Why third-party rights don’t work

Solicitors are always on the look out for a burning issue that will persuade their clients to attend a breakfast briefing. Collateral warranties and third-party rights are not normally worth an early morning alarm call. After all, collateral warranties in favour of funders and end-users have been a common feature of the construction industry for the past 20 years. But what is new is the inclusion within the 2005JCT standard building contract of a separate section devoted to assignment, third-party rights and collateral warranties.

It was this novelty that ensured a good turn out at a recent breakfast event. The JCT has long since published standard forms of collateral warranty in favour of purchasers, tenants and funders. These forms are more often than not discarded in favour of bespoke wordings introduced by the funders and end-users themselves.

Section 7 to the standard building contract does give an alternative, however. This, if implemented, operates to give such beneficiaries rights under the building contract itself as an alternative to receiving warranties from the contractor. The drafters of the JCT contracts were motivated by a desire to save a few rainforests, no doubt.

However, at the briefing it soon became apparent that none of the delegates in attendance had elected to choose the third-party rights option and were continuing to insist on the execution of warranties. Was this the result of ignorance? Or was there a more positive reason for rejection?

It soon became apparent that none of the delegates in attendance had so far elected to choose the third-party rights option

It is true that people are traditionally averse to change unless they can identify clear benefits. Those working within the construction industry are no exception. Reducing the quantities of warranties – and also legal fees – must be a worthwhile ambition, but there are problems.

The rights of the third parties are set out within a schedule to the standard building contract (schedule 5). Part 1 of the schedule is to apply to purchasers and tenants and part 2 applies to funders. These rights are intended to apply generally, but in practice beneficiaries insist on stronger protection.

They reject, for example, a net contribution clause, which leads to amendment. This will apply where more than one party is to blame and where the clause will apportion liability. It means that a claimant would have to sue all the parties to recover 100% of its loss. A further example within the schedule is exclusion of any liability for losses caused by delay. This is also unacceptable and will lead to change.

A glaring omission is a failure to include a mandatory requirement for a contractor’s professional indemnity insurance cover. This is usually insisted on by end-users and funders alike. They seek the comfort of knowing that if there is a claim in the future it is covered by an insurance policy. There is a reference to PI insurance in the third-party schedule, but it is not mandatory except where the contract elsewhere states that it is necessary.

A glaring omission is a failure to include any mandatory reference to the contractor’s PI insurance cover

There are also practical difficulties. There may be a continuing argument between the contractor and the employer as to the terms of the contract. This will mean that the exercise of the third-party rights option will be delayed. If it is not and the third-party rights option is exercised by the giving of notice, then it will not be possible to change the building contract without the prior consent of the third parties. If no agreement is reached between the employer and the contractor, no contractual third-party rights will exist either.

Finally, the need to obtain warranties from consultants will be entirely unaffected by the execution of any third-party rights schedule. End users may well ask why they are not, in the interests of consistency, obtaining warranties from contractors as well as from the consultants.

What all this means is that if you use the JCT third-party rights options, you would at best need a heavily amended third-party rights schedule, or at worst, a number of different schedules applicable to the beneficiaries. This would be self-defeating.

So if it ain’t broke, why fix it? asked one of the delegates. A sensible comment indeed. This was the consensus from the delegates.

It seems that warranties will be insisted on – for the foreseeable future at least.