors are sometimes required to provide parent company guarantees.

Construction consultancy services

We are experienced construction consultants based in Bristol and working for clients across the UK and worldwide. We see a lot of construction contracts and the associated collateral warranties, performance guarantees and bonds, third party rights and parent company guarantees. Our advice will explain what you are being asked to sign up to and what the risks are, in plain English terms and with no-nonsense explanations.

We can draft relevant documents and can provide advice to anyone being asked to sign up to them, or other third party rights. The consequences of signing up to an excessively onerous warranty or bond could be millions of pounds, so it is extremely important to take advice from experienced construction consultants.

Free initial consultation

All initial enquiries from new clients are completely free of charge. Please contact us by phone, email or using our contact form for a free initial consultation. We can discuss how we can help you in relation to collateral warranties, performance guarantees and construction bonds.