Collateral Warranties: Step-in rights (and wrongs…)

by Hardwick Legal | Aug 3, 2015 | Purpose Built (LexisNexis)

Ann Minogue, partner at Macfarlanes LLP, explores the issues and risks regarding step-in rights, particularly in relation to the Contracts (Rights of Third Parties) Act 1999 (C(RTP)A 1999).

What is the difficulty regarding step-in rights in relation to the use of C(RTP)A 1999 to grant rights to third parties, instead of giving a collateral warranty?

What solutions to this problem can be adopted?

The step-in rights must be exercised by a notice issued by the funder. If, in order to be a valid notice for step-in, the funder must accept as a condition of the notice that it assumes the employer’s liabilities under the consultancy agreement or building contracts, then the obligations are also transferred. Accordingly, the step-in is a conditional right which is triggered by a notice under which the employer must assume the obligations. The Joint Contracts Tribunal (JCT), who have adopted third party rights (TPRs) for funders, secured a QC’s opinion to the effect that this was a valid solution to the conundrum created by C(RTP)A 1999.

Which is the most favourable? Is this also the most common?

Unfortunately, solicitors acting for funders and banks are very cautious and have not readily embraced this solution. The use of TPRs is simpler and avoids a proliferation of paper work. It is so much easier to trigger TPRs rather than get collateral warranties executed particularly where a funder comes on board after the relevant consultancy agreement or building contract has been executed. However, while adopted by the JCT, TPRs are not much used in practice for funders where the use of collateral warranties is more

Are there any common pitfalls or mistakes to avoid?

In relation to the drafting of step-in rights, whether in collateral warranties or in TPRs, the following issues arise:

• the question of what should happen if the employer disputes the right of the funder to exercise its step-in rights because of an event of default or termination of the finance agreement—most collateral warranties or TPRs will provide that, as between the employer, funder and consultant or contractor, the service of the notice by the funder is ‘conclusive evidence’ of the funder’s right to serve the notice but obviously, there should be some redress under the finance agreement if the notice is wrongly served

• since the employer needs to consent to the consultant or contractor acting on a funder’s notice, it is vital that the employer is a party to any collateral warranty or TPRs where step-in rights are conferred, otherwise the consultant or contractor risks being in breach of contract by acting on the funder’s notice

• notice periods all need to marry up—if, for example, the consultant or contractor alleges he has not been properly paid and he must give, say, 21 days’ notice under the consultancy agreement or building contract before terminating for non-payment, the funder’s notice will ideally dovetail with that notice period, there is no point in providing that the funder’s notice takes effect after, say, seven days when the employer has a further 14 days under the consultancy agreement or building contract to cure his breach

• when a funder validly steps in, he must assume all of the obligations of the employer under the consultancy agreement or building contract. If he only assumes an obligation to pay amounts which become due after step-in—but not amounts accrued due at the date of step-in—then the consultant or contractor will simply serve another notice of intention to terminate under the consultancy agreement or building contract on the basis that non-payment is a continuing breach and accrued amounts remain outstanding

• if step-in rights are given to more than one party there is a question of who takes priority—clarifying this provides comfort for the consultant or contractor about which notice to ‘accept’

Has this issue been considered by the courts?

So far as I am aware, the precise operation of step-in provisions has not been considered by the courts. In truth, this is because funders will usually appoint administrative receivers to the employer in the event of an insolvency rather than exercising their step-in rights. Though all parties to the construction process spend endless hours worrying about the terms of the funder’s security, the truth is that the step-in rights in collateral warranties or TPRs are rarely used.

Does the decision in Hurley Palmer Flatt v Barclays Bank cause concern as to how the provisions and mechanisms developed to deal with this issue might be interpreted by the courts and whether they will be enforceable?

No, the decision in Hurley Palmer Flatt v Barclays Bank plc 2014 does not consider TPRs and step-in rights. Rather, it determined that a third party enforcing its rights could not bring its claims by way of adjudication. It can, however, enforce its rights in litigation or arbitration and C(RTP)A 1999 expressly states that rules relating to damages, injunctions, specific performance and other relief will apply to enforcement by a third party just as they apply to enforcement by a party to contract.

The decision in Hurley Palmer Flatt should be contrasted with the decision of Akenhead J in Parkwood Leisure Ltd v Laing O’Rourke Wales and West Ltd 2013 in respect of a collateral warranty. He decided that a collateral warranty was a ‘construction contract’ and, therefore, the right to adjudicate applied. So it seems there is no right to adjudicate in relation to TPRs but a right to adjudicate under collateral warranties given by contractors before practical completion (so warranting future performance) at least. This does not seem very logical or

Given that funders are generally reluctant to forgo a collateral warranty in favour of TPRs, is this problem largely hypothetical, rather than one commonly dealt with in practice?

