This article was originally published in Project Scotland.
Around six years ago, I wrote in Project Scotland about the then forthcoming Scottish Law Commission report on Third Party Rights, together with draft legislation which, if effected, would introduce a statutory third party rights regime into Scots law – replacing an old common law principle under which a third party could be given a right to sue under a contract (known by the Latin phase ‘jus quaesitum tertio’).
I commented that the Contract (Third Party Rights) (Scotland) Bill – if implemented – would remove the obscurity around this area of law and may, in time, provide an institutionally acceptable alternative to collateral warranties in construction projects.
The Contract (Third Party Rights) (Scotland) Act 2017 was subsequently passed by the Scottish Parliament, and came into effect in full on 26 February 2018.
The COVID-19 pandemic accelerated a change in the way we do things, with a focus on more simple and efficient ways of processing documents – for example, by using legislation allowing contracts to be signed in counterpart and delivered electronically. In the light of this, I thought that it would be timely to look again at the case for using third party rights instead of collateral warranties on construction projects in Scotland.
A recap on the key provisions in the Act: it allows a person who is not a party to a contract to acquire the right to enforce the terms of it where (a) a contracting party undertakes that it will do, or not do, something for the benefit of the third party; and (b) it is the intention of the parties to the contract that the person concerned should be legally entitled to enforce that undertaking.
In construction contracts, third party rights can be given in two ways. First, the contract may contain a schedule of clauses which resemble those in a typical collateral warranty, with an undertaking from the party carrying out the work or services that a third party is entitled to enforce the provisions of the schedule for its benefit.
The second way is for the contract to contain an undertaking that the third party may enforce for its benefit specific clauses in the body of the contract itself (for example, provisions relating to the standard of performance, professional indemnity insurance and the right to use documents).
The third party rights take effect by the giving of a notice by the employer to the other party specifying that a named beneficiary has acquired the third party rights.
This looks like a much more straightforward and efficient approach which avoids the need to get separate collateral warranties signed up by multiple parties. So why are we still seeing collateral warranties being procured as the norm on projects in Scotland?
An oft-cited reason is that third party rights can’t effectively deal with step-in rights (the right of the third party to take over a contract where, for example, the employer is in default) – which normally involve an obligation on the party stepping in to make good outstanding payments.
Hence, parties getting step-in rights (principally those providing finance for projects) normally require a collateral warranty.
This is a valid point, but equally there is a workaround which involves the step-in right being conditional upon the person looking to step-in providing an undertaking to settle all outstanding monies due to the other party.
It may also prove to be more difficult to obtain third party rights from sub-contractors, because of lack of familiarity on their part and the typically limited involvement of lawyers below main contract level.
In truth, the main reason why there has been a lack of take up of third party rights is probably that those working within and advising the construction industry prefer the familiarity of collateral warranties.
We know that changes in embedded practices can take time – in England and Wales, it took several years for third party rights to become more commonplace there following the coming into effect of similar legislation more than 20 years ago.
If we can see the benefits of using third party rights over collateral warranties, how do we drive change and increase their use in Scotland? During the passage of the legislation, it was remarked that it will principally fall to the legal profession to change established practices and encourage use of the legislation. For me, it will be for legal practitioners to reach a consensus on a possible market standard position for third party rights and then to champion their take up within the industry. What are we waiting for?