One of the primary concerns of developers (as well as their tenants, funders and any future purchasers of their developments) is to ensure that, in the absence of a direct contractual relationship with the contractor and professional team engaged on the project, third parties can obtain the protection of direct recourse in the event of a defect arising in design or construction.
For many years, the only option available to third parties was to secure collateral warranties from the contractor and each member of the professional team, but with the introduction of the Contracts (Rights of Third Parties) Act 1999 (the Act) over fifteen years ago, those who were not party to a contract could potentially benefit directly from its terms. This led to hope in the industry that collateral warranties would become redundant as purchasers, tenants, funds and other potential beneficiaries could start to use the Act to benefit directly from the terms of a building contract or professional appointment, rather than needing protection under a separate collateral warranty.
In reality, uptake on the use of the Act was initially very slow as most parties still insisted on the provision of warranties. This seems to be down to a deep-seated resistance to change or unfamiliarity (largely on the part of banks and insurers), rather than any substantive concerns about the protection afforded by the Act.
Increasingly however, we are now seeing acceptance of the third party rights procedure. Some major players in the industry, including some large developers, are insisting on the use of the Act instead of warranties and, in our experience, third party rights are gaining institutional acceptability.
On the owner occupier side, the procedure is also in use - for example we act for a major retailer that generally accepts third party rights in place of warranties. By using the Act, the preparation, issue and chasing of large amounts of documentation can be avoided, and clients' and third parties' positions properly protected from the outset.
Benefits of using the Act
- Time and cost: Since no separate document (i.e. a collateral warranty) is being entered into, using the Act cuts down on the time and cost associated with warranties being drawn up, signed and circulated.
- Certainty: Once the rights to be conferred on third parties are negotiated and agreed by all parties, there is limited room to revisit the wording when protection is required as is often the case when new collateral warranties are circulated for signature.
- Ability of a developer to comply with its primary obligations: Even with the support of a diligent project manager and legal team, a developer will often find itself in the position of having to agree to procure and deliver collateral warranties before they have actually been returned by a contractor or consultant. The risk of the warranties never materialising means the developer faces being in breach of its own undertaking. Under the Act (assuming that the building contract or appointment is already in place), the developer simply issues a notice to a contractor or consultant confirming the identity of the third party upon whom the third party rights are being conferred, thereby retaining control of the process.
- Sub-contractors: The third party rights process can also be extended into sub-contracts, so that (provided the relevant building contract and sub-contract are drafted accordingly) an employer can confer third party rights in relation to work done by sub-contractors unilaterally. Again, this avoids the need to chase large numbers of individual warranties.
Disadvantages of using the Act
- Lack of flexibility: Once the schedule of third party rights being conferred has been agreed, there is limited room for negotiation. While this can be an advantage as it will help to keep costs down, in some circumstances the inflexibility could cause a problem if a specific provision is required for a particular party, such as an incoming tenant or purchaser.
- Enforceability of step-in rights: Concerns have been expressed that the Act does not allow funders or forward purchasers to invoke step-in rights as it does not permit third parties to assume obligations (in particular, the obligation to pay) under an underlying building contract or appointment. The general view is that this argument is misconceived, as the third party rights schedule can be drafted to deal with this. Our experience is that a number of funders, forward purchasers etc will now accept third party rights in place of warranties and those who have not traditionally accepted third party rights are becoming more willing to consider them.
- Need for careful drafting: Recent cases have shown the importance of drafting provisions relating to the enforcement of third party rights very clearly to ensure that all the necessary rights are conferred on the third party, for example the right to commence adjudication proceedings if this is required.
While the protection of third party rights offered under the Act may address the same issues as collateral warranties, the use of third party rights in appropriate circumstances will have a clear strategic benefit, avoiding for example, the developer being responsible for ensuring compliance with primary obligations (the provision of warranties) to its tenants, funders or purchasers.
Collateral warranties of course afford a more tailored approach but will always be costly and time consuming to procure. The provision of rights under the Act gives more certainty in terms of what has been agreed and control as to when the benefit will become available. Although it is not entirely clear how favourably or otherwise courts will look on particular bespoke clauses should a dispute arise, given the support that use of third party rights is now receiving in the market, it may be difficult for the courts not to stand behind a properly drafted third party rights clause.
One of the most notable changes in the more recent JCT building contract documents is the provision (in some forms at least) allowing third party rights to be used as an alternative to collateral warranties. While collateral warranties are still widely used to secure the interests of third parties with an interest in a development, the ongoing use of the Act in some of the JCT documents certainly marks a clear change in the attitude of the industry towards third party rights.