The third article in our guide to collateral warranties looks at how a beneficiary “steps in” to a scheme, and what to do with licences for design copyright.

Step-in rights

These provisions appear particularly in collateral warranties entered into with funders and freehold purchasers. They are intended to enable the beneficiary to take over the contract with the contractor (or professional adviser or subcontractor) if the contractor has a right to terminate that contract or if the beneficiary’s own contract has been breached. So, if the beneficiary is a bank, it may wish to step in if the borrower has breached the terms of the loan agreement.

Technically, step in has to take place by novation of the contract to the beneficiary, and many clauses are expressed in this way – if not, they may be difficult to enforce. The effect of novation is that the beneficiary becomes a party to the contract in place of the employer or client.

The main ingredients of a step-in provision are:

  • a requirement that the contractor give notice to the beneficiary if the contractor has the right to terminate its contract

  • a right for the beneficiary to give counter-notice to the contractor requiring it to carry on working for the beneficiary

  • a right for the beneficiary to give notice to the contractor requiring it to work for the beneficiary in place of the employer or the client (to cover the employer’s or client’s breach of its own contract with the beneficiary)

  • an obligation on the beneficiary, if notice is given to the contractor, to become responsible for sums payable to the contractor

    • The most important factor is the length of the contractor’s notice period, during which it will incur costs that will not be reimbursed if the beneficiary does not step in

  • a right for the beneficiary to require that the contract be novated to a third party instead of itself, but the warranty will usually require the beneficiary to guarantee any third party.

If the clause follows the provisions set out above, the most important factor will be the length of the notice period that the contractor has to give. The contractor has to continue working during the notice period, incurring costs that will not be reimbursed if the beneficiary decides not to step in. The beneficiary will require sufficient time to consider whether to step in and to consider what other arrangements to make, for example, to sell the development and require the contract to be novated to the purchaser.

Copyright licence

The beneficiary may want to step in and complete a development or bring claims against the contractor for defects in the development.

In either case, the beneficiary will need to use the design information prepared for the contractor.

It is a convention that collateral warranties contain an irrevocable royalty-free copyright licence in favour of the beneficiary enabling it to use and reproduce all such design information.

It is customary to limit rights to purposes related to the development, and to include a provision that the contractor will have no liability for use of the designs for any purpose other than those for which they were intended – although, in my view, this is unnecessary, because the contractor cannot be liable for more than it undertook to perform.

Although it is argued that a copyright licence contains an implied right to call for copies of the drawings and other documents, I do not agree, mainly because the ownership of the physical drawings and documents may be separated from the ownership of the copyright. Consequently, I think it essential to include a provision that the contractor shall provide copies of the drawings and other documents.

Postscript

Neil White is head of the construction and engineering group at Taylor Joynson Garrett.