Out-Law / Your Daily Need-To-Know

Drafting effective 'no greater liability' construction collateral warranty clauses

Out-Law Analysis | 20 Sep 2021 | 11:05 am | 6 min. read

For ‘no greater liability’ clauses in collateral warranties and third party rights schedules to work as intended, warrantors must ensure that their provisions do not conflict with those in the underlying building contract.

Negotiations relating to the provision of collateral warranties and third party rights can often become contentious. Common issues include the number of collateral warranties or third party rights notices to be provided, the categories of beneficiaries and the consequences of the contractor breaching its obligation to provide a collateral warranty.

Due to the increasing number of stakeholders in construction projects, it is not uncommon for employers to require contractors to provide a large number of collateral warranties or third party rights in favour of broad categories of beneficiaries. In fact, on high value, multi-phase projects, contractors may be obliged to provide scores of collateral warranties.

It is market norm for collateral warranties and third party rights schedules to include a 'no greater liability' clause. This provides that the contractor's liability under the warranty or third party rights schedule shall be no greater in extent or duration than its liability to the employer under the underlying building contract. In essence, the intended effect of such a clause is for any limitations or exclusions on the contractor's liability under the building contract to apply to claims against the contractor under the collateral warranty or third party rights schedule.

Helen Achilleos

Associate, Pinsent Masons.

The mistake often made by warrantors is that they do not consider their liability under the building contract and collateral warranties or third party rights schedule holistically

However, the mistake often made by warrantors is that they do not consider their liability under the building contract and collateral warranties/third party rights schedule holistically. Contractors often overlook the point that the liabilities under the collateral warranty or third party rights schedule are intrinsically linked to the underlying building contract, and that this and other factors can erode the effect of a 'no greater liability' clause as a means of limiting the contractor’s liability. What this means is that such a clause cannot be relied upon in isolation. Instead, contractors should always consider whether the risk allocation agreed in other parts of the suite of construction documents, and in the collateral warranty/third party rights schedule itself, could limit the effects of such a clause.

Here are five common oversights which contractors should consider as part of their negotiations.

Relying on limitations and exclusions on liability under the building contract

When the parties are negotiating limitations and exclusions on the contractor's liability under the building contract, the effect of such limitations and exclusions on collateral warranties or third party rights is sometimes overlooked.

For example, in the underlying building contract, it is common for certain liabilities to be carved out of aggregate limitations on the contractor's liability (for example, liabilities which are covered by insurance). However, when negotiating such carve-outs, contractors often forget that they are also agreeing to potentially unlimited liability in relation to these carved-out liabilities under collateral warranties or third party rights schedules.

Aggregate limitations on the contractor's liability under the building contract are sometimes expressed in terms of "the contractor's aggregate liability to the employer". This type of language may leave room for an argument that the same limitation does not apply to liability to third parties under collateral warranties or third party rights schedules – however, this also depends on how robust the wording of the "no greater liability" clause is in the relevant collateral warranty.

Forgetting assignment rights

The contractor may have negotiated restrictions on assignment of the benefit of the underlying building contract by the employer. This is usually done in an attempt to control the identity of those who can enforce the rights against the contractor under the building contract. The contractor may also have negotiated an overall limitation on the number of collateral warranties it is required to provide, again in an attempt to control who can claim against it.

However, what about assignment rights under the collateral warranties/third party rights schedules? The contractor may have reached an agreement with the employer that there will be no more than 50 collateral warranties in total. However, if, for example, each of these warranties may be assigned without the contractor's consent on two occasions, there is a risk that the contractor could end up with 150 different beneficiaries throughout the life of the project; albeit no more than 50 beneficiaries at any given time.

Therefore, contractors must not overlook restrictions on assignment under collateral warranties/third party rights schedules as part of their contractual negotiations. Restricting assignment rights is another way for the contractor to control the number of different entities to whom it may be liable throughout the project.

Not considering express limitations on liability in the collateral warranty/third party rights schedule itself

Rather than simply relying on a 'no greater liability' clause, contractors should consider including a limitation within the collateral warranty or third party rights schedule itself in relation to the types of losses recoverable by the specific beneficiary.

This may not be palatable to a funder receiving the benefit of a collateral warranty, but is sometimes accepted by purchasers and tenants. For example, a clause may be included which provides that the beneficiary can only claim the reasonable costs of repair, renewal or reinstatement in purchaser and tenant collateral warranties/third party rights schedules.

Not considering tortious rights of third parties

It is worth considering whether it may be possible for the beneficiary of a collateral warranty or third party rights schedule to seek to circumvent a 'no greater liability' clause and any other limitations on the contractor's liability by bringing a claim in tort.

Collateral warranties

Where a collateral warranty is provided and so a contract exists with the beneficiary, the law recognises that a concurrent duty of care in tort can still exist between the two parties.

However, there is case law which provides that, whilst a concurrent duty of care in tort can exist, it will likely be looked at in the context of the contractual liabilities assumed by the parties. So if, for instance, certain types of loss are excluded or otherwise irrecoverable pursuant to the collateral warranty, then the duty of care in tort is likely to be similarly limited.  The general reasoning behind this seems to be that the parties to a collateral warranty have reached agreement on its terms, and so beneficiaries should not be able to circumvent any limitations within that document by bringing alternative claims in tort.

In any event, it is probably best to ensure that the wording of limitations on the contractor's liability in the underlying building contract expressly extend to claims in tort (including negligence).

Third party rights

It is less clear whether the position relating to collateral warranties would be true of third party rights granted under the Contracts (Rights of Third Parties) Act 1999 (1999 Act).

Although this has not been tested in the courts, it seems unlikely that the courts would treat the third party rights provisions as constraining a concurrent duty of care in tort in the same way that they would treat the terms of a contract which the beneficiary has entered into.

In a third party rights situation, the beneficiary has not made any agreement at all as it is not a party to the relevant agreement. Instead, it has simply been granted the ability to enforce certain rights under the contract. In those circumstances, it is difficult to envisage that the beneficiary would be held to have agreed that its remedies in tort are limited by the terms of a contract to which it is not a party. It therefore also remains to be seen whether expressing a limitation on the contractor's liability as extending to tortious claims would be effective in limiting tortious liability pursuant to a third party rights schedule.

Inclusion of primary guarantees in collateral warranties

In certain complex projects, a parent company of the contractor may be a party to a collateral warranty for the purposes of guaranteeing performance of the terms of the warranty by the contractor - for example, in collateral warranties to funders. The terms of the guarantee may provide that the parent company has a primary obligation to ensure performance by the contractor of the collateral warranty. However, if the guarantee itself does not include a 'no greater liability clause' stating that the parent company's liability will be no greater in extent or duration than the contractor's, then it is likely that the liability of the guarantor will be unlimited if there is a breach of the collateral warranty.

Contractors should therefore ensure that the terms of the guarantee built into the collateral warranty also include a 'no greater liability' clause. When agreeing this 'no greater liability' clause, contractors should again consider all the factors set out above to ensure that the clause is as robust as possible in limiting the guarantor's liability.

Written by Helen Achilleos, a construction and engineering expert at Pinsent Masons, the law firm behind Out-Law.