The Contracts (Rights of Third Parties) Act revised

The issue: Using the Contracts (Rights of Third Parties) Act 1999.

The implication: The Contracts (Rights of Third Parties) Act 1999 can provide the opportunity to avoid the difficulties caused by the historical need to issue collateral warranties.

For many years, the doctrine of privity of contract was a fundamental feature of English law, meaning that it was only the
parties to a contract who could rely upon or enforce the terms of that contract.

The consequence of this was that if a third party suffered a loss because the contracting parties failed to fulfil their obligations
to each other, then the third
party had no recourse under the contract.

It is this doctrine of privity of contract that gives rise to the need for collateral warranties, whereby funders, purchasers, tenants and the like all wish to rely upon the proper performance of a contractor or consultant, but are not a party to the contract by which such performance is required.

To get around the problems that this creates, collateral warranties create new contracts between the service provider and the third party.

Third-party rights

It is against this background that, when it was introduced, the Contracts (Rights of Third Parties) Act 1999 was seen as a potentially revolutionary piece of legislation; opening the door for certain third parties to rely upon, and benefit from, the terms of a contract to which they were not a party.

The third parties potentially benefiting in this way were to be any expressly identified by the contract as possessing such rights, or any person upon whom a term of a contract purported to confer a benefit. While third parties falling into the first category would be readily identifiable, those falling into the second category were potentially far more wide-ranging.

For example, a contractor might be obliged to undertake works in a way that minimised inconvenience to tenants or adjacent occupiers, with the effect that the contract purported to confer a benefit upon those
tenants or adjacent occupiers. Potentially, therefore, the contractor could face claims for damages for breach of contract from a whole new group of people, not simply the employer.

The construction industry’s initial reaction was immediate and sought to maintain the position that existed prior to the Act, and amendments were made to all of the standard forms to the effect that "nothing in this contract confers, or is intended to confer, any right to enforce any of its terms on a person who is not a party to it".

This was probably the right reaction at the time, as the potential implications of the Act were widespread and had not yet been assessed in practice.

Collateral warranties

After the immediate reaction, it was realised that, in certain circumstances, the Act might provide a solution to the difficulties and inconvenience caused to everyone by the need to obtain or provide collateral warranties.

Just as contractors and consultants dislike negotiating and providing collateral warranties, so do clients (and their solicitors) dislike the difficulties created by having to obtain such warranties. The process can be lengthy and, where there are many potential beneficiaries, can be ongoing over a long period of time.

The first standard form of contract to utilise the provisions of the Act – in order to expressly confer benefits on third parties in this way – was the JCT’s Major Project Form (now known as the Major Project Construction Contract).

Through the use of a schedule, this form could provide specific rights to funders, purchasers and tenants and therefore do away with collateral warranties altogether – for which no provision was made.

The rights conferred in this manner included warranties in relation to compliance with the contract and (for the funder) step-in rights in certain circumstances. The BPF Consultancy Agreement (published in 2005) adopted the same approach, although it also provided for the use of collateral warranties as an alternative.

Embracing the Act

The 2005 editions of the JCT forms have utilised the Act widely and, while provision is made for collateral warranties, the ‘default’ option, by which rights are given to third parties, is the Act.

The main advantage of this approach, when compared with common practice in relation to collateral warranties, is that by providing third party rights as a part of the construction contract, all of the subsequent administration associated with the provision of warranties is removed.

Equally importantly, by removing this subsequent administration, the temptation (which always exists) for each warranty provider or beneficiary to seek to individually renegotiate its terms, is removed – taking away another frequent source of difficulty.

Finally, by relying upon terms within the original contract, there is less risk that the rights conferred on the third party are not ‘back-to-back’ with those in the original contract. With collateral warranties there is always the concern that the benefits conferred on the third party may be more than those conferred under the original contract.

Set against these benefits is the uncertainty associated with any new way of working and the fact that third parties will have to accept whatever rights are conferred by the contract, rather than trying to negotiate against their own standard requirements.

However, the use of standard wording for third party rights should overcome these difficulties, and create a norm that should satisfy most beneficiaries.

So, from initially being seen as a threat, the opportunities offered by the Act have been harnessed to provide a way in which the industry can address an area of frequent dissatisfaction. All that remains now is for the industry to avail itself of that opportunity.

[Contract Journal, 9 August 2006, p. 17]