Building Blocks: Collateral Warranties vs Third Party Rights

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

The aim of collateral warranties and third party rights is to provide security to third parties who are not party to an underlying building contract, appointment or sub-contract, but in which the third party has an interest.

What is a collateral warranty?

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.

An 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 as the occupier is not a party to the architect’s appointment.

What are “third party rights”?

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 terms of a contract, not the whole contract itself.

For instance, 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, for the Third Party Rights Act to apply, the contract must expressly state that a third party has specific rights 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.

Collateral Warranty vs Third Party Rights

Both collateral warranties and third party rights can provide effective construction security to a third party beneficiary if they are drafted properly and are comprehensive.

Despite collateral warranties tending to be the preferred option, third party rights are increasing in popularity as they can be incorporated into building contracts, subcontracts, etc, with a simple notice (nothing needs to be signed by the warrantor). Therefore, they avoid the need to produce detailed additional agreements.

In light of recent case law, it appears that adjudication applies to collateral warranties however adjudication does not apply to third party rights.

The rights being conferred by a third party rights notice can be narrowed to specify exactly which rights and/or contract terms are to be transferred. Whereas, with collateral warranties the terms of the entire contract are to be transferred across.

Collateral warranties remain popular because they are perceived as being more effective since they mirror the responsibilities of the underlying contract. Although the administrative exercise of organising collateral warranties can be considerable, they seem to be the chosen option for enforcing third party rights – the comfort of receiving a signed, physical document cannot be underestimated!