Are you missing a trick?

The Contracts Act came into force seven years ago but in most construction documents it is only mentioned in order to be expressly excluded. But the Act has real benefits for certain types of project, so it’s worth a second look.

The Act allowed those who were not party to a contract to benefit directly from its terms for the first time. This led some to hope that collateral warranties would become redundant. The idea was that purchasers, tenants and other potential beneficiaries could start to use the Act to benefit directly from the terms of a building contract, subcontract or professional appointment. This would neatly eliminate the need for protection under an entirely separate document.

However, in the immediate aftermath of its introduction, the only reference to the act in most construction documents was when its application was being excluded. Professional indemnity insurers widely advised that policies would not cover claims made by those who professed to be relying on the Act. Far from heralding the end of the collateral warranty, the reaction to the Act seemed to entrench the need for such documents further into the collective consciousness of the construction industry.

This has led inevitably to discussion as to the difference in the protection offered by a collateral warranty as against that offered by the Contracts (Rights of Third Parties) Act, to give it its full name. It has been asked whether one or the other is to be preferred either by developers or by potential beneficiaries. Some developers have abandoned collateral warranties entirely, adopting third party rights on a “take it or leave it” basis; others like to stick with what they know.

Benefits of using the Act

Some developers have abandoned collateral warranties, adopting third party rights on a ‘take it or leave it’ basis; others like to stick with what they know

Since no separate document is being entered into, using the Act cuts down on the paper chase and cost associated with collateral warranties being drawn up, signed and circulated.

Once the rights to be conferred on third parties are negotiated and agreed with the contractor or consultant, there is limited room for the consultant or contractor to revisit the wording when protection is required. This helps when rights are being conferred several years after the initial documents were agreed. This is because it precludes the possibility of opening up the terms of agreements reached previously with contractors or consultants, who no longer have a meaningful ongoing interest in a development and who therefore have less incentive to offer the level of protection previously on offer.

Without the Act, a developer will often be in the position of having to agree to undertake the procurement of collateral warranties before they have actually been returned to him by a contractor or consultant. As such, the risk of the warranties never materialising – as can often be the case in the construction industry – lies with the developer and he faces being in breach of his own undertakings.

Under the Act, assuming that the building contract or appointment is already in place, the developer simply has to issue a notice to the contractor or consultant confirming the identity of a new tenant or purchaser.

Disadvantages of using the Act

Using the Act cuts down on the paper chase and cost associated with collateral warranties being drawn up, signed and circulated

Relying on the Act is not tried and tested in the courts, unlike collateral warranties. Therefore some beneficiaries may not want to take the risk of being subject to a test case.

If used without caution, conferring a benefit using the Act could mean that any changes to the underlying appointment and/or building contract would have to be negotiated with individual beneficiaries. However, these restrictions are often already included in leases, funding or sale agreements.

Once the schedule of rights has been agreed there is limited room for negotiation. While from a developer’s perspective this could be seen as an advantage as it will help to keep costs down, the inflexibility could cause a problem if a particular party has a specific requirement. As well as having to agree a change with the consultant or contractor, the other third parties who have been granted rights may also need to consent to the change.

The process for dealing with step-in rights can be unwieldy and there is some doubt as to whether these are effective if not in a separate, stand-alone document.

While the protection offered under the Act may address the same concerns as a collateral warranty would do, the real benefits or disadvantages in using the Act are more strategic than substantive. Collateral warranties will give you flexibility and a more tailored approach but will always be costly and time consuming to procure.

The Act brings you certainty over what has been agreed and control as to when the benefit will become available

The Act brings you certainty over what has been agreed and control as to when the benefit will become available. However, it is not yet known how favourably or otherwise courts will look upon it, should a dispute arise.

Changed attitude

Last year the new JCT suite of documents was published, and one of the most notable changes from previous versions was the provision, in some new forms, allowing third party rights to be used as an alternative to collateral warranties.

While collateral warranties are still more often used to look after third parties with an interest in a development, the use of the Act in JCT documents marks a change in the attitude of the industry towards third party rights.

Given the various reasons for either using or not using the Act, it should perhaps be viewed as a preferable alternative to the collateral warranty, to be used when speed and certainty are the prime considerations. It should not, however, be an excuse for a blanket refusal to use collateral warranties in circumstances where clearly they are more suitable.