Difference between collateral warranties and third party rights

Construction projects often involve collateral warranties and third party rights so that third parties (such as funders, purchasers, tenants, and so on), can enforce the benefit (or benefits) of a contract they are not a party to.

They can be necessary because:

• Privity of contract: Without being expressly agreed, third parties are unable to enforce a term of contract they are involved in.
• Construction security: A lender may be unable to make an effective claim for losses directly from the party who caused something to go wrong.
• Unlikely success of a claim in tort: To claim for pure economic loss (i.e. damage caused by a defective building), a contractual right is much more likely to be successful than a claim in tort.

The aim of collateral warranties and third party rights therefore is to provide some security for third parties to a contract to which they themselves are not party to, but in which they have an interest.

Collateral warranties are agreements which are associated with another 'primary' contract. They provide for a duty of care to be extended by one of the contracting parties to a third party who is not party to the original contract. A typical example would be where an architect of a new office development owes a duty of care to an occupier of the development in so far as any subsequent defects which may arise. Privity of contract rules would prevent any liability arising between the architect and occupier without the existence of a collateral warranty. (Although most Architects PI Insurers would not allow a Collateral Warrantee agreement to be accepted and would not insure the architect in this event).

There may also be a contractual requirement for parties to obtain further warranties, for example there may be an obligation for the main contractor to obtain collateral warranties from sub-contractors.

The Contracts (Rights of Third Parties) Act, 1999 enables third party rights to be created by a contract. This is seen by some to offer an alternative to collateral warranties.

The right created is to enforce a term of a contract, not the whole contract itself. For example, if a building contract contains a term that the contractor is required to use materials of good quality, then that term might be the subject of a third party enforcement right.

However, the contract must expressly state that a third party has specific rights for the Third Party Rights Act to apply, and often these are excluded. Third party rights are typically provided for by way of a notice stating that the third party is entitled to rely on specific provisions of the contract.

Despite collateral warranties tending to be the preferred option, third party rights are increasing in popularity since they can be incorporated into building contracts, subcontracts, etc., with a simple notice; avoiding the need to produce detailed additional agreements. The administrative exercise of organising collateral warranties can be considerable, sometimes costing more in money and time than their actual value.

However, collateral warranties can be perceived as being more effective since they mirror the responsibilities of the underlying contract. The construction industry is also more used to using them.

The Contracts (Rights of Third Parties) Act 1999 maintains consistency of rights, i.e. with the main contractor and other third parties. However, there is a perceived weakness of the Act in that it does not deal directly with assignment or with step-in rights for funders. This can be handled by careful drafting that includes all assignees, and executes any step-in undertakings as a deed.

[edit] Related articles on Designing Buildings Wiki

• Assignment.
• Collateral warranties.
• Definition of collateral warranty.
• Design liability.
• Difference between assignment and novation.
• Essentials of a contract.
• Novation.
• Practical considerations of collateral warranties.
• Rights of third parties.
• Step-in rights in construction contracts.
• The Contracts (Rights of Third Parties) Act.
• Warranty.