What Is a Collateral Agreement in Contract Law? Explained

88% of contractual disputes are due to ambiguous terms or oral contracts entered into outside the primary contract. This is to say that a mere word of mouth promise or an email guarantee can result in costly legal wars if not managed appropriately. 

Contracts are supposed to be clear, but what then of promises that are made outside of them? 

Collateral agreements can complete gaps, make intentions clear, and even trump certain contract provisions, but only if they satisfy particular legal conditions. 

If a collateral agreement is not well documented, it can be hard to enforce. 

Courts look at things such as intent, clarity, and consistency with the primary contract before deeming it legally binding. 

In this blog, we will demystify what collateral agreements are, how they function, and the best practices for handling them so you can make sure your side promises do not turn into side problems. 

Key Takeaways 

• A collateral promise is an ancillary promise that may be legally enforceable, even if it's not in the original contract. 

• These promises may be oral or written, but being in writing makes them far easier to enforce. 

• In certain situations, a collateral agreement will be able to trump aspects of a written contract, due to contract law exceptions. 

• Having a contract management system in place (such as on Microsoft 365) can assist with managing side agreements, minimize misunderstandings, and lower legal risk. 

Understanding Collateral Agreements in Contract Law 

A collateral agreement is a legally enforceable promise that is separate from a primary contract. 

Imagine it as an aside agreement that creates a secondary level of obligation between parties. 

What Constitutes a Collateral Agreement as Legally Binding? 

In order for a collateral agreement to hold up in court, it must fulfill three essential requirements: 

• A Clear Promise – One side has to be making a clear promise, not an opinion or vague remark. 

• Intent to Create Legal Relations – Both sides need to have taken the promise seriously with the expectation that it will be legally binding. A throwaway comment won't do. 

• Consideration (Something of Value) – There must be some exchange of value, even if it's indirectly linked to the primary contract. 

How Is It Different from the Main Contract? 

• An agreement of collateral is independent – it's separate from the overall contract, yet related. 

• It can remain effective even if the overall contract turns out to be void. As an example, if a sale contract of a car collapses but the dealer has made an autonomous undertaking to undertake free servicing, the undertaking will still be binding. 

• Companies and individuals commonly employ collateral agreements to obtain additional guarantees that are not part of the primary agreement. 

Collateral Agreement Types and Where They Are Applied 

Collateral agreements are of great importance in numerous industries and tend to determine some of the most important deal terms and commitments. 

Below are some of the best-known areas where they occur: 

1. Real Estate

Collateral contracts are also common in property transactions, typically in the form of extra promises given outside the primary agreement. 

These might involve guarantees regarding repairs to property, future improvements, or specific lease terms. 

Verbal promises might be the norm but proving them can be tricky without paper trails. 

To prevent misunderstandings, it's always best to have such contracts clearly documented. 

2. Business and Commercial Contracts

In commercial transactions, side agreements may influence prices, delivery times, or guarantee of performance. 

Businesses tend to use these implicit promises to obtain more favorable conditions or other favors. 

Disagreements can emerge, though, if such promises are not formally recorded along with the master agreement. 

A methodical approach to monitoring and saving these promises is necessary to keep everyone accountable and reduce risks. 

3. Employment Agreements

Both employees and employers enter into side contracts for bonuses, benefits, or future promotions. 

Although these undertakings may not be explicitly stated in the employment contract, they are nevertheless legally binding if documented appropriately. 

Having a clear record of any other terms avoids future disputes. 

Common Risks and Challenges with Collateral Agreements 

Collateral agreements are helpful but present their own risks. 

If not managed well, they can cause confusion, disagreement, or even litigation. 

The following are some common risks and challenges and how to deal with them. 

Conflicts with the Main Contract 

One of the greatest problems with collateral promises is when they conflict with the primary contract. 

Suppose a supplier contracts to supply products in 30 days but promises verbally to ship within 15 days. 

In the event of a dispute, courts will hold by the written agreement and thus the side promise will be difficult to enforce. 

