Legal brief: Third party rights

Traditionally, third parties on construction projects, such as occupiers, purchasers and financiers, have looked to collateral warranties for construction security. The desks of contractors and consultants creak under the strain of the collateral warranties needed for each project. Do we need all these collateral warranties?

The answer is yes and no. But mostly no.

Collateral warranties are still seen by some as the safest way for a party to protect its interest in a construction project. A tenant, for example, is unlikely to have a contractual relationship with any of the construction team if the works in question were commissioned by the landlord. Should a defect to the property arise due to the way the works have been carried out and the tenant suffer loss, the likelihood of it being able to recover against the construction team is remote.

They thus provide a contractual relationship which would otherwise be absent between construction team members and a beneficiary. They work and they’re effective. But for over a decade, legislation has provided project participants with the same protection but without the time, cost or paperwork through the Contracts (Rights of Third Parties) Act 1999.

The Act allows a named or identified class of beneficiary (for example, commercial tenants) to enforce certain clauses of a contract to which the beneficiary is not party if the contract permits it.

So why are there still so many collateral warranties being produced when we can all use third party rights?

One argument often cited by holdouts is that funders are reluctant to use third party rights because they aren’t sure that step-in rights work under the act. However, these concerns can be addressed by careful drafting in the underlying contract. Another (less convincing) contention is that the legislation hasn’t been tested in the courts. This is not strictly correct - it has been upheld in shipping cases before and, in any case, the legislation is clearly-worded. A more dubious (and genuine) argument is that “it’s always nice to get a signature”. But then there are so many collateral warranties to sign, especially if the project in question has multiple beneficiaries, such as a large new shopping centre or a commercial skyscraper. If there’s a better way, why are we not using it?

Drafted wisely and used appropriately, third party rights can provide the security that third parties need but without the time, cost and pain associated with collateral warranties.

Kathryn Noble is an associate at Olswang