Third party rights in construction — can you teach an old dog new tricks?

In the construction industry, the interests of third parties — including purchasers and tenants — are significant. Why then does it seem likely, in the short term at least, the sector will continue to rely on collateral warranties to protect these rights?

For each construction project, there is a multitude of interest in it being built and designed correctly, including from those not often party to the building contract or professional team appointments — such as funders, purchasers and tenants.

And finding a way to enforce these third party rights is essential: without a contract, there are certain claims they can’t make, such as damages for defects including those appearing years after completion.

Picture the scene — you’ve bought an office block from a developer and, it turns out, there’s a problem with the drainage system.

With nothing in your purchase agreement allowing you to claim against the seller, never mind the architect who designed it, you’ll have to pay to fix the defect yourself.

Now, the Rights of Third Parties (Scotland) Act 2017 applies to contracts entered into from 26 February, 2018.

It gives third parties contractual rights in certain circumstances, and replaces the common law doctrine of ius quaesitum tertio.

But how will it affect the standard construction industry approach of using collateral warranties as an alternative to this common law to create these rights?

Collateral warranties

Collateral warranties provide a direct contractual link between the third party and, for example, the architect or engineer.

Claims under collateral warranties are covered by professional indemnity insurance, so granting those has become common practice, and the warranties generally —

  • last 12 years
  • provide a duty of care to the beneficiary
  • mean the grantor — such as the engineer or architect — has no greater liability to the beneficiary than they would have under the original contract
  • mean the grantor has the same defences against claims as it would have had against the original contracting party, such as the developer (except offsetting a claim by a beneficiary because the original contracting party hasn’t paid its fees)
  • mean the beneficiary can assign the benefit under the collateral warranty to a person acquiring its interest, such as a new purchaser

New legislation

Reform of third party rights has widely been seen a necessary step to bring greater clarity, particularly in relation to common law.

What does the 2017 Act say about creating third party rights?

  • It removes any ambiguity that a third party has the right to make the same claims as a contracting party
  • To acquire any right, one or more of the contracting parties undertake that a third party gets a benefit, and that they intend to create those obligations
  • A right can be cancelled, but there are protections against retroactive change (the contracting party can’t change its mind and revoke the third party right, particularly if the third party has been notified of the right and has acted on its existence); as well as from modification after notice has been given; or alterations after an undertaking has been relied upon
  • A contracting party is entitled to use any defence against a third party claim that it would have had against another contracting party
  • The third parties have access to arbitration, if the original contracting parties agreed to resolve their disputes that way

Will things change?

Not really, certainly in the short term.

It’s likely collateral warranties will remain the preferred option. Let’s take the situation south of the border as an example: nothing much changed in England after similar legislation was introduced in the late 1990s.

There, collateral warranties are still the norm.

And here, attempts such as drafting third party rights into construction contracts — where the contractor is responsible for design — have not been particularly popular.

In fact, the standard form contracts for construction introduced third party schedules in 2005 in an attempt to avoid the use of collateral warranties, but routinely these are deleted in favour of the latter.

These rights under the 2017 Act are untested, so third party beneficiaries, particularly funders, will likely want to stick with insurance-backed warranties. Of course we won’t see them tested in courts until people start using them and things go wrong, so we’re some way off.

Meanwhile at the very least, the new legislation offers the construction industry an alternative to collateral warranties that some may be keen to explore.

Sarah Stuart

With a litigation background advising clients on high value commercial disputes, Aberdeen-based partner Sarah Stuart works within the commercial team, advising clients on matters related to commercial contracts. This includes supply and framework agreements, development agreements, collateral warranties and performance guarantees.

Posted, 20 April 2018 by Sarah Stuart
Categories: Commercial contracts | Commercial property | Construction | Litigation

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