Where landlords undertake works to premises prior to putting a new lease in place, and that lease is a FRI (full repairing and insuring) lease, the tenant is likely to seek reliance / enforcement rights against the landlords' contractors and consultants. Here we look at the relevant documentation and landlords' considerations.
Collateral warranties – considerations for commercial landlords
In a market where 'spec' is increasingly important and retrofitting is growing in popularity, many commercial landlords are finding themselves considering whether current stock is fit for purpose. Against this backdrop, landlords may look to re-purpose or refurbish commercial properties, often involving significant landlord works, in a bid to attract a new or particular calibre of tenant. The landlord will enter into construction contracts for such works. Depending on the nature of the works, the landlord may also appoint structural engineers, architects or other members of the professional team under appointment agreements. .
When faced with a letting at a recently refurbished unit, and taking on a full repairing obligation, well-advised tenants will invariably look for a 'construction package' to be delivered alongside the keys. That ensures that if there is an issue with the landlord's works the tenant would seek contractual recourse against the contractors / professional advisers, rather than having to meet the repair costs itself. An important element of this package and route to claim will be any collateral warranties to be provided to the tenant.
Here, we provide a reminder as to what collateral warranties are and when they might be required. We also consider what a commercial landlord should look for the warranty to contain, and any pitfalls that should be borne in mind.
What are collateral warranties and when are they required?
A collateral warranty is a contract that creates contractual rights between two parties who did not contract with each other originally i.e. it creates a direct contractual link between two parties where there had previously been no such link.
For example, where a landlord has recently refurbished a property and has a potential tenant lined up to take a lease of the property, the tenant may demand collateral warranties from the building contractor appointed by the landlord to carry out the works, as well as from any significant sub-contractors and also other consultants forming the 'professional team' employed by the landlord or building contractor to assist in the completion of various aspects of the works.
Where the landlord has appointed a building contractor, who has in turn employed sub-contractors to carry out certain aspects of the works, the landlord itself may wish to seek collateral warranties from those sub-contractors.
Additionally, if security can be granted over the proposed letting, collateral warranties may be sought by the tenant's funder, or indeed any funder of the landlord. Alternatively, should the landlord choose to market the newly refurbished property for sale, purchasers are also likely to demand that collateral warranties are delivered at the point of sale. Again, they may be required for the purchaser and its funder.
What should collateral warranties contain?
There are certain clauses that would be expected in any collateral warranty such as:
- a duty of care undertaking whereby the warrantor confirms that it has complied with its obligations in the underlying contract (be that the building contract, appointment or sub-contract) and that the warrantor has exercised the level of reasonable skill and care to be expected of its peers;
- a copyright licence allowing the beneficiary to copy and use drawing, specifications and other project documents in relation to the works. A copyright licence might be required, for example, to allow a tenant to integrate its fit out into shell and core works; and
- an undertaking to maintain professional indemnity insurance at a certain level for a set number of years following completion of the works.
Collateral warranties will also routinely include step-in rights and liability caps, and while their inclusion in principle is fairly standard, the exact terms of such rights are likely to be robustly negotiated. More detailed commentary on step-in rights and liability caps is provided at Brodies Insights. In addition, a collateral warranty may only permit a certain number of assignations to a third party.
Limitations
There are a few shortfalls when procuring the provision of warranties that commercial landlords should be aware of:
- Timing: the right to have collateral warranties granted has been found to prescribe after a period of 5 years from the date upon which the obligation to provide a warranty is created. That being the case, available warranties should be ingathered efficiently;
- Substance: the value of any collateral warranty, no matter how robust, is only as good as the covenant of the party granting it (e.g. if a contractor goes bust, and in the absence of step-in rights, there is no value to obtaining a warranty). Unless agreed otherwise, the tenant would have no recourse to a third party for the works/services performed by that party;
- Synergy: in a similar vein, given collateral warranties are 'collateral' to the underlying contract, they are generally only as good as the underlying contract itself. That being the case, the collateral warranty and the principal contract should be consistent with one another; and
- Dispute Resolution: following a recent Supreme Court Decision, it is unlikely that a collateral warranty will be considered to be a "construction contract". This means that there will be no statutory right to adjudicate for any breach of the warranty and therefore making a claim may be a more drawn out process.
Key takeaway
Commercial landlords investing in and upgrading their existing stock should be aware that well-advised incoming tenants will seek collateral warranties, and should get on the front foot in procuring their delivery. As with the collateral warranty and underlying contract themselves, the provision and delivery of collateral warranties is best served by collaboration between all parties.
