Collateral Warranties & Professional Indemnity Insurance

A collateral warranty is a warranty that gives a third party rights over an existing contract they are not a party to, writes Terry O’Malley.

There are normally two parties to a collateral warranty, the warrantor, who provides the benefit of the warranty and the beneficiary, who is the recipient of the warranty. Professional consultants such as architects, engineers and contractors would usually provide a collateral warranty in a property development. The purpose of a collateral warranty agreement is to create a contractual link between the beneficiary and the warrantor.

The benefits of collateral warranties:

The beneficiary may be the owner or a purchaser or tenant of all or part of the development or a bank or other party providing finance for the development. Lending institutions will often insist on collateral warranties being assigned over to the purchaser before they approve release of equity over a new commercial building.

The material terms of Collateral Warranty:

Compliance with the Professional Appointment:

The consultant will warrant that they have complied with its obligations under their professional appointment including, not making material change to the designs or specifications without the beneficiary’s prior written consent and acting fairly and impartially when exercising its power to issue warranties. The consultant will also give a warranty to exercise the required standard of care when performing their services and not to use any products in the project which are deemed to be deleterious at the time.Furthermore a consultant’s duties or liabilities under a collateral warranty will not be diminished by any inspection or approval of the property by the beneficiary.

The consultant may not terminate or discontinue their professional appointment:

The consultant cannot exercise any right to terminate their employment under the professional appointment or seek to discontinue their performance of the services without giving the beneficiary written notice of its wish to do so.

Professional Indemnity Insurance:

It is vital that the consultant maintains professional indemnity insurance for a specified period after the date of practical completion. The indemnity limit should be agreed between the parties and it is usually between 6-12 years. In addition a consultant cannot settle any claim with the insurers that relates to a claim by the beneficiary without the beneficiary’s written consent.

Assignment:

It is standard practice for the benefit of a collateral warranty to be assignable onto third parties subject to the consultant been given prior written notice of this assignment.

Pitfalls for the warrantor:

The warrantor will often insist on limitations being inserted into any a collateral warranty in order to protect their position. A collateral warranty is often be limited in time to a period of between 6-12 years and if there is a monetary cap within the underlying contracts limiting liability to a set sum the warrantor should seek to incorporate similar provisions within the collateral warranty.

Structural defects insurance

On large commercial developments builders often take our structural defects insurance on a no fault basis. The cover will last up to 10 years from the date of practical completion and it can be the preferred option for many investors, given the uncertainty in attempting to enforce the provisions of a collateral warranty. Relying on a collateral warranty requires proof of liability which can be a lengthy and costly process. Simply put, structural defects insurance reduces the risk for building owners. It insures against the physical damage to the property caused by poor design, materials or workmanship which may not have been discovered on completion. The major attraction to this insurance for a policyholder is that they do not have to prove the negligence of a third party to make a claim. A lot of building contractors have fallen victim to the property downturn and the usual means of redress such as collateral warranties is proving quite ineffective. This is where structural defects insurance compares favorably to the reliance on collateral warranties. The insurance is a major source of comfort to the purchasers, investors and tenants of the property that they will be protected from any potential structural liabilities long after practical completion. It should be noted that the cost of such insurance is a major consideration for any building contractor and it is often viewed as cost prohibitive.

Conclusion

It is important for all purchasers, investors and tenants in new buildings to be aware of the benefit of collateral warranties or where possible the provision of structural defects insurance.  In future, it may well be that developers are increasingly drawn towards structural defects insurance as opposed to collateral warranties as investors will demand greater protection for their assets and structural defects insurance offers this reassurance.

Terry O’Malley is a solicitor in the Commercial Property unit at Leman Solicitors. He can be contacted on O1 639 3000 or at tomalley@leman.ie

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