In an ongoing construction project, you will seldom see a collateral warranty granted in favour of an employer or funder that does not contain "step-in rights".

While the inclusion of these rights are considered a market-standard protection afforded to certain beneficiaries, they are rarely exercised in practice. This blog covers the operation of step-in rights, instances in which they may be applicable to an ongoing construction project and other practical considerations that may become relevant when exercising such rights.

What are "step-in rights"?

In summary, step-in rights provide a beneficiary of a collateral warranty with an ability to step into the shoes of another party in certain circumstances, being a party to the underlying agreement to which the collateral warranty relates (usually a build contract, consultant appointment or sub-contract). Such circumstances include, for example:

  • where a contractor has the right to terminate a build contract due to the insolvency or breach of the employer, in which case a party with step-in rights under a contractor collateral warranty (e.g. a funder) may wish to exercise its right to step-in.
  • where a sub-contractor or sub-consultant has the right to terminate a sub-contract or appointment due to the breach or default of the contractor, in which case the employer may wish to exercise its right to step-in under its collateral warranty.

The aim of stepping-in is to ensure the continuance of a construction project.

How do step-in rights operate in practice?

Step-in clauses generally prohibit a construction party from terminating its employment under a contract for any reason without first providing notice to any beneficiary who holds step-in rights under a collateral warranty. Once notified, the beneficiary is usually provided with a specific time period (usually between 20 – 28 days) in which to decide whether they intend on stepping into the contract in question, effectively replacing the defaulting employer/contractor and allowing the relevant contract to continue.

Step-in clauses also typically provide that a beneficiary can notify the grantor of a collateral warranty at any time that it wishes to step into a contract, notwithstanding there may not be a breach or default on the part of the original contracting party under such contract. Such clauses typically come into play when a separate contract with the beneficiary has been breached. An example is a funding agreement, and circumstances where an event of default has occurred and the funder decides to step-into the shoes of the employer/borrower.

If a party exercises their step-in rights, they are usually required to provide notice to the grantor of the collateral warranty in which they confirm that all obligations previously held by the original party to the underlying contract will be assumed and that any sums due and payable (unpaid, at present and in the future) will be paid by the party stepping in. In instances where multiple beneficiaries are granted step-in rights in relation to the same contract, the relevant step-in clause will often set out a ranking of each beneficiary to ensure that notices from competing beneficiaries are correctly prioritised. Often funders will look for priority.

Why are these rights important?

Step-in rights, although rarely exercised, can sometimes "save the day" and protect the economic interests of third parties with a stake in a construction project.

If, for example, a developer becomes insolvent during a construction project it may be economical for the development funder to assume the developer's obligations in order to 'rescue' the project and preserve its financial interest until such time as it can navigate its exit or disposal of its interest.

If you have any questions about step-in or require advice in relation to collateral warranties or any other construction agreements, please get in touch with a member of our construction team.

Contributors

Cameron Prenter

Solicitor

Harriet Rutherford

Senior Associate