Developers beware of third party rights

The case of Chudley v Clydesdale Bank plc demonstrates how the Contracts (Rights of Third Parties) Act 1999 (the Act) is being more freely applied to allow a third party to sue under a contract to which they are not a party if they have suffered a loss as a result of a breach or default.

When used correctly, third party rights create a contractual link between a party to a contract and a third party beneficiary, typically a funder or purchaser.

Traditionally, collateral warranties provided by a contractor, consultant or any other party involved in the design and construction of a development, have given beneficiaries protection and, subsequently, the ability to sue under the warranty.

Whilst warranties are undoubtedly an effective form of protection for parties with an interest in a development, they are time-consuming and expensive to implement. The alternative use of third party rights has often been met with a certain reluctance in the construction sector. However, in recent years there has been an increasing readiness to replace collateral warranties with the vesting of third-party rights, giving any potential beneficiary the comfort of protection as soon as a notice is served on the original party.

The case

The claimants (Chudley) had invested in a holiday resort development in Cape Verde. According to a letter of instruction between the promoters, developers and the bank, any deposits by investors were to be held in a separate account, subject to certain terms - notably the need for a solicitor's undertaking for any release of those funds from the segregated account. After the claimants became aware that their funds were being fraudulently released, they brought proceedings against the bank.

In the first instance, the court found the claimants could not bring a claim under the Act, one reason being that the letter itself did not amount to a contract capable of binding third parties to the provisions of the Act. The claimants appealed to the Court of Appeal.

The ruling

Unlike in the first ruling, the Court of Appeal underlined the flexibility of using third party rights, providing clarity as to the circumstances under which the Act could be applied:

  • A third party beneficiary need not have been aware of an underlying contract in order to rely upon it at a later date.
  • Where the Act requires “express” identification of the third party to be able to sue under the contract, identification of a class of beneficiaries is sufficient, and they need not be referenced by name. In this case, the reference to a “segregated client account" satisfied the requirement for express identification even though the class of beneficiary was not referred to.
  • The fact that the segregated client account had been set up in order to protect the investment funds satisfied the requirement of the Act to confer a benefit on the third party.

What it means

The Court of Appeal’s decision demonstrates a willingness to apply the Act broadly in relation to the vesting of third party rights. While there has been some aversion to relying solely on third party rights within the construction sector, this court decision and the development of robust clauses are likely to encourage a further shift away from collateral warranties over the coming years.

The decision also shows the risk to contracting parties who are unaware of these rights. Those wishing to avoid the granting of third party rights should seek professional legal advice to ensure their contracts effectively exclude them.

For more information on third party rights, or to discuss your construction related matters, please get in touch with Alice Brydon or a member of the Construction team.

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