Death of Collateral Warranties?  Part 2

 

Case Law Update  

Back in July 2018, we wrote about collateral warranties, and whether the emerging alternative of Third Party Rights (TPRs), with many benefits but some disadvantages, would gain marketplace traction.

In order for that to happen, however, an industry often needs time and new legal cases to set precedent and give an industry comfort about trying a different concept.  One such recent case has provided some impact, both positively and negatively.

Prior to the new case law, though, a quick recap on Collateral Warranties and TPRs:

Background

A Collateral Warranty (CW) is a supporting legal document to the main construction contract, that provides potential legal cover to third parties that the main contract does not offer. 

It is used because in the build contract there is no direct relationship with, or obligation between and to, some of the project stakeholders and participants, such as between a contractor and either a tenant, lender or purchaser. 

Not having this legal protection can result in financial risk for third parties that are not stated or covered in the primary contract.

In practice a CW requires a construction contractor, sub-contractor or architect to warrant to a third party such as a lender, end buyer or tenant, that they have fulfilled their duties under the construction contract.

The alternative is to utilise the Contracts (Right of Third Parties) Act 1999 (TPRs).

TPRs allows the primary contract to assign rights to third parties who aren’t signatories in the primary contract.  This is deemed a more efficient way to work instead of creating separate, time consuming and expensive collateral warranties. 

In essence TPRs should amount to the same thing as CWs but without the time, cost and hassle factor.  However, industries can be slow to adopt change until there is solid case law to back up a change in direction.

(If you’d like a quick refresh, the July 18 article is below)

The Death of Collateral Warranties?

 

So what’s the new case law?

Amongst other cases this year, the most interesting is the judgement on 6^thMarch 2019 in the case of Chudley vs. Clydesdale Bank.  

Chudley was a group of investors who lost their deposits on a failed scheme in Cape Verde. 

Clydesdale Bank, who were holding the investor deposits, has supposedly provided deposit protection using an escrow account but the bank had been found to have released the deposits without permission. 

Chudley were not named on any paperwork, and the only possible ‘contract’ in place was a Letter of Intent on investor deposits between the developer, promoters and the bank. 

Chudley in the first instance lost their case as the Courts ruled there was no legally binding contract in place.  Chudley then appealed to the Court of Appeal, who ruled in their favour, citing that the LOI was in fact binding. 

Even more interestingly, there was no formal identification of Chudley on any paperwork, with the Court of Appeal ruling that the “Segregated Client Account” was enough to effectively name Chudley as a beneficiary.

 

So what’s the upshot of all this?  

Whilst this was not a suit against a developer, the principles remain the same and serve to have a future impact on developers looking at whether to use TPRs instead of CWs.

Effectively the Courts are using a more flexible and arguably looser approach to how beneficiaries are covered, when calling upon the Contracts (Right of Third Parties) Act 1999, particularly if no CW or Third Party assignment is in place.

 

The impact as I see it for developers (and I’m not a lawyer!) are three fold:

1 - Be extra careful how your warranties or TPRs are drawn up, given third party beneficiaries have arguably more cover now than ever before.

2 - Whilst contracts still need to be carefully drawn up, TPRs are being given more credence these days, and the benefits of which cannot be ignored for much longer by lenders, developers and contractors alike. The ability to assign beneficiary rights into the main contract has the ability to do away with much of the time, cost and hassle factor that collateral warranties bring with their use.

3 - Any further cases may further affect the usefulness of TPRs either way, depending on the case and result.

 

Now for some expert legal comment on the above: 

"As Chris has identified, the Contracts (Rights of Third Parties Act) 1999 (“Act”) has clearly not taken off to the extent that had been hoped.  

However, this case again shows the courts are willing to apply a very broad interpretation of the Act and there is hope this might give construction parties more confidence to move away from the traditional collateral warranties approach. 

My personal view is that any substantive change is likely to take more time as construction parties are still reluctant to move away from their tried and tested collateral warranties. 

I suspect the bigger impact of this case will be parties tightening up on the application of the Act to ensure they do not inadvertently grant any third party rights."

Paul Bramall, Partner, Wolferstans

 

If you’d like to look at this case in more detail, from different legal perspectives, please take a look by clicking on some of the following links.

Case Links

https://thrings.com/news/developers-beware-of-third-party-rights

https://www.stevens-bolton.com/site/insights/articles/banks-duties-to-noncustomers-who-has-the-right

http://www.allenovery.com/publications/en-gb/Pages/third-party-rights-identification-of-third-party.aspx

https://www.dacbeachcroft.com/en/articles/2019/may/third-party-rights-chudley-ors-v-clydesdale-bank-plc/