Collateral warranty deeds – small documents, big risks
Aug 2020 | Construction & EngineeringIt is now commonplace on most major projects for subcontractors and suppliers (referred to generally in this article as subcontractors) to be asked to provide a collateral warranty deed in favour of the principal under the head contract, or in favour of other stakeholders with a general or specific interest in the delivery of the project. In this article, we set out some of the key risks for subcontractors to look out for when reviewing collateral warranty deeds.
Introduction
Collateral warranty deeds may be given a different label (such as a ‘side deed’) or executed in the form of a simple agreement rather than a deed, but their effect is generally the same. They ensure that the principal of a construction project has direct contractual rights against subcontractors that the principal can rely on in the event the head contractor cannot satisfy the principal’s claim (or if the principal prefers to claim against the subcontractor).
Often, head contractors will take the position in the negotiation of the subcontract that collateral warranty deeds are ‘not up for negotiation’ with the subcontractor. Invariably, the reason given is that the form of the warranty deed has already been agreed to under the head contract with the principal. Perhaps more honestly, it might be because the head contractor has very little motivation to secure amendments to the collateral warranty deed for the benefit of the subcontractor.
For this reason, and perhaps also because they can be as brief as one or two pages, these collateral warranty deeds can be an afterthought in subcontract negotiations. They are often given far less attention than more trivial issues.
However, it can be disastrous for a subcontractor to ignore these documents – every collateral warranty deed should be carefully reviewed and considered (even if they are described as the principal’s ‘standard form’) because in the event of a breach, subcontractors can be completely exposed to the principal’s claims for uncapped damages (including for consequential loss). Such claims are fertile ground for dispute, because often the subcontractor’s responsibility for the principal’s claim is unclear, especially where the project involves multiple contractors performing interdependent works packages. This can significantly increase the overall project risk for the subcontractor.
Issues to consider – onerous obligations
The immediate task when reviewing a collateral warranty deed is to determine whether the deed requires the subcontractor to assume greater obligations or risks than it is assuming through its primary obligations under the subcontract.
Under nearly every collateral warranty deed, the subcontractor will warrant that the work it performs will comply with the subcontract. This is usually accompanied by a promise to correct any failures or defects notified within a certain period, often aligning with the defects liability period under the head contract (which might be a far longer period that the period agreed to under the subcontract).
However, many warranty deeds will also contain additional warranties as to fitness for purpose and quality of workmanship. Occasionally there will also be indemnities for all loss arising out of breaches of the warranty deed, and even a right to take over the works in the event the subcontractor breaches the warranty deed. These types of provisions will be the subject of close scrutiny in negotiation of the general conditions of the subcontract, but often go unnoticed in the collateral warranty deed.
A common reason that this occurs is that the collateral warranty deed is often a placeholder in the version provided to subcontractors at the time of tendering and subcontract negotiations. The collateral warranty deed is then added to the subcontract at a later stage when the parties are under mutual pressure to close out the subcontract, and at that time there is little appetite to add to the final drafting issues to be closed out before the subcontract is executed.
Issues to consider - limitation of liability under collateral warranty deeds
It is generally incumbent on the subcontractor to insist that its liability under the collateral warranty deed is subject to appropriate limitations. A common approach is to simply lift and insert the limitation of liability clause that has already been agreed under the subcontract, to avoid further rounds of negotiation.
However, it is rare that this will achieve the desired effect. For instance, if there is a cap on the subcontractor’s liability under the subcontract, recycling the limitation of liability clause in this way could create a separate cap on liability to the principal under the collateral warranty deed, which might amount to exposure that is twice the agreed cap on liability under the subcontract. This will not achieve the commercial intent if it is desired that the contractors aggregate liability under both the subcontract and the collateral warranty deed will not exceed a certain amount (i.e. where it is agreed that there should be a single, shared cap on the subcontractor’s liability).
At times, it can seem that the task of improving the warranty deed is simply too hard, and for that reason it should simply be deleted from the subcontract. This uncompromising approach can be an effective strategy for major subcontractors with overwhelming market power and leverage over head contractors and principals.
For those subcontractors in a less advantageous negotiating position, a drafting solution will be of greater assistance. Unfortunately, it is difficult to be absolutely certain that a particular limitation of liability clause will be effective, as there is a frustrating lack of judicial consideration of these types of provisions, and even less guidance as to how they apply to collateral warranty deeds.
