Third party rights and why they matter

2 June 2015

Louise Forbeslouise.forbes@olswang.com | +44 20 7067 3632 | @forbes_louise

What are third party rights?

• Typically, construction contracts include a clause that a third party cannot rely on a contract unless the contract expressly grants third party rights to them

• This provides certainty for all parties to the contract as to the extent of their obligations and the scope of their liability

• However, third parties who have or acquire an interest in the site will want some protection in the event that any defects arising out of works on the site cause them a loss

• Third party rights are rights in favour of a person who is not a party to a contract (a third party) to enforce the benefit of a term or terms of that contract. E.g. the right for a funder to enforce a term of:

• A professional appointment;

• A building contract; or

• A sub-contract (but this is more rarely seen)

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Putting third party rights in context

• Generally, only the parties to a contract can generally sue to enforce the rights and obligations under it (privity of contract)

• There are exceptions to this doctrine:

• Assignment;

• Action in tort (although this is becoming more difficult);

• Trust; and (more recently)

• Contracts (Rights of Third Parties) Act 1999 (‘C(RTP)A’)

• C(RTP)A followed a Law Commission report on privity of contract (31 July 1996) which recommended that the doctrine of privity of contract be relaxed in certain circumstances, citing the construction industry as a prime sector in which third party rights would be beneficial

• The report stated that third party rights could resolve issues of privity whilst being more flexible and convenient than collateral warranties

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Common third party rights practice

• Usually, a construction contract that uses third party rights sets them out in a schedule. This is the preferred route for many consultants and contractors who want certainty over what rights are being granted (often the preferred presentation for third parties too)

• This is not necessarily what the Law Commission report envisaged (they lauded third party rights as being more flexible, but codifying them in the contract arguably diminishes flexibility)

• Similarly, construction contracts are often drafted so that rights are granted by service of a notice on the consultant/contractor/sub-contractor

• Again, this is not a legal requirement, but is the approach preferred by the industry to provide clarity as to whom third party rights are owed

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What does C(RTP)A say?

• There is no requirement under the C(RTP)A to set out the rights in the contract or to serve a notice

• The only statutory requirement is that the contract expressly provides that the beneficiary may enforce a term (or terms) of the contract, or that the term purports to confer a benefit on him

• The third party must be expressly identified in the contract:

• By name

• As a member of a class or as answering a particular description (e.g. a ‘Purchaser’)

• The third party in question need not be in existence when the contract is entered into

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How do they differ from collateral warranties?

• Content is usually the same:

• A primary covenant that the consultant/contractor has complied with the terms of the underlying contract

• Services or design performed with all reasonable skill and care

• Copyright licence

• Assignment provisions

• Professional indemnity insurance

• Sometimes limitations on liability including limitation periods

• Step-in rights for certain beneficiaries

• Under a collateral warranty, the warrantor is warranting their performance under the underlying contract, rather than granting rights under the contract directly – it is a collateral agreement

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Practically speaking, the difference is usually mostly one of mechanics:

Third Party Rights

• Either a notice is issued as per the relevant notice provisions in the underlying contract (where relevant in the form agreed in the underlying contract) and the third party rights vest on service of the notice

• Or there is an existing ‘pre-notified’ class of beneficiary whose rights vest on enrtyinto the contract

Collateral Warranties

• Must be executed by the warrantor (and the warrantee where the warrantee has obligations under the warranty, usually owing to step-in rights where the original counterparty to the underlying contract also has these obligations)

• In the form approved in the underlying appointment, or as agreed between the parties

• This is a separate contract www.olswang.com7

Practical differences

Why has the uptake been slow?

• On publication of the C(RTP)A, many considered the availability of third party rights to be the death knell for collateral warranties

• Initially, uptake was slow and the construction industry’s response was initially to exclude its operation

• However, there is a trend towards third party rights, accelerated, in part, by the introduction of third party rights to the JCT 2005 and the NEC3 2005 suite of contracts

• Consultants and contractors favour the “better the devil you know” approach

• In addition, the concern over control over to whom third party rights are given has been a driver for consultants and contractors to keep collateral warranties

• Haven’t been extensively tested in the courts - particularly the issue of step-in rights (however, there have been some cases which support their use)

• Some beneficiaries like to have a document to hold

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Why to use them

• Speed - particularly for prospective tenants, purchasers and funders whose interest in the site may be contingent on acquiring contractual protection –property transactions have been delayed whilst the forms of collateral warranty are negotiated by the parties

• Administrative burden of collateral warranties

• Expense of collateral warranties on lawyer’s fees and other administrative costs (such as posting)

• Collateral warranties not efficient for multi-let developments (e.g. large shopping centres where multiple consultants will have been involved)

• Difficulties associated with collateral warranties in sub-contracts:

• Often little control over how they are drafted

• Have to reply on contractor to procure the warranties

• Perceived issues with step-in can be tackled with effective drafting

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Recent developments (1)

Parkwood Leisure Limited v. Laing O’Rourke Wales Limited

• Collateral warranties may be construed as construction contracts for purposes of Part II of the Housing Grants, Construction and Regeneration Act 1996 (the “Act”) in certain circumstances, depending on the wording of the warranty and the time of entry into the warranty

• May therefore be subject to certain of its mandatory provisions

• Of particular concern is the right to adjudicate:

• Potential availability of adjudication could positively encourage beneficiaries to bring claims that they may otherwise have ignored

• As a result, contractors and consultants may become increasingly reluctant to provide collateral warranties and, or may enter into costly negotiations in relation to the availability and wording of collateral warranties

• Controversial decision

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Hurley Palmer Flatt Ltd v Barclays Bank plc

• Third party rights should not be construed as a construction contract

• Therefore no right to adjudication unless provided for expressly in the underlying contract

• “Better the devil you know” approach to favouring collateral warranties over third party rights is no longer viable

• Third party rights, on the other hand, confer all the benefits of collateral warranties without the potential uncertainties inherent in predicting whether or not the Act will apply

• Contractors/consultants may therefore increasingly favour third party rights to avoid the risk of beneficiaries adjudicating against them

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Recent developments (2)

Practical tips

• Set out the rights as an appendix - funders and potential purchasers favour complete clarity in respect of their rights

• Keep any template form of notice in the underlying contract simple, make sure the service of notices provisions are clear

• If seeking to enforce step-in rights, make sure the notice being issued deals with the question of obligations of the beneficiary effectively

• Identify the beneficiaries clearly (in both the underlying contract and the notice)

• It is possible to draft contracts to include both collateral warranties and third party rights (although it may be best to avoid this, as beneficiaries often opt for collateral warranties out of familiarity)

• Keep an eye out for case law updates – Parkwood caused controversy and may yet be overruled

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