REUTERS | Mike Blake

Third party rights or collateral warranties? The world after Parkwood

The real estate industry can be slow to react to innovation. The slow uptake of third party rights in lieu of collateral warranties is a classic example of this: the Contracts (Rights of Third Parties) Act 1999 (Third Party Rights Act 1999) is 14 years old, yet there are still parts of the industry that do not trust third party rights.

Ironically, the recent judgment in Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd suggests that perhaps our scepticism might have been better directed at collateral warranties. If Parkwood is correct, then for the last 17 years it would seem that the industry has fundamentally misunderstood the nature of some of the collateral warranties that it has been writing.

What if Parkwood is right?

In Parkwood, Akenhead J decided that a collateral warranty was a construction contract for the purposes of the Housing Grants, Construction and Regeneration Act 1996 (Construction Act 1996) in a situation where it:

  • Included an undertaking by the contractor to continue to comply with the underlying construction contract.
  • Was delivered before practical completion.

It would be fair to say that this conclusion caught the legal profession by surprise, with many commentators concluding that the decision is wrong (for example, see John Hughes-D’Aeth and Matt Molloy’s recent blog posts).

I too was rather surprised by Akenhead J’s conclusions and found myself pondering over my morning coffee what would be the effect if we followed Parkwood to its natural conclusion. I picked up my trusty copy of the Construction Act 1996 and started to read. Twenty minutes later I put it down again in a cold sweat.

What had upset me? This: if Parkwood is correct, then it is not only the adjudication provisions of section 108 that would be incorporated into collateral warranties – the rest of the Construction Act 1996 will also apply.

Section 109 provides that a party to a construction contract is entitled to some form of periodic payment if the duration of the work is to be more than 45 days. The parties are free to agree the amounts, frequency and circumstances triggering such payments, but in the absence of such agreement, the Scheme for Construction Contracts (England and Wales) Regulations 1998 will apply.

Now, I have never seen a collateral warranty that includes Construction Act-compliant payment provisions. This is not surprising, given that no-one would ever expect the beneficiary of a collateral warranty to be liable for payment (except in the case of step-in). However, if the collateral warranty is a construction contract, then section 109 will import all of the Scheme’s payment provisions. The Scheme in turn provides for the contractor to be paid for the value of work done, less sums already paid.

In short, the decision in Parkwood potentially gives the absurd result that, against all the intentions of the parties, the beneficiary becomes directly liable to pay the contractor.

One would hope that the courts would give such an argument short shrift. Nonetheless, if I were one of those banks that has continued to insist on collateral warranties over third party rights, I would be looking at my filing cabinet full of warranties with an air of suspicion.

Where does Parkwood leave third party rights?

Where parties have used third party rights, they should be able to breathe a sigh of relief. While the beneficiary’s third party rights derive directly from the construction contract, sections 108 and 109 of the Construction Act 1996 are applicable only to “a party to a construction contract”. A third party is by definition not a party to the contract, so the provisions of sections 108 and 109 do not apply and they cannot be held liable for payment. Indeed, the Third Party Rights Act 1999 can only be used to confer rights, and not obligations.

That said, there is no reason why the right to adjudicate could not be extended to third parties, should the parties wish to do so. There may also be arguments about whether sub-section 1(5) of the Third Party Rights Act 1999 itself extends adjudication rights to the beneficiary, as this provision makes any “remedy” for breach of contract that is available to the parties in an action for breach of contract available to the third party (although, strictly speaking, adjudication is a means of enforcing such remedies as the party has, not a “remedy” in itself). However, unlike collateral warranties subject to the Construction Act 1996, the contracting parties are free to extend or exclude the third party’s rights. After all, where the Construction Act 1996 is all about limiting freedom of contract, the Third Party Rights Act 1999 is concerned with extending it.

Given the overwhelming cost and administrative advantages of third party rights, I cannot help but wonder whether the uncertainties raised by Parkwood might help lay collateral warranties to rest.

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