Collateral warranties: Practical points for AHBs

AHBs often acquire homes that are delivered by a developer using a building contractor and a professional team. A recurring risk is that AHBs acquire buildings or developments where they are not a party to the building contract or the professional appointments, writes Ruth O’Connor and Katelin Toomey of O’Connor LLP.

If issues arise with the construction of the property, they have no contractual relationship with the contractor or professional team. That no privity of contract gap can leave the AHB without a direct contractual claim against the contractor, designers, or key subcontractors.

A collateral warranty is a common way to bridge that gap. It creates a direct contractual link between the recipient of the warranty or beneficiary (such as an AHB) and the contractor/consultant doing the work or design, even though the AHB may not have been a party to the underlying building contract/appointment. Usually, the AHB’s funder will also seek to be included as a beneficiary so it has a similar direct link.

A collateral warranty gives the beneficiary rights to enforce the underlying obligations and recover its loss directly from the party that caused that loss. It also typically includes a warranty that the professional/contractor has complied with its underlying contract.

When reviewing collateral warranties, provisions to focus on include:

1. Scope: The warranty should be consistent with the underlying appointment or building contract it relates to.
2. Standard of care: This is the benchmark to be proven if defects arise, so AHBs should ensure it is robust and consistent with the underlying appointment.
3. Copyright/intellectual property rights: Ensure the AHB can use the design documents as needed.
4. Assignment: Whether and how the AHB can pass the warranty on, for example on a transfer of the property.
5. Step-in rights: These protect continuity if the developer relationship breaks down, by letting the beneficiary ‘step into the shoes’ of the developer under the appointment.
6. Professional indemnity (PI) insurance: Check whether cover is ‘each and every claim’ or ‘in the annual aggregate’. Each and every claim means the full policy limit resets for every separate claim during the policy year, whereas in the annual aggregate means there is one shared limit for all claims in that year, so earlier claims can reduce (or exhaust) what remains available for subsequent claims in the same year.
7. Limit of liability/liability caps: Liability can be capped for each and every claim, with specified carve-outs (e.g. fraud, willful default, etc.)

PI insurance is often the pinch point. Issues to be aware of are the basis of the cover, the level of insurance, and if there are any exclusions or inner limits, and to ensure cover aligns with the underlying contract.

Please note that this does not constitute legal advice and AHBs should always seek advice from their legal advisors in relation to collateral warranties.

O’Connor LLP
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