How to enforce collateral warranties

Q: I have asked my contractor to provide a collateral warranty to the bank that is funding my project. However, the contractor is refusing, insisting that this is an extra cost that I must pay. The contract specifies that the contractor has to do so, and if it does not then I can withhold payment. Can I refuse to pay the contractor until it provides the warranty? Is there anything else I can do to force it to do so?

A: It is not uncommon to see main contractors trying to avoid providing collateral warranties. That is because it generally costs them financially to put a warranty in place, for example if they instruct external solicitors to prepare and negotiate the terms on their behalf. It will also extend contractors' exposure to liability.

Nevertheless, warranties are a key part of the contractual framework, giving recipients the right to take direct action against contractors. Such recipients are typically interested third parties such as funders or asset owners, who would not otherwise have a direct contractual relationship with contractors.

Enforcing contractual provisions when one party does not comply represents an unwelcome burden on a project. It is important to understand your rights – as well as the other party's – to ensure contractual obligations are fulfilled in an efficient and cost-effective way.

In your case you have the opportunity to withhold payment, which is often sufficient to ensure compliance. However, the main contractor may argue that withholding money amounts to economic duress and could push it towards insolvency.

Clearly, whether you enforce your contractual right is a commercial decision for you and the employer. The law, however, seems to be leaning in your favour. The Supreme Court recently resisted the opportunity to widen the application of what is referred to as lawful act duress.

Times Travel had tried to argue that its agreement to waive payments and accept a potentially invalid termination notice was as a result of improper pressure applied by the airline corporation, relying on 'lawful act duress'. This is a relatively obscure variant of the doctrine of duress.

In circumstances where a party, despite acting lawfully, still exerts so much pressure in an improper – or as the court said in this case, 'illegitimate' – way, this can amount to duress and the other party can claim relief from the bargain.

The court outlined three essential elements of lawful act duress. First, there must be an improper or illegitimate threat or application of pressure. Second, the threat or pressure must cause the other party to do something; for example, enter into a contract or waive a valid claim. Third, the party must have no reasonable alternative but to give in to the threat or pressure.

The Supreme Court concluded that lawful act duress has limited application in English law. Unlike the US for example, we have no general principle of good faith in contracting or doctrine of imbalance of bargaining power.

The judgment suggested that if the parties had been bound by a duty of good faith or their respective bargaining power had been a material consideration, this may have tipped the scales towards lawful act duress. The improper pressure applied by the airline corporation would then have been even more at odds with the accepted, legitimate behaviour of a party to a contract. In any event, it was felt that wider use of lawful act duress would create too much uncertainty in the field of commercial negotiations.

Applying this to your first question, it seems that withholding payment would be unlikely to amount to lawful act duress in light of the Pakistan International judgment. You would simply be enforcing your rights under the contract. What is more, these are rights that are generally adopted by the industry's main standard-form contracts, and accepted as a proportionate response to non-provision of a warranty.

As to the second question, withholding payment in itself may not do the trick. Parties often reach a stalemate where the contractor resists its warranty obligation and challenges the withheld payment.

Hewavisenti and another v Wickramsinghe and another [2021] EWHC 2045 (Ch) provides a useful reminder of the test for specific performance. Here, the court had to decide whether to grant an order for specific performance that would compel Wickramsinghe to comply with the terms of a settlement agreement by assigning its interest in certain properties and cooperating in the sale of others.

The defendant argued that the order for specific performance was an exceptional remedy. While the court will always be guided by the specific facts of the case, with the primary objective of administering justice, it held in this case that damages would not be an effective remedy. Only specific performance would enable proper implementation of the settlement agreement, it concluded.

Returning to your second question, if withholding payment does not achieve the desired outcome, the decision in Hewavisenti reminds us that specific performance may offer the solution you require. Certainly it is an often overlooked yet effective remedy where a party is unjustly refusing to comply with its obligations under a contract.

David Greenwood is a senior associate at Pinsent Masons
Contact David: Email

Naveed Hanif is a solicitor at Pinsent Masons
Contact Naveed: Email

Related competencies include: Contract administration, Contract practice