Although the word ‘warranty’ is frequently used in the construction industry, it is often used with different meanings. This article explains how ‘warranties’ work in the context of a construction contract. It is intended to assist principals, head contractors and subcontractors in negotiating and interpreting their contractual obligations.
What is the legal definition of a warranty?
In a strict legal sense, the terms of a contract can be divided into three categories: conditions, warranties and intermediate terms.
If a 'condition' of a contract is breached, the innocent party will have the right to terminate the contract and claim damages.
If a 'warranty' is breached, the innocent party will not have the right to terminate the contract. But it may still claim damages, assuming the breach causes a loss.
An 'intermediate term' lies somewhere between. Whether the breach of an intermediate term will entitle the innocent party to terminate will depend on the circumstances, potentially including the severity of the breach.
However, when people in the construction industry talk about 'warranties', they are not usually thinking about this traditional legal classification.
What is the construction industry definition of a warranty?
When people in the construction industry refer to ‘warranties’, they are probably referring to an obligation that arises from a document that has been signed or issued by the warrantor. Alternatively, they might be referring to a warranty that arises under statute or is implied by law.
This article is focused on the first type of ‘warranty’ mentioned above – that is, warranties that appear in documents that are signed or issued by the person giving the warranty.
Why do written warranties exist?
The purpose of any warranty is to provide comfort, in the form of a legally enforceable obligation, to someone buying goods or services from the person giving the warranty.
Warranties are intended to clarify the parties' rights and obligations, and will often explain what should happen if something goes wrong.
For example, say you engage a contractor to perform work, and you do this without signing a contract.
If the contractor’s work is defective, the law will probably supply you with a remedy. You might have an action against the contractor in tort (negligence), under statute (such as trade practices legislation or specific building legislation), or (less commonly) in equity.
But sometimes, the law might not be clear about precisely what should be expected of the contractor. For example, the law might be silent about the expected service life of the works, or in relation to specific performance characteristics of the works. It is areas of uncertainty like these that warranties are intended to address.
A well-drafted warranty will describe precisely what is required of the contractor or supplier. It will give you clarity around the circumstances in which a remedy is intended to be available. The protections given by warranties can be invaluable, particularly where the law is silent or potentially ambiguous.
Contractual warranties generally supplement other legal rights that a principal or head contractor may have, including any remedies that may be available under applicable trade practices and building legislation.
Obtaining warranties from contractors and suppliers is one of the most practical ways principals (and head contractors) protect themselves against the risk of contractor, subcontractor and supplier non-performance.
What are collateral warranties in construction?
A collateral warranty is a warranty that is given separately to the main contract that contains the parties’ primary obligations. Usually, collateral warranties are signed by subcontractors and suppliers and are provided by a head contractor to its principal under a head contract.
Principals will often seek collateral warranties from subcontractors and suppliers to ensure that they can make a claim directly against the subcontractor, should the need arise.
Without a collateral warranty deed, the principal may not have a direct right of action against the subcontractor. That can become a serious problem if the head contractor experiences an insolvency event. This is the problem that collateral warranty deeds are often designed to address.
Collateral warranties will often be required by a principal in the form of a deed, to ensure that they are enforceable.
The two types of construction warranty: time-based warranties and general warranties
Warranties in the construction industry typically fall into one of two categories: time-based warranties and general warranties.
A time-based warranty is a binding promise that a particular thing will be in a particular state at a specific point in time, or remain in that state for a specified period of time.
For example, a contractor might be required to warrant that, on completion of their work, the work will comply with all applicable statutory requirements.
Or, as a separate example, a contractor might be required to give a warranty that (say) a structure will be waterproof on completion of the works, and that it will remain waterproof for a period of 5 years.
This style of warranty is intended to give a buyer comfort that about the state, quality or performance characteristics of the goods or services they are buying at a particular point (or points) in time.
Time-based warranties are particularly important given that law will rarely specify how long things should be expected to last.
Within the meaning used by the industry, general contractual warranties are other contractual promises given by the contractor or supplier that are not time-based warranties.
For example, under AS 4902 (an Australian Standards form of design & construct contract), the contractor is required to 'warrant' that:
- it is suitably qualified and experienced;
- it has examined the preliminary design and the principal’s project requirements and that the design is suitable, appropriate and adequate;
- it will carry out its design obligations in accordance with the principal’s project requirements;
- it will carry out and complete the work under the contract in accordance with the design documents so that the works when complete are fit for their intended purpose; and
- its consultants are suitably qualified and experienced.
Confusingly, some terms that are expressed as ‘warranties’ may in fact be intermediate terms or even conditions within a strict legal sense. A breach of that type of ‘warranty’ may entitle the other party to terminate the contract.
For example, a contractor may be required to ‘warrant’ that it is appropriately licensed to perform the work. If that warranty is breached, with the result that the contractor is not legally permitted to perform the work, the likelihood is that the principal would have the right to terminate the contract.
When someone starts talking about 'warranties', understanding the distinction between time-based warranties and general warranties will help you understand what they are talking about.
What happens if a warranty is breached?
The consequences of a breach of warranty will normally depend on four things:
- Whether the obligation is of a kind, and the breach so serious, that the other party should be entitled to terminate the contract.
- Whether the person with the benefit of the warranty has suffered any loss.
- Whether the contract or warranty document explains what should happen where there is a breach.
- When the claim is made.
If the contract explains what should happen in the event of the breach, the law will usually (but not always) treat the contract as a complete code. The contract may explain how a party needs to claim for the breach, and it may also explain how the claim is intended to be resolved. Some contracts will identify specific terms that, if breached, will entitle the innocent party to terminate.
Where a party suffers a loss as a result of a breach of warranty, and absent any terms of the contract to the contrary, the innocent party would usually be entitled to claim damages. Damages for a breach of warranty are normally calculated with the aim of putting the innocent party in the position they would have been in, had the contract been performed.
The timing of a claim for breach can be critical. Keep in mind that the expiry of the 'defects liability period' does not mean that the contractor can no longer be liable. (You can read more about this here.) A claim brought after the period allowed by the applicable statute of limitations will be barred.
Takeaways for buyers (eg principals and head contractors)
When you are buying goods or services from someone else, including construction services, you should seek to:
- obtain warranties from that person;
- obtain warranties from any other person in the supply chain who may be responsible for any material defects or other issues that emerge (such as key subcontractors and major suppliers of plant and equipment); and
- ensure in each case, the warranties clearly identify what is expected of the person giving the warranty, and what will happen in the event of a breach. Normally, a mix of general warranties and time-based warranties will be appropriate.
Takeaways for sellers (eg head contractors, subcontractors and suppliers)
Where you are selling goods or services to someone else, you should seek to:
- read the terms of all warranties carefully, to ensure you understand precisely what is expected of you and your potential liability in the event of a breach;
- carefully consider any time-based warranties, particularly warranties with extended durations, and seek to ensure they are qualified for factors beyond your control (eg wear and tear, failure to maintain, misuse or deliberate damage, etc); and
- obtain warranties from your suppliers and subcontractors, to ensure you will have back-to-back protection should it be required.