A collateral warranty is a legal document in the context of construction projects or real estate transactions. It is a secondary or ancillary agreement that runs alongside the main contract and is usually provided by a third party, such as a contractor, consultant, or supplier, to a party not directly involved in the main contract.
The purpose of a collateral warranty is to create a direct contractual relationship between the third party and the beneficiary (the party not directly involved in the main contract). This provides the beneficiary with certain rights and protections, similar to those set out in the main contract.
In the context of project finance:
Like all lenders, project finance lenders take collateral from a borrower so that if the loan cannot be repaid the collateral can be sold and the proceeds applied to loan repayment.
In the case Scottish Widows Services Ltd v Harmon, 2010 SLT 1102 “The purpose of a collateral warranty… is to provide a right of action between parties who, under the standard legal structures used in construction contracts, would not otherwise be in any contractual relationship; it thus confers title to sue on the grantee of the warranty. A collateral warranty constitutes a contract between the granter and the grantee. Under that contract, the granter undertakes that it will perform specified works to a standard of competent workmanship (in the case of a contractor), or will provide specified services and observe proper professional standards of skill and care (in the case of an architect or engineer). If the granter fails to perform its duties to the required standard, the grantee can raise an action to compel such performance…. Alternatively, if the grantee suffers financial loss as a result of the defective performance, it may raise proceedings against the granter in order to recover the amount of that loss” .