A refresh for third party rights?

MANY involved in the legal and commercial side of construction projects will be used to seeing collateral warranties being given to parties with an interest in a project – such as funders, purchasers and tenants.

Collateral warranties are agreements additional to a contract or appointment which give these third parties contractual remedies where they would otherwise not be available or limited in scope. Some projects such as shopping centres with many tenants can generate significant numbers of these documents.  On larger projects, the preparation and signing of them can involve considerable administrative time and cost.

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Jonathan Gaskell

Elsewhere in the United Kingdom, the use of collateral warranties has started to decline because of an increased reliance on the Contracts (Rights of Third Parties) Act 1999.  This legislation allows the parties to a contract to grant enforceable rights to third parties – in the process creating an exception to the long-standing principle called “privity of contract”.

Scots law is different in this area because of an age-old doctrine that contracting parties can create enforceable rights in favour of a third party. This “common law” principle is known by the Latin phrase jus quaesitum tertio, and is infrequently used in practice – the main reason for this being a perception that it is an old-fashioned, inflexible aspect of Scots law which is not fit for purpose for modern commercial contracts.

However, that might soon change. The Scottish Law Commission intends to publish in the near future its Report on Third Party Rights, together with draft legislation – the Contract (Third Party Rights) (Scotland) Bill – which, if implemented, would introduce a statutory third party rights regime into Scots law.

The proposal is that the existing legal principles will be replaced with a clear and comprehensive statutory statement of the law of third party rights in contracts, with some limited reform, making it more relevant and attractive to commercial parties.

The draft Bill sets out the essentials for the creation of a third party right: the contract must contain an undertaking that one or more of the contracting parties will do, or not do, something for the benefit of the third party and, additionally, they must intend that the person should be legally entitled to enforce or otherwise invoke the undertaking.

The key proposed reform relates to the contracting parties’ rights to cancel or modify a third party’s right.  One of the requirements of the existing law is that the parties must intend that the contract is not capable of being changed so as to alter or cancel the third party right. This is seen as an inflexibility, as it prevents commercial parties from altering or cancelling a third party right to reflect changing circumstances.

The draft Bill expressly allows a third party right to be given even though it may be cancelled or modified – with exceptions where it is being enforced after a condition to it coming into effect has been satisfied, or where the third party enforcing the undertaking would be adversely affected by it being cancelled or modified.

This would be an important development in the law.  However, it is unlikely to have significance for third parties with an interest in construction projects, because they are likely to insist that their rights are not capable of being altered, as is effectively the case with collateral warranties at present.

The draft legislation also permits a contracting party to raise as a defence against a claim under an undertaking any defence that it could assert against the other party to the contract, so long as that defence is also relevant to the third party undertaking. Those familiar with collateral warranties will note the similarity of this provision to the “equivalent rights in defence” clauses which are often required by the providers of warranties.

This is unobjectionable in principle, but third parties will want to be clear that a claim under an undertaking will not be met be a defence arising from commercial issues between the contracting parties (such as a “set-off” defence).

The law as it currently stands is established and capable of allowing third party rights to be given in construction projects. Indeed, the main Scottish Building Contract Committee standard form contracts have included an option for third party rights for over a decade now.

However, the Bill, if passed by the Scottish Parliament, would remove the perception of obscurity around this area of law and may, in time, provide an institutionally acceptable alternative to collateral warranties in construction projects.

Jonathan Gaskell is a Legal Director in DLA Piper’s Construction and Engineering Group