However, the recent English decision of Swansea Stadium Management Company Ltd v City & County of Swansea & Anor1 provides a useful example of effective drafting that has been accepted by the Court. The warranty deed under consideration included the following provision:
‘the Contractor shall have no greater liability under this Agreement than it would have had if the Beneficiary had been named as joint employer with the Employer under the Contract.’
The Court found that by this wording the parties intended that the Contractor’s liability to the Beneficiary under the collateral warranty deed was ‘coterminous’ with its liability to the Employer under the primary contract. In more straightforward terms, the protections in favour of the Contractor under the primary contract applied to the warranty deed as if the Beneficiary were standing in the shoes of the Employer.2
This decision provides a degree of reassurance that this type of provision will be effective in collateral warranty deeds. However, contractors must always ensure that the drafting is appropriate for the contractual arrangement at hand.
Collateral warranty deeds which are required to be given in the form of a deed poll (which are deeds signed by one party only in favour of another party who does not execute) present an additional, curious challenge. For instance, the subcontract might include wide exclusions from liability in favour of the subcontractor. A common example that most in the construction industry will be familiar with is an exclusion of all consequential loss ‘however arising, including as a result of negligence’ (or similar). The same consequential loss exclusion will not achieve the same effect in a deed poll, which is executed by the subcontractor only. This is because the principal cannot be said to have consented to waive its rights against the contractor arising at common law if it has not agreed to the terms of the one-way deed poll executed by the subcontractor. At best, this would require that the exclusion provision is read down in accordance with the principles set out in Darlington Futures Ltd v Delco Aust Pty Ltd.3 At worst, this could render the exclusion clause ineffective due to its uncertainty. This is a useful example of why legal advice should be sought on any occasion where subcontractors are uncertain of the risks posed by a particular collateral warranty deed.
How to review a collateral warranty deed
When asked to provide a collateral warranty deed, prudent subcontractors should ensure that all issues with the warranty deed are identified and raised in early rounds of departures. If the warranty deed is not provided at the time of tendering or initial subcontract negotiations, subcontractors should ensure that it is clearly understood that the subcontractor reserves the right to require further departures if the warranty deed is more onerous than the subcontract or otherwise presents an unacceptable risk.
Further, subcontractors should ensure that collateral warranty deeds include a limitation of liability clause that is appropriately tailored to both the collateral warranty deed and to the subcontract. The drafting may be more complex if there are additional deeds that the subcontractor must provide to the principal (or others).
In addition to the terms of the collateral warranty deed, subcontractors should be wary of provisions of the subcontract that provide that the collateral warranty deeds are deemed to be agreed to by the subcontractor in the event that the subcontractor fails or refuses to sign and return the collateral warranty deed. These provisions could operate to bind subcontractors to the terms of the collateral warranty even if it is never executed as a separate document.
Finally, subcontractors should ensure that insurance advisors are kept aware of the terms of collateral warranty deeds, because, in certain cases, if the terms of the collateral warranty deed require that the subcontractor assumes greater liability than it does under the subcontract this could affect how applicable insurance policies will respond in the event of a breach.
Key takeaways
- Collateral warranty deeds should always be carefully scrutinised as part of the contract review process;
- Ensure that warranties given under the collateral warranty deed are not more onerous than those contained in the remainder of the subcontract;
- Ensure that liability to the principal and / or other beneficiaries of the collateral warranty deed is appropriately limited according to the overall risk of the project; and
- Always seek legal advice if you are unsure about the terms of a collateral warranty deed
The above are broad guidelines and in each instance it is necessary to consider the specific risks involved in the project, and especially those that will flow through to the subcontractor under the collateral warranty deed.
If you are concerned about the risks presented by a particular warranty deed, or if you would like more detailed advice on collateral warranty deeds generally, please contact our Construction & Engineering team.
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1 [2018] EWHC 2192.
2 Interestingly, in Swansea Stadium this provision was used to defeat a cause of action on the grounds of a limitation period expiring – although it is likely that the same logic would apply if the scope of the exclusion of liability was in issue.
3 (1986) 161 CLR 500.
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