The contracts bill introduced in the House of Lords late last year will mean that collateral warranties are no longer needed in construction contracts in England and Wales – but the Scots aren't rid of them yet.
The Contracts (Rights of Third Parties) Bill was introduced in the House of Lords on 4 December 1998. It gives third parties the right to enforce a contract term if the contract expressly provides that they may; or if it appears that the contracting parties intended a term to be enforceable by the third party and the term grants a benefit in favour of the third party. It will, therefore, reform the existing English common law provisions regarding privity of contract. The upshot of this change is that collateral warranties will no longer be required in contract documentation in England.

The third party must be expressly identified in the contract, by name, as a member of a class or as answering a particular description. They need not, however, be in existence when the contract is entered into. This means purchasers, funders, tenants and so on can be granted rights to a construction contract where they are a third party to that contract – their exact identity need not be known at the time the contract is entered into.

Bringing a breach of contract action

Third parties will be allowed to bring actions for breach of contract as if they had been a party to the contract. This should overrule the "no loss argument" that arose in St Martin's Property Corporation Ltd vs Sir Robert McAlpine Ltd (1994) AC 85. In that case, the contractor successfully argued that since the developer had suffered no loss and the party that had suffered loss was not in contract with them, there could be no recovery (although the court decided that the developer could recover on behalf of the party suffering loss).

Also included in the provisions of the proposed act is the standard "original contract" defence inserted by contractors and consultants into warranties. This provides that their liability is restricted where they are able to point to an appropriate exclusion or limitation under the original contract or appointment.

Where third parties are given rights to enforce contract terms, the contracting parties may not cancel the contract or vary it to extinguish the third-party rights. This is subject to the following provisos: the third party must have advised the contractor or consultant that it accepts the rights; the contractor or consultant must be aware that the third party has relied on the contract term or that it is reasonably foreseeable that the third party may do so; and the third party must actually have relied on the contract term.

It should, however, be noted that the proposed act will give the contractor or consultant a number of defences if the third party seeks to enforce a term of a contract that is in their favour.

The proposed act makes provision to guard against double recovery, a concern that has been raised by commentators in light of the decision in Alfred McAlpine Construction Ltd vs Panatown Ltd [1998] CILL 1353.

There are also a number of exceptions in relation to which the doctrine of privity of contract will continue to exist, but none of these are particularly relevant for construction contract purposes.

Regional variations

The act is to extend to England and Wales only. On the face of it, this seems sensible, since it is an act reforming the English doctrine of privity of contract. Scots law has always acknowledged that third-party rights can be created and enforced in contracts (see, for example, Carmichael vs Carmichael's Executrix 1920 SC (HL) 195).

Carmichael asserts that a number of requirements must be met in order to establish the existence of third-party rights (known by the Latin tag ius quaesitum tertio in Scotland). These are that the third-party rights must not be capable of variation or cancellation by the contracting parties; there must be an intention to benefit a third party which is ascertainable from looking at the contract objectively; the contract must identify the third party by name or as a member of a class of persons; and there must be an intention to benefit the third party as opposed to an intention to promote the convenience of the contracting parties.

The possible occurrence of double recovery from the contractor or consultant should not prove to be an issue in Scotland because of the common law principles regarding unjustified enrichment (see, for example, Cantiere San Rocco vs Clyde Shipbuilding Co. 1923 SC (HL) 105).

Although the provisions of the proposed act appear similar to those requirements to establish third-party rights in Scotland, there is no real certainty or clarity in the law as regards the application of the ius quaesitum tertio. In particular, there is some debate over what requires to be done to make the third-party rights irrevocable. No such difficulty will exist in England since the requirements to establish third-party rights will be expressly stated in an act of parliament. This means that, from a commercial viewpoint, parties will still wish to obtain collateral warranties in Scotland in order to have some certainty that they will have an actionable remedy.

At present, it appears that we in Scotland could be left with the strange situation where we will be relying on collateral warranties (a remedy created to circumvent the English doctrine of privity of contract).

In England, third-party rights will be inserted directly into the construction contracts and appointments without the need for collateral warranties – this right has arguably always existed by virtue of the common law.

An end for collateral warranties? Possibly in England, but not yet in Scotland.

  • Collateral warranties will no longer be required in contracts in England and Wales
  • Third-party rights will be inserted directly into contracts
  • Collateral warranties will continue to exist in Scots contracts