There are often complex contracting arrangements in the construction industry and sometimes the need arises to circumvent ‘privity of contract’ to enable third parties to rely upon rights they are not prima facie entitled to.
Collateral warranties are the accepted norm, but can mean extra cost and time, which can in turn hold up property deals.
The Contract (Rights of Third Parties) Act 1999 (“the Act”) provides the right for third parties to obtain benefits under contracts entered into by other contracting parties. It is therefore possible to negate the need for collateral warranties by applying the Act in the main contract.
Why has uptake of use of the Act been so limited? Old notions of, ‘if it ain’t broke, don’t fix it’, and, ‘change for the sake of change’, persist and it is clear that any alternative to collateral warranties needs to provide the same protection at a tangible cost saving. There is plenty of research to suggest that the perceived certainty and ‘tried and tested’ nature of collateral warranties seems to outweigh the potential time and cost saving in using the Act.
- Separate contracts between parties in a project (can include funders/future users). Main contractor obligations dealt with under the main contract and other members of the team i.e. consultants/subbies etc. are ‘collateral’ to the primary contract. Collateral warranties mirror the responsibilities of underlying contract and, as such, can be just as effective.
- In some circumstances, collateral warranties can be construed as ‘construction contracts’ (and, therefore, can be referred to adjudication). The Act may need reconsideration, as the standard JCT wording suggests use of the Act would not qualify. However, if the main contract expressly contains the right to adjudicate, some experts suggest it would also be possible for third parties to exercise this right.
- Need to be sensible as to whom collateral warranties are required from; it’s not always necessary to require them from all parties (depends on the value of the particular contract and the extent of design responsibility).
- Although commonplace, collateral warranties have not been regularly tested in the courts. Consequently, they are not fully reliable and some clauses are yet to be 100% understood. Some go as far as to say that collateral warranties’ value in a well-structured security package are worth less than the cost and effort in obtaining them, although step-in rights can be critically important.
- Well understood by the industry, so using standard format keeps costs and time at a minimum. The administrative exercise can be great, though, on the main contractor and lawyers alike, and signatures are often not a priority for consultants and subcontractors.
Contract (Rights of Third Parties) Act 1999
- Third parties may enforce a term in the main contract if it purports to confer a benefit upon them.
- There is obvious saving in reducing the number of collateral warranties, although it is rarely the funding bodies requesting the collateral warranties that bear the cost. As it makes no difference to them, funders tend to want the tried and tested and can accordingly set the form of protection they require.
- The Act maintains consistency of rights i.e. with the main contractor and with other third parties.
- Added complication of ‘rights schedules’ for each category of beneficiary (e.g. purchaser / tenant / funder), each with their own levels of rights. The need to obtain warranties from consultants would still exist and for some subcontractors?
- The main criticism centres on (the lack of) step-in rights for funders. Although the Act can confer the benefits of contractual terms by allowing third parties to step-in, it cannot address step-in provisions which set out obligations on the funder regarding payment as it would be stipulated in the main contract. This can be overcome by careful drafting and executing any step-in undertakings as a deed, as these would be enforceable without consideration.
- Assignment is another perceived weakness of the Act as it does not deal directly with it. This can also be overcome by careful drafting, defining third parties clearly to include all assignees.
- Also, variations. The main contracting parties may need the consent of third parties before doing so, once executed. Some experts state the Act does allow for this – changes to the application of s.2 by including provisions to do so within the contract itself.
- That said, use of the Act is becoming more commonplace, especially with large developers and insurance brokers who tend to be more comfortable with how the rights operate.
The Act is not being used to the degree that commentators suggested and, until there is increased use across the industry and “buy in” from all the parties who require the rights and those providing the rights to use the Act, then the established process of providing collateral warranties is likely to continue.