At the moment, yes. Until funders’ or banks’ lawyers can be persuaded to change their longstanding practice of asking for collateral warranties. In truth, on most projects it is not hugely inconvenient for the employer to obtain a collateral warranty in favour of the funder since the funder is usually known and identified by the time all consultancy agreements or the building contract is entered into and therefore it can be executed at the same time as the relevant contract.

Source: LexisNexis Purpose Built
Collateral Warranties: Step-in rights (and wrongs…)

In theory – CDM Regulations and novation

by Hardwick Legal | Aug 3, 2015 | Purpose Built (LexisNexis)

 What effect do the new CDM Regulations 2015 have on a principal designer novated to a contractor? Seb Oram, construction law barrister at 3PB Barristers, considers a hypothetical scenario that addresses the implications of the new CDM Regulations.

Does this situation contravene the requirements of the CDM Regulatiosn 2015? Must a direct relationship be maintained between the client and the principal designer?

In my view the situation does not contravene the CDM Regulations. As long as a principal designer is appointed there is no requirement for a direct relationship between him and the client.

I consider that reg 5(1) clearly requires the client to ‘appoint in writing…a designer with control over the pre-construction phase as principal designer’. In the situation we are discussing, there would be a written appointment by virtue of the novation agreement, and indeed the original contract of appointment that is being novated. The critical issue is therefore whether the appointment has to be direct (between client and principal designer) or can be indirect (between the contractor and the principal designer).

In my view ‘appoint’ in reg. 5(1) is capable of being interpreted as ‘secure the appointment of’, and would be interpreted in that way. It does not require the client to make a direct appointment. Firstly, guidance on the CDM Regulations  inferentially supports this view. Managing Health and Safety in Construction: CDM Regulations 2015—Guidance on Regulations (HSE Publications, L153), provides at para 37 that:

‘The duration of the principal designer’s appointment should take into account any design work which may continue into the construction phase or any issues that may arise during construction involving the need to make suitable modifications to the designs. For projects involving early work by a concept architect or project management company where a design and build contractor or novated designer is subsequently involved, it may be appropriate for the initial principal designer appointment to be ended and a new principal designer appointed.’

It doesn’t go so far as to say by whom the new principal designer needs to be appointed. However, the reference to novation is a reasonably clear indication that our scenario was not intended to be contrary to the scheme of the new CDM Regulations.

Secondly, it is of some relevance that the CDM Regulations envisage that the appointment of the principal designer may be terminated (see reg 11(7)). It would be odd if the client could terminate the appointment, but could not transfer it to another. (In my view, however, reg 5(1) would be interpreted as requiring a principal designer throughout the pre-construction phase, as defined in reg 2(1).)

I suspect that the effect of the arrangement that we are discussing would be that PDQ (the design/build contractor) would itself have become a designer under the CDM Regulations—it would be a person who ‘arranges for, or instructs, [a] person under [its] control to [prepare or modify a design]’ (definition of designer in reg 2(1)). It would therefore owe the duties in reg 9. So we have a situation where there is a contractor who is the designer and the principal designer who is appointed to act for him who is also the designer.

If this situation is contrary to the CDM Regulations 2015, what should the parties do upon novation to continue to satisfy the requirements of the CDM Regulations ?

I don’t think there needs to be a direct contract or a deed of warranty or anything similar. I think the scheme of regulation is simply to make sure that you have someone there who is looking after the health and safety aspect of the pre-construction phase—I don’t think how he or she is appointed is too material so long as they are in post and there is effective control over the performance of their duties.

A cautious contractor would be advised to obtain a contractual indemnity from ABC (the architect) should they fail to fulfil their duties under the regulations. That would require a minor modification to cl 1.4 of the City of London Law Society novation agreement. A cautious employer would want to do the same, particularly because 3.16 of the JCT Design and Bulid contract (as amended by Amendment 1, March 2015) contains an undertaking by the employer (to the contractor) that they will ensure that the principal designer carries out their duties under the CDM Regulations 2015.

Do you envisage any other areas of potential confusion or inadvertent non-compliance arising out of the new CDM Regulations ?

One area that I think might be a potential source of considerable difficulty is the application of the CDM Regulations to framework agreements and partnering contracts where you have an overarching agreement under which various projects might be instructed to be carried out. It’s unclear whether you can have just one principal designer under the framework contract or whether you would need separate appointments for each of the underlying contracts.

Source: LexisNexis Purpose Built
In theory – CDM Regulations and novation