What is a Collateral Contract?

Summarise with: ChatGPT Perplexity Microsoft Copilot

---

Table of Contents

• What is a Collateral Contract?
• Examples of Collateral Contracts
• The Parol Evidence Rule
• Elements of a Collateral Contract
• Consequences for Breaching a Collateral Contract
• Key Takeaways 
• Frequently Asked Questions

As part of your business, you frequently enter contracts with other parties. Therefore, you must be aware of collateral contracts and how they may benefit your commercial arrangement. Conversely, you should know how collateral contracts form so you can avoid unintentionally entering one. This article will discuss the elements of a collateral contract and the consequences of breaching it. 

What is a Collateral Contract?

Generally, a collateral contract can be a verbal statement or a separate written statement to the main contract. Once established, it exists independently of the main contract. Therefore, if the main contract is illegal (and thus unenforceable), the collateral contract can still be valid and enforceable.

Examples of Collateral Contracts

In summary, a collateral contract is essentially a promise that can be enforced but is not a term of the main contract. 

The Parol Evidence Rule

The parol evidence rule states that you cannot use extrinsic evidence to change the terms of a written contract. Extrinsic evidence includes verbal statements or implied agreements you have not written in the original contract. This rule exists to uphold the integrity of a written contract. However, a collateral contract is an exception to this rule. 

Elements of a Collateral Contract

You must demonstrate the following elements are present to prove a collateral contract exists:

• the statement or document must have been promissory; 
• the parties did not intend for the statement or document to be part of the main contract; 
• the statement or document must be consistent with the main contract; 
• you must provide consideration for the promise; and 
• all the elements of a contract must be present. 

To illustrate how the elements of a collateral contract are addressed by the legal system, here are some examples.

Consequences for Breaching a Collateral Contract

Breach of a collateral contract can allow the injured party to seek financial compensation. As such, it is in your business’ interests to avoid unintentionally entering and breaching this agreement. However, the breach will not affect the main contract as it exists independently of the collateral contract.

Directors' Duties Complete Guide

If you are a company director, complying with directors’ duties are core to adhering to corporate governance laws.
This guide will help you understand the directors’ duties that apply to you within the Australian corporate law framework.

Download Now

Key Takeaways 

A collateral contract is a separate contract that builds on the main contract. It may appear verbally or written as a smaller agreement, but does not form one of the terms of the main agreement. You must satisfy the prerequisite elements to demonstrate a collateral contract exists. Furthermore, once established, a collateral contract will exist independently of the main contract.

It is important for business owners to be aware of collateral contracts and how they arise to ensure that they are aware of all rights and obligations they may have.

If you need assistance understanding whether a collateral contract applies to you, our experienced contract lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1800 534 315 or visit our membership page.

Frequently Asked Questions