Have third party rights come of age?

27 November, 2017
by: Cripps Pemberton Greenish

For many years, construction projects have been burdened by the additional time and money involved in collecting in collateral warranties from contractors, consultants and subcontractors. The Contracts (Rights of Third Parties) Act 1999 (“the Act”) should have finally abolished this by allowing third parties to rely on contracts to which they were not a party but this has not been the case. However, the recent case of Chudley v Clydesdale Bank plc (t/a Yorkshire Bank) [2017] EWHC 2177 (Comm) offers hope that the Act will be more widely used.

Third Party Rights

Fundamentally, the Act will allow a third party to rely on a contract if:

(a) The contract expressly allows them to do so; and
(b) The clause they seek to rely on is a benefit (as opposed to a burden).

Practically, this can be done in two main ways:

1. An independent schedule of third party rights; or
2. A schedule which identifies which clauses on which a third party may rely.

The first option is the more common. It allows the drafting to be tailored to the particular circumstances and the interest of the beneficiary as tenant, funder or purchaser and so is more similar to a conventional collateral warranty.

What should you consider when using Third Party Rights?

Firstly, the contract must expressly state that a particular third party can rely on its terms. Whilst those undertaking and managing a construction project may have some idea as to the identity of potential recipients, it is not possible to provide for all eventualities.

Secondly, only the benefit such as the right to bring proceedings and not the burden (such as the obligation to make payment) can be passed on. This has been the main obstacle to the expansion of third party rights, especially to those providing finance.

Collateral warranties are often required by funders, who need to be able to realise their security should the borrower, the employer running the construction project, become insolvent, or no longer able to continue with the works. Collateral warranties achieve this by giving them “step in rights” which allow them to “step into” the employer’s place under the building contract and complete the works. Therefore, as well as benefits, the funders inherit burdens. For example, the responsibility for payment. Whilst this does not prevent third party rights being used, it means that the third party schedules must be carefully drafted.

So what are the risks?

The key risk has always been that third party rights have never been properly tested in court. So we are still on uncertain ground when it comes to what works and what doesn’t.

However, whilst the question of third party rights wasn’t a deciding factor in Chudley v Clydesdale Bank plc (t/a Yorkshire Bank) [2017] EWHC 2177 (Comm), the judge helpfully provided guidance on how they can work in practice.

In particular, the Chudley case usefully suggests express reference to a class of third parties, who can rely on the contract, meets the first requirement of expressly relying on them to do so.

This simplifies the drafting of third party rights schedules considerably, as types of people who may later need to rely on third party rights – for example, a funder, a property owner or purchaser or a tenant – can be more easily identified than named individual bodies.

The case also held that the same contractual term could both expressly identify the third party and the intention to confer a benefit upon that third party. Here, reference to a client account, and hence clients who paid into that account, would have identified the claimants as persons intended to benefit from the contract.

What does this mean?

Whilst there are still many uncertainties associated with the Act, the Chudley case suggests we are moving towards a world where construction projects can routinely and confidently rely on third party rights, rather than collateral warranties.