Know your rights

Collateral warranties used to be the only effective way of protecting subsequent building owners and occupiers from defective construction work. Then along came the Contracts (Rights of Third Parties) Act, which applied to contracts entered into, on or after 11 May 2000.

This was meant to help the construction industry by doing away with the cost and bureaucracy of processing large numbers of collateral warranties. The act enables contracting parties to give benefits to those not party to the contract, which those third parties can then enforce.

So previously, when an employer and contractor agreed that a subcontractor would be paid by the employer, the subcontractor had no way of enforcing this. Now they have.

So, five years on, why haven’t all those involved in commercial property development embraced the benefits of the act? From early on there were concerns over the replacement of funder warranties with third-party rights.

For one thing, the act does not permit obligations to be imposed on third parties. This creates a problem: if the funder is to be granted “step-in rights” (meaning the right to take over as client) over construction contracts using third-party rights, how can the contractor or consultant oblige the funder to pay them?

There is a way around this. As the act allows the creation of conditional rights, it is possible to make the granting of third-party rights conditional on the funder’s agreeing to discharge the payment liabilities of the former client.

However, if the funder defaults, the relevant contractor or consultant will not be able to take legal action against them to recover such payments.

Also, funders typically require particular provisions in their collateral warranties with contractors and consultants. These go beyond the standard duty of care provision and might not always readily be accommodated when using third-party rights.

But there is still no reason why lawyers and clients cannot use the act to totally replace standard purchaser and tenant warranties, particularly in a multi-let office or retail developments where large numbers of collateral warranties would usually be used.

A cynic might say that lawyers see more fees being generated by the use of collateral warranties. However, most construction lawyers have expressed backing for the use of third-party rights and gradually these rights are being used in place of collateral warranties. But the process of change needs to speed up. To achieve this, some of the ill-founded fears about using third-party rights need to be dispelled.

The restrictions imposed by the act on the freedom to amend contracts containing third-party rights are often exaggerated by those who are still attached to using collateral warranties. In any event, these restrictions can be modified when drafting contracts. It is sometimes said that the professional indemnity (PI) insurers might be reluctant to cover third-party rights. I have seen no evidence of this.

As a result of the standard limitations on PI insurance, it is common practice for consultants to obtain the prior approval of their insurers to collateral warranties and appointments in non-standard form. Third-party rights provisions will need to be disclosed in the same way.

Third-party rights are flexible and it is possible to build into them the same standard protections for contractors and consultants that are accepted in relation to collateral warranties – for example, net contribution clauses and exclusion of consequential economic loss.

Another example of the flexibility of third-party rights is that the need to formally assign them to subsequent purchasers and tenants can be avoided by using a well-defined class of future beneficiaries. This class may be restricted to the first two or so purchasers and/or tenants, which is currently done under collateral warranties.

There are good examples in the market of all these issues being adequately addressed. Once the industry becomes more familiar with third-party rights, collateral warranties will, hopefully, become a thing of the past.

Alan Elias is a partner in Clifford Chance and chairman of the City of London Law Society construction law committee