The Arch

Collateral Warranties – Alive and Kicking

For many years the use of collateral warranties has been widespread within the construction industry. They began to be used with increasing frequency during that period of time when England would play well in the World Cup but fail to get into the final (i.e. between “the Hand of God” incident at Mexico’ 86 and Gazza’s tears at Italia’ 90).

Although the form and content of such documents has developed considerably over the years (despite attempts by a number of institutions to develop standard provisions) their true purpose remains to provide contractual remedies to a third party (e.g a purchaser, funder or occupier) who has an interest or potential interest in a project.

The Contracts (Rights of Third Parties) Act 1999 (the “Act”) applies to contracts entered into on or after 11th May 2000 and is intended to abolish the rule that a person who is unconnected with a contract cannot sue to enforce any right the contract purports to confer nor rely in any action bought against him by a party to the contract on any exclusion or limitation of liability which the contract purports to confer upon him (the “third party rule”).

As the Act was being formulated the Law Commission commented that it should particularly benefit the construction industry where typically a project had numerous consultants’ appointments and sub contracts. The net effect of such a framework was that only one party to each contract could recover from the other for non performance whilst key parties (especially purchasers, funders and occupiers) who are likely to suffer loss as a result of poor design and workmanship could not recover in the absence of an appropriate warranty/duty of care document being in place.

The third party rule is a right of enforcement which gives the third party equivalent rights of action for breach as if that party was a party to the contract itself because in accordance with the Act either the contract expressly provides for the third party to have such a right of enforcement (section 1(1)(a)) or the contract purports to confer a benefit on him (section 1(1) (b)). This second circumstance is considered uncertain and very much open to interpretation not least because the Act goes on to state that it would not apply if on a proper construction of the contract it appears that the relevant part of the contract does not intend that the term should be enforceable by a third party.

Given this it is not entirely unsurprising that the industry has decided that if its going to rely on the Act then it should set out the nature of the obligations within contracts in the form of a third party rights schedule. This approach appears to be developing along the lines of reproducing a number of clauses which have been negotiated and developed over the years in the collateral warranty.

There are a number of reasons why, notwithstanding the intentions behind the Act, that it appears the use of collateral warranties remains prevailent within the industry:

• Some trade and professional bodies associated with the industry consider the Act as “all embracing” which may potentially “open the flood gates” to a large group of claimants
• The breadth of Section 1(1)(b) and its uncertainty has caused clauses to be incorporated which specifically exclude any such benefit on third parties
• If the Act is deemed to apply then it is difficult to vary any contract without the consent of a potentially large class of interested third parties because consent is required for such purposes by Clause 2 of the Act

Perhaps the greatest reason for the Act not progressing as quickly as one might expect is because of the established benefits of a collateral warranty. One of the key advantages of a warranty is that if it is carefully and accurately prepared then it will clearly define and safeguard both a beneficiary’s position and that of the donor too. This in turn should allow parties to a project to proceed in confidence in that they know where they stand and the true extent of the duty of care that is owed or expected.

Even though we now have contracts that include a schedule of third party rights in favour of beneficiaries it is the writer’s view that, for the time being at least, collateral warranties are here to stay. Indeed we may well still be using collateral warranties the next time England win the World Cup (or is that the next time England appear in the European Championships)?

Why not let us know your views.

If you require any further information on this, please contact Martin Jones of the Construction & Engineering team on martin.jones@harveyingram.com or 0116 257 4429.