Provision of collateral warranties to third parties (including funders and other beneficiaries) has long been a feature of projects including stadium developments. 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 to drawdown.

The direct alternative to preparing and executing separate collateral warranty documents is by 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 some 7 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 by parties in development projects, particularly banks providing finance and contractors and consultants and their professional indemnity insurers;
  • lack of use of the Act by various bodies that produce standard form contracts;
  • lack of confidence regarding 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 this is required.

Many of the above factors have been resolved over time. Within the last 2 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 properly executed;
  • banks, in particular, have now become comfortable with step-in rights in third party rights schedules;
  • sensible consideration should be given to the requirements for third party rights from sub-contractors; where required the obligation to procure such rights can be imposed on the principal contractor and then contained in the subcontract.

How does the imposition of third party rights work?

Under the Act a person who is not a party to a contract may enforce a term of the contract if the contract expressly provides that he may or if a term of the contract purports to confer a benefit on him. In this context we are concerned with the imposition of express provisions. The simplest way to use the provisions of the Act is to include in the contract a third party rights schedule clearly setting out the rights to be given to one or more third parties. Those parties do not need to be individually specified, they can be specified as classes of beneficiaries and it is not necessary for them to be in existence at the time the contract is made. This allows the use of the provisions of the Act in respect of individual beneficiaries unknown at the time of the contract.

Some issues to be aware of

The third party’s right of enforcement is subject to the contract’s terms and conditions and it open to the parties to limit or place conditions on the third party’s rights. Care needs to be taken in the drafting of the third party rights schedule to ensure the rights given are appropriate and are appropriately limited to reflect the requirements and real intentions of the parties. For example, the application of specific limitations of liability and availability of defences and set-offs under the contract and the ability to assign the third party rights all need close attention.

For the attainment of certainty and clarity provision can be made for the giving of notices to the party giving the rights of the identities ofspecific third parties once they become known and making the rights effective only on the giving of appropriate notices.

The position and ability of the parties to the contract to amend the terms of the contract or make variations to the works required under the contract without the consent of the relevant third party must be made clear both before and after the time that the relevant third party’s rights take effect.

Care needs to be taken over the inclusion of ‘step-in’ rights in the third party rights schedule and the need for the third party to give written notices to bind that party, for example, to payment obligations under the contract.

Where third party rights are to be imposed on a subcontractor, an obligation to procure those rights will need to be imposed on the principal contractor under that contract and an appropriate third party rights schedule specified. To be effective the rights must in fact be included in the relevant subcontract and that subcontract executed by the parties. There is inevitably some uncertainty inherent in this arrangement, but in reality it is no greater than under an arrangement whereby an obligation to procure a form of collateral warranty from a subcontractor is imposed on the principal contractor. Equally, the provision of the collateral warranty by a subcontractor is of very limited value without provision also of the relevant executed subcontract. Proper consideration should always be given at the outset as to whether subcontractor warranties are really required and worth the effort and if so from which subcontractors.

Advantages of using third party rights under the Act

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).

So is this the end of collateral warranty documents? The Act will be used more frequently. We are seeing this happen and we would certainly encourage our clients to make use of the provisions of the Act. The use of collateral warranty documents is still alive but we expect will and should diminish.