Resolving Warranty and Guaranty Confusion in Construction
The most confusion I have seen in the discussion of construction topics concerns the concepts of “warranty” and “guaranty.”
This article will address the confusion, explain the important distinctions between these two concepts, and describe how to effectively administer and enforce warranty and guaranty provisions in construction contracts.
In a typical construction contract warranty provision, the contractor warrants, represents or covenants, that its work will be performed in accordance with certain standards stated in the contract (e.g., in “a good and workmanlike manner”) and otherwise be free of defects and in conformity with the design documents. While the terms "warranty" or "warrants" are often used in connection with this concept, they really pertain to any provision in the contract — whether a representation or a covenant — that prescribes a standard of performance governing the contractor’s work.
The remedy for breach of warranty is the recovery of monetary damages incurred by the other party (e.g., the project owner or general contractor) by reason of the breach. So, for example, if defective materials need to be repaired or replaced by the owner, the owner is entitled to recover from the contractor the cost of the repairs or replacement.
The duration of the warranty will sometimes be designated in the contract or design specifications, but if it is not, the statute of limitations period for contract breaches will constitute the time frame for enforcement (in New York, for example, the period is six years from the accrual of the cause of action).
A typical guaranty (or guarantee) provision becomes operative after completion of the contractor’s work. It requires the contractor to return to the project site to repair or replace defective or nonconforming materials or equipment, or remedy improper workmanship, at the contractor's own cost and expense.
The contract, or design specification, containing this obligation generally provides for an expiration date or period beyond which the guaranty is no longer enforceable. The design specifications may contain certain guaranty time periods that are longer than the time period provided for in the contract, so it is important to state in the contract that the longer period prevails.
It's possible that the term “guaranty” is not be used to characterize this obligation, and often the word “warranty” is used, which can generate confusion because of the different remedies available under a true guaranty and a true warranty.
The confusion surrounding the different concepts of warranty and guaranty can create the following problems in drafting or enforcing the construction contract.
As stated earlier, “warranty” may be used when, in fact, the so-called warranty is really a guaranty.
For example, the contract may state that the contractor “warrants that the materials will be free from defects and that the contractor will repair or replace any defective materials within two (2) years after completion of the work.” The first part of this provision is a true warranty, but the second part is really a guaranty.
By conflating these two concepts in one sentence, the drafter has created uncertainty as to the time period for enforcement of the true warranty — is it two years or the statute of limitations period for breach of contract? If the first part of the sentence were segregated from the second part, into two different provisions, as shown below, there is no doubt that the enforcement period for the warranty remedy (i.e., recovery of damages) is the statute of limitations period:
The contractor warrants that the materials will be free from defects.
If any materials are found to be defective within two years after completion of the work, the contractor will repair or replace said materials.
The term guaranty may be used, mistakenly, instead of the term warrant, which can result in a contractor guaranteeing that the work will be performed in a good and workmanlike manner and otherwise be free of defects and in conformity with the design documents.
That might be fine by itself, but because the drafter was thinking that the provision operated as a warranty, important guaranty elements may have been omitted (such as, the obligation to commence repairs within a designated time frame and prosecute the repairs to completion, and the obligation to replace inherently defective materials).
On the other hand, the terms warrant or represent may be used instead of guaranty or other covenantal language, which may limit the owner’s remedy to the recovery of damages for breach of the warranty or representation, whereas the owner may have thought that it could require the contractor to return to the site and correct the defective work.
Enforcement of Warranties and Guaranties
The other party to the construction contract is entitled to enforce the contractor’s guaranty or warranty, as well as any other party who is named as a beneficiary of the guaranty or warranty provisions (e.g., the owner if the contract is with a subcontractor) or to whom the contract (or separate guaranty or warranty document) has been assigned.
When assessing the contractor’s responsibilities, the enforcing party should make sure it reviews any warranties or guaranties contained in the design specifications, in addition to those set forth in the contract.
It is also important to note that if the warranty breach is discovered during the guaranty period, the breaching party should be given the opportunity to remedy the defective work; otherwise, that party may have a defense to a damage claim under the warranty provision (at least to the amount of damages sought), arguing that it could have mitigated the damages if it had corrected the defect itself. After the guaranty period has expired, there is no obligation to afford the breaching party the right to repair the work itself, but there may be business or practical reasons to do so.
The owner is, of course, the direct beneficiary under the guaranty and warranty provisions in the prime contract (i.e., the agreement with the general contractor, or GC, or construction manager, or CM) and the prime contract should require that the owner be named a third-party beneficiary under the guaranties and warranties provided by each subcontractor (whether in its subcontract or a separate warranty/guaranty document). The owner should have the option of enforcing its rights against the general contractor/construction manager or the subcontractors.
If the owner elects to take action directly against a subcontractor while its warranty or guaranty rights against the general contractor have not yet lapsed, it would be advisable to involve the general contractor in the process in order to preserve its warranty and/or guaranty claims against the GC/CM. In fact, the prime contract should provide that the GC/CM must, at the owner’s discretion, either enforce the warranties or guaranties against the subcontractors or assist the owner in its prosecution of the warranties or guaranties.
Even though the owner will have recourse against the GC, it is important for the following reasons that the owner ensure that the warranty and guaranty benefits it expected to receive from the subcontractors are actually memorialized and the documents granting such benefits are secured by the owner for its files:
The warranty or guaranty periods in the prime contract may be shorter than the periods afforded by a particular subcontractor.
If the GC/CM becomes bankrupt or otherwise ceases operations, the only recourse available to the owner may be against a subcontractor.
There may be an independent business relationship between the owner and the GC/CM, making it inadvisable for the owner to seek recourse against the GC/CM.
It is essential that owners, contractors and their lawyers understand the key distinctions between warranties and guaranties, and are mindful of these distinctions in drafting and enforcing the prime contract or subcontract.
“Resolving Warranty and Guaranty Confusion in Construction,” by Michael Scheffler was published in Law360 on November 14, 2019.