Construction is a complex, multi-party industry. In almost all construction projects, many parties, beyond the employer and the contractor, are brought together to complete the project. Without a direct contractual link, third parties can struggle to claim for losses caused by defects in the design or workmanship. This is due to the common law doctrine of privity of contract, a rule that means only parties to a contract can enforce rights and obligations under it.
For a long time, third parties brought claims using the tort of negligence, but then a series of cases decided by the House of Lords in the 1980s confirmed that generally a contract would be required to claim damages for defects. This led to the development of two separate methods for creating a contractual link between third parties and those involved in the construction of buildings, collateral warranties and the Contracts (Rights of Third Parties) Act 1999.
Collateral Warranties
Collateral warranties have been in use since at least the end of the 19th century in various guises, but it wasn’t until the 1990s that their usage in the construction industry exploded. Collateral warranties provide a direct contractual link between various parties linked to construction projects, including tenants, owners or funders and the consultants, contractors and sub-contractors carrying out the works.
A collateral warranty is usually a tripartite agreement, involving two parties to a separate contract and a third party receiving a benefit under that contract. The purpose is to promise the third party that the party providing the service, or completing the work will perform all their obligations under the separate contract with reasonable skill and care. If the party is in breach of its obligations, the third party can then claim damages from them.
The steady development of the law of collateral warranties has helped to bolster their position as the primary method of granting rights to third parties, despite the costs involved in negotiating and chasing them.
Contracts (Rights of Third Parties) Act 1999
The process of drafting, negotiating, and re-drafting innumerable collateral warranties on construction projects is lengthy and involves huge amounts of legal costs. Even on smaller projects, there can be many separate warranties required making the legal costs out of proportion to the profit of the project. Reducing the number of, or eliminating the need for, collateral warranties was one of the primary aims of the Contracts (Rights of Third Parties) Act 1999.
The Act provides a mechanism for third-party rights to be included within the main contract. This is usually set out in a schedule that defines which third parties are to receive a benefit and what those benefits are. Having these rights set out within the main contract simplifies the contractual arrangements as numerous additional collateral warranties are no longer required.
Comparison
Both these mechanisms can be used to provide almost identical rights to third parties including:
- Performance obligations owed to the third party.
- Grant license to copy and use design documents for any purpose relating to the works.
- Define required levels of professional indemnity insurance.
- Right of assignment, often with limits.
- Limitation of liability for the party granting the rights.
- Nett contribution clauses, to also limit liability.
- Step-in rights where appropriate.
However, the courts have taken the view that a collateral warranty can be a construction contract. This means that a dispute under a collateral warranty could be referred to adjudication, but a dispute under the Contracts (Rights of Third Parties) Act 1999 cannot because there is no separate contract and the third party is not a party to a construction contract.
The use of the Act has started to steadily increase in recent years, but collateral warranties are still the preferred option for many clients, despite the lengthy process and higher costs involved. This may be due to the additional benefit of statutory adjudication, but it could also be because collateral warranties are a tried and tested method.
It is important to understand what rights are being granted to third parties whether that is through the use of collateral warranties or the Act so you can understand the potential liabilities you are agreeing to. If this is something you are not confident about, VOLOCO can provide advice and support to understand the risks.
Please get in touch if you think this would be of benefit to you.
This article is an abbreviated version of a larger piece of academic research carried out by one of our consultants, Richard Perry, comparing the two primary mechanisms used to grant rights to third parties in construction contracts. The full document can be found here – Third-Party Rights in Construction Contracts: Developments since Murphy v Brentwood.
