Understanding Collateral Warranties in Insurance: Ensuring Adequate Cover for Clients

In the realm of insurance and risk management, collateral warranties play a crucial role in protecting the interests of all parties involved in a contractual agreement. Brokers, in particular, must have a comprehensive understanding of collateral warranties to ensure that their clients have adequate coverage, including Professional Indemnity (PI) and Public Liability (PL) insurance. Let’s delve into what collateral warranties entail, their significance in insurance, and the importance of reviewing them regularly.

What is a Collateral Warranty?

A collateral warranty is a legally binding agreement between parties involved in a construction project or transaction. It is typically provided by a contractor, subcontractor, or consultant to a third party, such as a funder, purchaser, or tenant. This warranty assures the third party that certain obligations will be fulfilled, typically relating to the quality of work, compliance with regulations, or future performance.
In simply terms, a collateral warranty acts as a bridge between parties that may not have a direct relationship under the main contract. It creates a legal link between a party involved in the original contract, such as a contractor or consultant, and a third party, such as a funder, purchaser, or tenant, who may require assurances or commitments beyond what is provided in the primary contract. This connection allows the third party to enforce certain rights or obligations directly against the party providing the collateral warranty, providing an additional layer of protection and assurance in complex contractual arrangements.

Tie-In with Insurance

Collateral warranties often intersect with insurance, especially in sectors like construction where risk exposure is high.

In many cases, parties requesting collateral warranties will specify certain insurance requirements that contractors or consultants must meet to fulfill their obligations under the warranty. This often includes maintaining specific limits of insurance coverage, such as Professional Indemnity (PI) or Public Liability (PL) insurance, to ensure adequate financial protection against potential liabilities.

Additionally, collateral warranties may stipulate a duration for which the insurance coverage must be maintained. It’s not uncommon for this duration to extend beyond the completion of the project and the expiry of the original contract. In construction projects, for example, it’s typical for collateral warranties to require contractors to maintain insurance coverage for a significant period, often up to 12 years or more after completion. This extended period helps ensure that parties relying on the collateral warranty have recourse to insurance coverage for any defects or issues that may arise well into the future.

The inclusion of phrases like “as long as commercially viable” acknowledges that the ongoing fulfilment of obligations, including insurance requirements, should be reasonable and aligned with the commercial realities of the situation. It provides a degree of flexibility for parties to adjust their obligations over time, taking into account changes in circumstances, market conditions, or legal requirements. However, it’s essential for parties to ensure that such clauses are drafted clearly and fairly to avoid ambiguity or disputes regarding their interpretation.

Common Clauses

Indemnity Clause: This clause outlines the obligation of the warrantor (e.g., contractor or consultant) to indemnify and hold harmless the beneficiary (e.g., funder or purchaser) from certain losses, damages, or liabilities arising from the performance or non-performance of the contract.

Duty of Care Clause: This clause sets out the standard of care that the warrantor is expected to meet in carrying out their obligations under the collateral warranty. It typically requires the warrantor to exercise reasonable skill, care, and diligence in performing their services.

Limitation of Liability Clause: This clause limits the extent of the warrantor’s liability for certain types of damages or losses. It may specify a cap on the amount of damages that the warrantor can be held liable for, often to a certain multiple of the contract value or fees.

Notices Clause: This clause establishes the procedure for giving notice under the collateral warranty, including how and when notices must be delivered to the parties involved.

Assignment Clause: This clause addresses whether the collateral warranty can be assigned or transferred to another party, and under what conditions, such as requiring the consent of all parties involved.

Governing Law and Jurisdiction Clause: This clause specifies the governing law that will apply to the collateral warranty and the jurisdiction where any disputes arising from the warranty will be resolved.

Severability Clause: This clause states that if any provision of the collateral warranty is found to be invalid or unenforceable, the remaining provisions will remain in full force and effect.

Termination Clause: This clause outlines the circumstances under which the collateral warranty may be terminated, such as breach of contract or completion of the project. Certain clauses can be considered difficult or uninsurable in collateral warranties due to the inherent risks they pose or the challenges they present for insurance coverage. 

Fitness for Purpose Clause: This clause guarantees that the goods or services provided by the warrantor will be suitable for a specific purpose intended by the beneficiary. Insuring against claims arising from fitness for purpose guarantees can be challenging because it involves predicting and covering potential future performance issues, which may be difficult to quantify or assess.

Express Guarantees Clause: Similar to fitness for purpose clauses, express guarantees clauses involve the warrantor providing explicit assurances or guarantees regarding the quality, performance, or characteristics of the goods or services provided. Insurers may be hesitant to cover claims arising from express guarantees due to the uncertainty and potential for subjective interpretation.

Liquidated Damages Clause: Liquidated damages clauses specify a predetermined amount of damages that will be payable by the warrantor in the event of a breach of contract. While liquidated damages clauses themselves are not necessarily uninsurable, insurers may scrutinize them closely to ensure they are reasonable and proportionate to the potential losses incurred. Excessive or punitive liquidated damages may be difficult to insure against.

Exclusion of Consequential Damages Clause: This clause excludes liability for certain types of indirect or consequential damages resulting from a breach of contract. Insurers may be cautious about providing coverage for claims arising from consequential damages due to the difficulty in predicting and quantifying these types of losses.

Exclusion of Liability for Design Defects Clause: In construction-related collateral warranties, clauses that exclude liability for design defects may pose challenges for insurance coverage. Design defects can lead to significant financial losses and legal liabilities, making insurers hesitant to provide coverage for claims arising from such exclusions.
While these clauses may be included in collateral warranties, their presence can complicate the insurance process and may require careful negotiation and consideration by all parties involved to ensure adequate protection and coverage. Insurers may impose certain conditions or limitations on coverage for claims related to these clauses, or they may require additional premiums or endorsements to address the increased risk exposure.

Importance of Regular Review

Contractors should review collateral warranties periodically to ensure that their insurance coverage aligns with the contractual obligations outlined in these agreements. Common clauses found in collateral warranties include indemnity provisions, duty of care clauses, and limitations of liability.

Collateral Warranty Checking Services

Some insurers offer collateral warranty checking services to assist in evaluating the adequacy of clients’ insurance coverage. These services provide valuable insights into the compatibility of insurance policies with the terms of collateral warranties, helping client’s make informed decisions.

Legal Implications and Contractual Obligations

It’s essential to recognize that collateral warranties are legal documents that carry significant legal implications. While insurance policies may provide coverage for certain liabilities, they may not fully indemnify clients against all risks outlined in collateral warranties. Clients should seek legal advice to review and negotiate collateral warranties alongside their contracts to ensure comprehensive protection.

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