How to Avoid This: Make sure that the collateral agreement complements, and does not contradict, the fundamental contract. If at all possible, add a clause to the fundamental contract referencing the side agreement. 

Lack of Documentation 

Oral promises may be convenient in the here and now, but later, it may be a nightmare to establish. If an employer makes a verbal promise of a year-end bonus but fails to put it in writing, it may be a hard sell to enforce that promise. 

How to Avoid This: Always record collateral agreements. A quick email verifying the promise can be used as proof. Even better, utilize a contract management system (CMS) to keep and monitor all agreements in one location. 

Disputes Over Terms 

Ambiguous language in a collateral agreement can lead to confusion. Picture a construction firm promises to work with "premium materials," but the contract is silent as to what that entails. Later on, the client may contend they thought it would be high-end brands, but the firm believes they utilized good-quality generic products. 

How to Avoid This: Be clear. Define your terms and agree on the terminology with the other party. Use a contract lifecycle management (CLM) solution to monitor agreements, keep versions current, and avoid ambiguity. 

Collateral Agreements vs. Collateral Warranties 

Collateral agreements and collateral warranties are two terms that sound the same but have different meanings. 

A collateral agreement is an independent promise that runs parallel to the primary contract, usually affecting the manner in which the contract is performed. 

A collateral warranty, however, is a particular form of guarantee, typically in construction or property, that guarantees a party performs according to certain standards or requirements. 

Though both involve third parties, warranties are generally more concerned with quality control while agreements are more concerned with additional obligations. 

Role in Third-Party Relationships 

Collateral agreements have the power to form legal obligations over parties who are not directly covered under the general contract. 

Oftentimes, these agreements function as exceptions to the general principle that only parties who sign the contract are subject to it. 

This can come in handy where there are sophisticated business transactions that involve several different stakeholders who all depend on a certain commitment in order to keep things going. 

How Contract Management Software Simplifies Tracking Collateral Agreements 

Collateral agreements can be simple to miss until they are an issue. 

Side promises tend to live independently of the master contract, which means they are more difficult to keep track of. 

Without good management, you may overlook important obligations, find yourself in conflict, or even in legal trouble. 

The good news is that contract management software (CMS) simplifies the entire process. 

Keep Everything in One Place 

Ever had to dig through emails or old documents to find a side agreement? With CMS, all agreements, main and collateral, reside together in a secure, searchable folder. No more frantic searches to validate what was promised. 

Stay on Top of Changes with Version Control 

Collateral agreements usually get revised over time, but tracking those changes is a hassle. A quality CMS tracks each edit, and it indicates who made the changes and when. That way, there's never any question whose version is the final one. 

Create an Indestructible Audit Trail 

Most collateral agreements begin with a casual email or oral commitment. But how do you show that they're real? A CMS maintains an exhaustive record of approvals, e-signatures, and contract changes, so you have the proof you need when you need it. 

Never Miss a Commitment with Automated Alerts 

Collateral agreements may fall through the cracks if they are not included in the primary contract. Automated reminders from CMS prior to obligation due dates ensure you remain compliant and out of trouble with the law. 

Integration with Microsoft 365 

If you use Microsoft 365, a CMS based on it makes contract management a breeze: 

• SharePoint stores contracts and side agreements safely in one location. 

• Teams makes it simple for business and legal teams to work together. 

• Power Automate automates contract approvals and reminds you of deadlines. 

Collateral agreements don't need to be a headache. The proper contract management software tracks, documents, and enforces every agreement, so you can focus on what matters most. 

Final Thoughts 

Collateral agreements can appear to be side agreements, but they can significantly affect contract obligations. 

Whether in writing or oral, monitoring these obligations is important to prevent disputes and maintain compliance. 

How best to manage them? A contract management system that consolidates agreements, monitors changes, and reminds when obligations are due. 

With Dock 365, built on Microsoft 365, you can streamline contract tracking and never let an agreement fall through the cracks. 

Try a free demo today and see how simple it is to manage contracts with total visibility and control. 

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