Privity of Contract: The role of statutory warranties for third parties to construction agreements

Increasingly, we are reviewing contracts whereby developers seek to provide benefits to third parties by increasing who the contractor owes its obligations to under a contract. For example, a developer may amend all the indemnities in a contract to benefit “Indemnified Parties”. These “Indemnified Parties” are ordinarily third parties which have an interest in the works such as homeowners in residential projects or financiers where the developer is taking out a development loan.

On a first glance, this appears to contradict the well-established doctrine of privity of contract. Privity of contract prevents third parties from being bound by or suing upon a contract which they are not a party to.[1] Only a party to a contract can sue the other party to the contract for a breach of that contract.

Traditional construction contracting

Privity of contract plays an important role in the structure of construction contracts, particularly for developers, head contractors and subcontractors. There is a ‘chain’ of contracts which characterises most large construction projects. A party’s liability is limited to the counterparty it contracts with.

On a construction contract, a developers contracts with a single entity (i.e. the head contractor) and that head contractor contracts with its subcontractors. A subcontractor cannot sue the developer under contract (for example, for non-payment) as it has no contractual link. Likewise, a homeowner cannot sue the head contractor (for example, for defective works) under contract – it would have to sue the developer under its sales contract first and then the developer would then sue the head contractor and so on.

Therefore, third parties with an interest in the works can become vulnerable to loss arising from acts of parties within a private contractual arrangement. For example, if there are defective works on a residential project, but the developer becomes insolvent, how does a homeowner recover its losses?

To provide better consumer protection, the legislators have developed various statutory regimes which import non-excludable warranties and duties of care which protect third parties from the potential unjust consequences of the privity of contract doctrine. In the construction industry, certain third parties are able to hold parties to private contracts accountable for a breach of contract.

In the balance of this article, we review the statutory regime which provides a remedy for homeowners in NSW that circumvent the doctrine of privity in construction agreements and compare this to the approach taken in England.

Influence of statute on privity of contract in NSW The Home Building Act 1989 (NSW) (HBA)

The HBA contains a number of warranties which contractors carrying out residential building work owe to third parties outside of those expressly stated in the construction contracts. Under section 18B of the HBA, warranties protect all homeowners, including successors in title, against residential building work which is not completed with due skill, care and diligence. Third parties are also protected with respect to the quality of the materials supplied for the work. These warranties apply regardless of any limitations of liability imposed by construction contracts.

These warranties are not restricted by the privity of contract doctrine. For example, section 18B(2) of the HBA allows homeowners to claim against head contractors and subcontractors with whom a homeowner does not have a contractual link. These warranties promote accountability for all parties engaged to perform residential building work.

Another example is Section 18D, which allows future successors in title (such as purchasers of the homeowner’s property) to hold head contractors and subcontractors liable for breaches of the warranties under section 18B. Such purchaser may therefore sue head contractors and subcontractors for failing to meet the HBA standards.

The English ApproachThe Contracts (Rights of Third Parties) Act 1999 (C(RTP) Act)

The C(RTP) Act enables a person who is not party to a contract to enforce a term of a contract if that contractual term purports to provide a benefit to them.[2]

In effect, the C(RTP) Act cuts through the difficulties which arise through the privity of contract doctrine. However, parties are permitted to contract out of the C(RTP) Act and it is commonplace to see the C(TRP) Act excluded by developers in English construction contracts.

Conclusion

Privity of contract is commercially important for parties entering into a contract. In the construction sector, it enables parties to understand the scope of their obligations and risks on a given project and manage these appropriately.

However, for residential building work (where the end-consumer may be a homeowner), the HBA plays an important role in overcoming the doctrine to enable the end-consumer to enforce rights under a contract to which they are not a party.

Statutory regimes which extend the liability of the parties to a contract to third parties create contractual uncertainty as it is not always clear where the risk lies.

Head contractors should be aware that when entering into a head contract with a developer on a residential project, they may ultimately be sued by a homeowner (or Owners Corporation). Their obligations and risks are not just those set out in writing in the contract between the developer and head contractor.

If you’d like to discuss this article and your circumstances further, contact Stefan Fenk, Partner or William Barrington, Senior Associate.

This publication is for general information purposes only and does not constitute legal advice. You should seek legal advice regarding your particular circumstances.

[1] Carberry v Gardiner(1936) 36 SR (NSW) 559 at [573]-[574]; Wilson v Darling Island Stevedoring & Lighterage Co Ltd (1956) 95 CLR 43 at [66]-[67].

[2] s1 Contracts (Rights of Third Parties) Act 1999