Provision of collateral warranties to third parties (including funders, purchasers and tenants) has long been a feature of development projects. On larger projects this can result in a huge number of separate collateral warranty documents having to be prepared and executed. This can be time consuming and sometimes causes problems with funding drawdowns where, for example, provision of certain collateral warranties is a condition precedent.

The direct alternative to preparing and executing separate collateral warranty documents is providing rights to third parties in the principal contract through the use of the Contracts (Rights of Third Parties) Act 1999 (“Act”). Although the Act has been in force for seven years it is only relatively recently that wider and more frequent use of the provisions of the Act has been experienced in development projects.

The slow take up has been due to a number of factors including:

  • resistance to change, particularly by some banks involved in providing finance;
  • various drafting bodies taking their time to include them in standard form contracts;
  • lack of confidence about enforcement;
  • uncertainty on how to deal with ‘step-in’ rights;
  • lack of confidence in dealing with the imposition of third party rights on sub-contractors, where required.

Many of the above factors have been resolved over time. Within the last two years:

  • key participants in development projects have become far more comfortable with the formulation and use of third party rights schedules;
  • third party rights schedules were included as an option under the revised suite of JCT standard form contracts that were first published in the latter half of 2005;
  • enforceability is not an issue provided the rights are properly drafted and, of course, the principal contract (containing the third party rights) is executed by the parties;
  • many banks have now become comfortable with step-in rights in third party rights schedules;
  • where third party rights are required from sub-contractors the obligation to procure them can be imposed on the principal contractor and then contained in the subcontract.

Some advantages of using third party rights under the Act

  • It reduces the number of documents to be prepared and executed and therefore time and cost;
  • Only one contract document is needed to contain all the relevant rights instead of the principal contract and the relevant collateral warranty which can easily become separated over the years and difficult to find;
  • Once the relevant contract is executed the third party rights are effective (subject to any specific terms in the third party rights schedule, e.g., written notices).

We believe that the Act will be used more frequently in the future and we would certainly encourage our clients to make use of the provisions of the Act. It will be some time before we can say that collateral warranties are a thing of the past but we expect that their use will and should diminish.