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.
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FREE CHECKLIST: Reviewing a Funder Collateral Warranty
This checklist sets out the key issues to consider when reviewing a collateral warranty on behalf of a funder. The term ‘funder’ is used throughout to refer to any party that is providing finance in connection with a project.
Available from our free downloads area.
Source: LexisNexis Purpose Built
Collateral Warranties: Step-in rights (and wrongs…)
