Third-party rights and step-in provisions: Happy bedfellows?


Author: Hollie Docherty


This article was previously published in Construction News.

Most involved in projects want the benefits of collateral warranties or third-party rights in contracts, with a trend towards the former due to step-in requirements. But are third-party rights really incompatible with step-in provisions?

Those who have an interest, or are acquiring an interest, in a construction project will generally want the benefit of collateral warranties or third-party rights in respect of the building contract, key consultants’ appointments and design subcontractors’ subcontracts.

Over the past decade or so, there has been a gradual move away from collateral warranties to third-party rights, with the industry recognising that these are quicker and cheaper to obtain.

Some funders of projects insist upon being provided with collateral warranties rather than third-party rights due to step-in requirements. But are third-party rights and step-in provisions really incompatible?

Step-in rights

Step-in rights allow a funder to step into the place of another party, usually the employer, in a building contract or a consultant appointment. In doing so, the funder will take on the obligations of the employer, including the obligations to make payments.

Funders require step-in provisions to give them comfort that in circumstances where the employer defaults on the funding arrangements, the funder can step into the building contract and appointments in order to continue the development with the same contractor and project team.

In practice, step-in rights are rarely used by funders.

Third-party rights

Third-party rights allow a person who is not party to a contract – a building contract or consultant’s appointment, for example – to enforce the benefit of the contract terms against the contractor or consultant.

The right is derived from the Contracts (Rights of Third Parties) Act 1999. The act does not permit obligations or burdens to be imposed on a third party.

Third-party rights are usually appended as a schedule to the building contract or appointment. The schedule includes terms such as:

  • The contractor or consultant warranting compliance with the building contract or appointment;
  • An intellectual property licence in favour of the third party;
  • Step-in provisions (if applicable to the third party);
  • The right for the third party to assign the rights contained in the schedule;
  • Any limitations or caps on the contractor’s or consultant’s liability under the rights.

So long as the building contract and appointments are properly drafted, administratively third-party rights are easier and quicker to obtain than collateral warranties.

The building contractor or consultant only needs to be given notice of the third party’s details and interest in the project in order for the third party to obtain such rights. This can be by naming the third party in the building contract or appointment or giving notice of such a third party to the contractor or consultant.

This is significantly quicker than issuing and chasing signatures on collateral warranties, and – when solicitors are involved – far cheaper.

At the time the Contracts (Rights of Third Parties) Act 1999 came into force, many believed that the act would be the death of collateral warranties. But nearly two decades later some parties, and particularly funders, are still insisting upon collateral warranties.

Need for collateral warranties?

Some funders insist on collateral warranties over third-party rights. One of the reasons given is that step-in provisions cannot operate in third-party rights schedules.

The argument from funders is that third-party rights only give third parties the benefit of the terms of the third-party rights schedule and do not impose any obligations.

Step-in rights, by their very nature, impose obligations on the third party in stepping into a building contract or appointment.

This is true to an extent, but there is a way around this.

The step-in provisions in the third-party rights schedule can be drafted so that it is a condition of the third party giving a step-in notice that it accepts the obligations of the employer under the building contract or appointment.

By requiring the third party to give notice that it intends to step in, the third party is verifying that it accepts the obligations of the employer under the building contract or appointment.

So long as the third-party rights provisions are carefully drafted, third-party rights schedules can include effective step-in provisions.

Funders and other parties should consider whether the drafting of the third-party rights schedule is sufficient before insisting on collateral warranties.

If third-party rights are universally accepted, it will save the construction industry time and money, and may finally spell the death of collateral warranties.

Hollie Docherty, Associate, Fladgate LLP (hdocherty@fladgate.com)

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