Third-party rights have failed to dispose of collateral warranties. But maybe they could still do so – and eliminate the hated net contribution clause into the bargain

It was trumpeted from the rooftops that the Contracts (Rights of Third Parties) Act 1999 could do away with the need for collateral warranties. But here’s an even more radical thought. Might it also do away with the need for the highly unpopular net contribution clause?

The collateral warranties nightmare

First, a brief reminder of the background. A wrongdoer can be sued for 100% of any damage it causes jointly with another, even if it is individually culpable for, say, 10%. Looking at this in the context of warranties, the contractors and consultants who grant them feel that that’s just not cricket.

However, where all consultants and contractors involved have dutifully granted warranties to the usual recipients – purchasers, tenants and financiers – then any of those consultants or contractors that is sued on its warranty can happily claim a contribution from any other jointly liable consultant or contractor. The fact they are all individually in contract with the claimant enables this.

Hence it is sometimes proposed as a precondition to the validity of any warranty that all others involved in the project will (when the time for sale, let or financing comes) also grant warranties to the same beneficiary. However, this does not tend to be of great appeal to the beneficiary, who fears that if just one warranty cannot be obtained for any reason (often years down the line), then all the other warranties can come tumbling down like a house of cards.

The maligned net contribution clause

Instead, a net contribution clause in a warranty works better. This has the effect of making any culpable party liable for only its own share of the blame and no more. And that must surely be fair. Nonetheless, net contribution clauses in warranties are far from popular with those most commonly on the receiving end: purchasers, tenants and financiers.

Personally, I think net contribution is a sadly misunderstood sheep in wolf’s clothing. However, I must acknowledge that it sounds suspiciously like an elaborate legal stitch up. However, the beneficiaries have an even worse time when they try to make sense of the complex and lengthy legal mumbo-jumbo commonly drafted into warranties in order to establish the principle. Small wonder net contribution clauses arouse suspicions. So, all too often, the sadly misunderstood sheep turns into a sacrificial lamb at negotiation stage.

A third way: Third Party Rights

It struck me that perhaps there is, after all, an alternative that would be more palatable to all concerned. And this is where the third-party rights act comes in.

Each and every consultant and contractor confirms in its contract with the client that it is granting third-party rights under the act in favour of purchasers, tenants and financiers. This enables beneficiaries to claim directly against each of them in respect of its faulty work under its contract with the client. And – this is the essential bit – the client also commits in its contract with each consultant and contractor to set up those same third-party rights arrangements in its contracts with all the others. In other words, the act is used as a more efficient and effective way of distributing liability early on.

As a result, the client, the warrantors and the beneficiaries of the warranties all know, right at the outset, that third-party rights from all others are guaranteed to be in place. As a result, so should be the rights of contribution between jointly liable parties. And this, in turn, should mean that, where consultants and contractors grant rights to purchasers, tenants and financiers, there need be no mention of net contribution, as every contractor and consultant can be confident that it will not be left alone holding the baby.

Of course, the client would need to clarify from day one that these third-party rights are an essential part of its terms of business. But this does not present the same high risk to the clients as hoping warranties may be granted at some distant day; we are talking here and now. The client should only appoint consultants and contractors that confirm they are prepared to sign third-party rights straight away. And it is hard to imagine on what grounds any would decline. Consultants and contractors – and their insurers – would have to be pretty unreasonable to refuse to allow third-party rights. At the very least, they should permit them to kick in automatically in circumstances where they contract to grant warranties but fail to do so.

This proposal does, of course, rely on the premise that consultants and contractors are able to claim a contribution under the Civil Liability (Contribution) Act 1978 against a jointly culpable party whose liabilities to the claimant lie under the third-parties right act, rather than through a warranty. But can there be any reason why not?

Here's an idea
Here's an idea

I have no doubt the purists in the industry will regard me as a traitor to the net contribution clause in proposing its demise. But there are times when holding out for the best deal is the worst thing you can do

Everyone’s a winner

The best part is that there is a benefit for all. The consultants and contractors granting the third-party rights would still have the security of knowing they could claim a contribution from any jointly liable parties by virtue of those guaranteed third-party rights of others. Yet they would be spared from entering the net contribution boxing arena in their contract negotiations with their treasured client.

Purchasers, tenants and financiers need no longer be saddled with the dreaded net contribution clause. They also have the great advantage of being able to sue just one partly culpable party for the whole loss, leaving it to claim contributions where appropriate. This is vastly preferrable to having to sue several parties for their particular share, as the net contribution provisions dictate. And, for those purchasers, tenants and funders that might prefer a paper warranty to clasp to their bosoms, those third-party rights could be expressed to materialise only where the warrantor fails on an obligation to provide a traditional warranty.

As for the client, it would know at the outset that all necessary rights have been granted. It would no longer have to rely on a host of parties granting warranties some years hence. Nor need it fear the highly unpopular net contribution clause jeopardising its deals with prospective purchasers, tenants and financiers.

Certain limitations

Now I am not pretending that there are no drawbacks at all. For contractors and consultants granting warranties, it would not eradicate the risk of other jointly liable parties becoming insolvent. However, for those who have been accepting the common alternative – the precondition that other warranties are granted, outlined in my fourth paragraph above – this does not place them in any worse a position. Second, some net contribution wording does not cater for insolvency anyway. Third, many take the view that the likelihood of the insolvency of a jointly liable party are a lot less than the scenario of the jointly liable party not having granted a warranty, which can prevent a contribution being claimed against it. And fourth, insolvency can, if necessary, be dealt with as a separate provision without a full-blown net contribution clause.

There also remains for the consultant the risk that the client and contractor are jointly insured, which (following the Co-operative Retail Services Ltd vs Taylor Young Partnership in 2002) can prevent the consultant from claiming a contribution from the contractor. But, again, many net contribution clauses do not cater for this anyway, and in any event, this too can be dealt with as a separate provision.

Further, there is the possible issue for consultants and contractors that they will have to actively claim a contribution from a jointly culpable third party rather than, as with net contributions, simply not be liable in the first place for another’s share. But that is the norm in most industries; why should construction be different? Besides which, insurers tend to baulk at a lack of ability to claim a contribution rather than the hassle and cost of doing so.

A future without net contribution

I have no doubt that the purists in the industry will regard me as a traitor to the net contribution clause in proposing its demise. But there are times when holding out for the best possible deal is the worst possible thing you can do. Perhaps, at least, my alternative is a pragmatic way forward when negotiations have ground to a halt over the infamous net contribution.

Although it would be bit complex to cover in depth in this article, the same arrangement could also be used to resolve other commonly disputed issues that relate to joint liability. For example, “step in rights”, or the assignment of the appointment to a party that may not necessarily take an assignment of (or step into) all the client’s other contracts. With appropriate drafting, it could even deal with the joint liability issues thrown up where warranties are demanded in favour of the contractor and employer for pre- and post-novation work. But perhaps this is racing ahead. Just to be spared the net contribution arm-lock over the purchaser, tenants and financier warranties would be relief enough for now.

A few years ago, I thought the third-party rights option would never catch on in preference to warranties. Now, I am inclined to think that life would be a lot simpler on many fronts if it did.

Melinda Parisotti is an in-house barrister at Wren Managers, which manages a professional indemnity mutual for architects