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Has the time finally arrived for third party rights?

    • Real estate sector

    11-12-2013

    It’s now some 14 years since the Contracts Act 1999 (“the Third Party Rights Act”) first heralded the death knell of collateral warranties, the perennial bugbear of major development projects. As things turned out, however, rumours of the collateral warranty’s demise were greatly exaggerated. Despite the prohibitive costs and administrative burden of obtaining myriad collateral warranties in favour of funders, purchasers and tenants, the construction and development industry has by and large adopted a “better the devil you know” approach. With relatively few exceptions, collateral warranties still seem to be the preferred way of conferring contractual rights on interested third parties as opposed to going down the third party rights route introduced by the Third Party Rights Act. But, are things finally about to change?

    At the end of August, a decision by the Technology and Construction Court sent shock waves throughout the construction legal world. The case was Parkwood Leisure Limited v. Laing O’Rourke Wales Limited and the issue in dispute was whether or not a collateral warranty should be construed as a “construction contract” for the purposes of Part II of the Housing Grants, Construction and Regeneration Act 1996 (“the Construction Act”).
    The significance of this issue is due to the mandatory requirements that the Construction Act imposes on all construction contracts, including the right for parties to adjudicate, the requirement for interim payments and other mandatory payment provisions.

    The perceived wisdom before this judgement was that warranties would not be construed as construction contracts for the purposes of the Construction Act. This was because warranties are by their very nature collateral to and dependant on an underlying contract, which is a construction contract. Of themselves, however, warranties do not actually impose any obligation on a contractor to carry out construction works and they do not include any obligation on the beneficiary to pay for the delivery of those construction works.

    The right to adjudicate

    The judgement in this case, however, decided otherwise and confirmed that the collateral warranty in dispute was indeed a construction contract and therefore should have included a mandatory right for either to adjudicate. In the absence of such a provision, the right to adjudicate was automatically implied into the collateral warranty as a result of the Scheme for Construction Contracts (England and Wales) Regulations 1998, which will apply whenever the relevant provisions are missing from a construction contract.

    To some extent, this decision was dependant on the specific wording of the warranty in question and the timing of when the warranty was delivered. In particular, the warranty included an express undertaking by the contractor to continue to comply with the underlying building contract (as opposed to a simple warranty to do so) and the warranty was delivered to the beneficiary before practical completion. It may well be that other warranties that do not contain such an undertaking, or which are delivered after practical completion, would not be construed as construction contracts. The point is, however, no-one can be sure of this until further court decisions come to light and, in the meantime, the implications of any collateral warranty being construed as a construction contract are potentially far reaching and uncertain, not only in terms of the mandatory right to adjudicate but also in terms of the mandatory payment provisions.

    Clearly, the potential ability to refer a dispute under a collateral warranty to adjudication, with its relatively cost-effective and fast-track approach to dispute resolution will do nothing to discourage beneficiaries from bringing claims against contractors and consultants.  Quite the opposite, the potential availability of adjudication could positively encourage beneficiaries to bring claims that they may otherwise have ignored. As a result, contractors and consultants will become increasingly reluctant to provide collateral warranties and, at the very least, the fall out from this decision will be further protracted and costly negotiations in relation to the availability and wording of collateral warranties.

    Third party rights

    The same issues and concerns should not apply, however, if parties decide to adopt the third party rights approach as opposed to collateral warranties. Under the third party rights approach, whilst a third party beneficiary’s rights are conferred directly by the relevant construction contract, any such third party is, by definition, not a party to that contract. This is significant because the mandatory requirements of the Construction Act, such as the right to adjudicate and the payment provisions, are only applicable to “a party to a construction contract”. As a result, a third party beneficiary obtaining rights under a construction contract by virtue of the Third Party Rights Act will not have the right to adjudicate.

    In short, the “better the devil you know approach” to favouring collateral warranties over third party rights is no longer viable; this is because, as it turns out, no-one actually knew what they dealing with when it came to collateral warranties. 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 Construction Act will apply. When this is added to the inevitable cost savings and reduction in administrative hassle that will result from avoiding the usual warranty paper chase, the case for preserving the status quo of collateral warranties is rapidly diminishing.  After 14 years, third party rights may finally have their day.

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