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Collateral Warranties — Third Party Rights in Construction

The developer sells the building. The purchaser discovers defects. It has no contract with the contractor and cannot sue under the building contract. Without a collateral warranty, the purchaser may have no remedy at all.

5 min read · Updated 21/04/2026

In this article

1. Why privity creates a structural problem in development
2. How collateral warranties work as separate contracts
3. Key terms in a collateral warranty
4. Risks to warrantors — and how they accumulate
5. Mitigation — negotiating warranty terms at procurement
6. Conclusion

Key takeaway

Collateral warranties are separate contracts that create direct rights between a warrantor and a third party beneficiary such as a funder, purchaser, or tenant. They generate material long-term liability — often 6 to 12 years — and require coordinated professional indemnity cover. The time to negotiate warranty terms is at procurement, not when the beneficiary’s requirements arrive mid-project.

1. Why privity creates a structural problem in development

The law of privity of contract is well established: only parties to a contract can enforce it. In construction and development, this creates a predictable structural problem. A building is constructed under a contract between the employer and the contractor. The employer sells or refinances the building. A purchaser discovers defects. The purchaser has no contract with the contractor and cannot sue under the building contract. Absent a collateral warranty or equivalent statutory mechanism, the purchaser may have no effective remedy.

On typical UAE developments there are multiple stakeholders with a legitimate interest in the quality of the works who are not party to the main construction contract: funding institutions that finance the development, forward purchasers who buy the building off-plan or before practical completion, future tenants of commercial space, and subsequent owners in the chain of title. The privity rule means none of these parties can sue the contractor or the design team under the main contract or professional appointments.

2. How collateral warranties work as separate contracts

A collateral warranty is a separate contract between the warrantor — the contractor, subcontractor, architect, engineer, or other consultant — and the beneficiary: typically a funder, purchaser, or tenant. It creates a direct contractual relationship, allowing the beneficiary to sue the warrantor for breach of defined obligations, usually mirroring those owed to the employer under the main contract or professional appointment.

3. Key terms in a collateral warranty

The commercial weight of a collateral warranty sits in a small number of clauses:

4. Risks to warrantors — and how they accumulate

Warrantors face cumulative liability across multiple warranties for the same defect, potentially from several beneficiaries simultaneously. Net contribution clauses mitigate this but are sometimes resisted by beneficiaries insisting on joint and several liability. The obligation to maintain professional indemnity insurance for the duration of the warranty period — which may be 6 or even 12 years from practical completion — creates a significant long-term liability that persists well after the project team has been demobilised.

Contractors who grant warranties containing fitness-for-purpose obligations, rather than reasonable skill and care, may find those warranties uninsurable. Professional indemnity policies typically exclude fitness-for-purpose liability. A warrantor that accepts such an obligation in a warranty but cannot insure it is carrying the full risk on its balance sheet.

5. Mitigation — negotiating warranty terms at procurement

Negotiate warranty terms at procurement stage — not when the beneficiary’s requirements arrive mid-project. Once the main contract is signed without clarity on warranty forms, the warrantor loses commercial leverage and the employer can reasonably argue that any form within industry norms is acceptable.

• Insist on net contribution clauses limiting liability to proportionate share.
• Limit or exclude fitness-for-purpose obligations; confirm the standard is reasonable skill and care.
• Cap the number and identity of beneficiaries who may receive warranties.
• Limit the number of permitted assignments — commonly two.
• Ensure the professional indemnity obligation in the warranty matches what your insurer will provide, including the annual cap and territorial cover.
• Maintain a warranty register with renewal reminders for PI cover.

6. Conclusion

Collateral warranties are a commercial reality of construction and development finance. They create real, enforceable liability and require careful management both pre-signing and throughout the limitation period. The professional approach is to negotiate terms at procurement stage, maintain a warranty register, and ensure that insurance obligations are manageable and adequately covered throughout the full warranty period — which for a long-dated PI obligation may mean two decades of policy management.

Review your warranty exposure

Warranties accumulate across a portfolio quietly. A single audit of warranty obligations and matching PI coverage often reveals exposure gaps that are simple to close.

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