Securing the construction project - legally

Developers are rightly concerned to protect the physical security of construction sites.  But prudent developers and investors will be equally attentive to the need for protecting the legal security of their projects.  This article briefly explores just a few of the available options.  (A longer article could have described latent defects insurance, professional indemnity insurance, and the step-in rights contained in warranties to lenders.)

Performance bonds

An employer may require the contractor to procure a bond from a bank or insurance company as surety or bondsman.  The surety will undertake to meet the employer’s additional costs, up to an agreed maximum, if the contractor fails to perform (usually because of insolvency).  The agreed maximum is typically 10% of the contract sum, which is a rough and ready pre-estimate of the additional cost of paying a second contractor to complete the works.  The surety will charge a substantial premium, which the contractor will recharge to the employer as part of the contract sum.

A bond normally expires at practical completion or when defects appearing during the defects liability period have been made good.

Parent company guarantee

A contractor's ultimate holding company may guarantee the contractor's performance of the contract.  Unlike a bond, a parent company guarantee usually does not expire until six or twelve years after practical completion, so it underpins the contractor’s solvency not only up to practical completion (as a bond does) but also during the subsequent and much longer limitation period.  Moreover, a parent company guarantee usually does not cost the employer any money, whereas a performance bond requires payment of an insurance-type premium.

Collateral warranties and third party rights

The collateral warranty is – or rather, used to be - one of the most important documents in non-contentious construction.  Its main purpose is to provide security for a lender, tenant or buyer ("third party").  It's an agreement under which a consultant, contractor or subcontractor warrants to the third party (essentially) that it has complied (and/or will comply) with its appointment, building contract or subcontract.

It is important that the benefit of the warranty should be freely assignable, usually twice.  Unless it can be assigned by a buyer or tenant the warranty may be far less valuable to him, so assignability makes the property more marketable.

If the third party didn't have this warranty, it would be reluctant to lend money to the developer, or to buy or take a lease of the property.  Warranties therefore enhance both feasibility and marketability.

The Contracts (Rights of Third Parties) Act 1999 now seems to be replacing warranties, thereby reducing the warranty paperchase.