Loss Prevention Alerts

Alert No 5 Contracts (Rights of Third Parties) Act 1999

Date of Issue: 1 February 2000

This loss prevention alert has been produced by the loss prevention working group (LPWG) of the AGS. It highlights issues that the LPWG considers may be of relevance to members. It is not intended to provide a definitive response to any issues and before taking action members should consider carefully whether they need to seek independent legal advice.

Collateral warranties are contracts which stand alongside the client contract and generate obligations with respect to the quality of the work to various interested parties such as purchasers of a site, tenants or funders. They are a perennial concern but, in the short term, they may be preferable to obligations which might be generated by recent legislation.

The Contracts (Rights of Third Parties) Act 1999 may alter the practice with respect to collateral warranties. The Act is intended to amend the doctrine of privity of contract which provides that a person cannot take the benefit of a contract unless he is a party to it. The main provision of the Act is section 1(1) which provides that a person who is not a party to a contract may in his own right enforce a term of the contract if (a) the contract expressly provides that he may, or (b) the term purports to confer a benefit on him. Under section 1(3) the Act goes on to say that the third party must be expressly identified in the contract by name, as a member of a class or as answering a particular description but need not be in existence when the contract is entered into. The Act was passed on 11 November 1999. Until 11 May 2000, parties who want the Act to apply to their contracts must expressly contract into the Act. After 11 May 2000, parties will need expressly to contract out of the Act otherwise its provisions will apply.

It is not at all clear at the current time how different parts of the construction industry will approach this legislation. We will not know until we see client's standard forms the drafting of which will be informed by a desire to give maximum protection not only to these clients but also to interested third parties such as their potential purchasers, tenants and funders. It is undoubtedly the case that to construe a contract and determine whether it purports to confer a benefit on a third party, and whether the third party's rights are limited in the manor one would expect to see in a collateral warranty (by equitable contributions clauses, or clauses excluding liability for consequential loss), will require, at least in the early period, specialist insurance or legal input. It is for this reason that members are initially advised to exclude any rights of third parties unless they have taken specialist advice. The contract with the client should contain the following wording which has been drafted by the Association of Consulting Engineers for the benefit of its members:

"Nothing in this contract confers or purports to confer any third party any benefit or any right to enforce any term of this contract."

At least for the moment, the definition of the rights of third parties should be left to negotiations over collateral warranties. In the long run, the Act is a progressive step and it is to be hoped that it eventually brings an end to collateral warranties which are often drafted in excruciating detail and add significantly to the transactions costs of development. However, it is best to wait and see how developers are likely to approach this.

Prepared for the Members of the AGS by Steven Francis of Dibb Lupton Alsop