What are 3 Party Contracts?
A 3 Party Contract is a legal agreement that involves three primary parties, typically consisting of a Principal, a Contractor, and a Subcontractor. This three-way relationship is designed to promote trust, clarify the roles and responsibilities of each party, and ensure accountability throughout the entire project.
For example, a homeowner, the Principal in this case, may enter into an agreement with an Architect or Engineer who will design a building for them. That Architect/Engineer will then likely need someone to build that structure and so they may enter into a contract with a Contractor who will build the structure and they may enter into a contract with a Subcontractor for them to perform smaller jobs until the work is complete and the structure is turned over to the Principal.
Through their agreements, the Architect or Engineer will give instructions to the Contract under the contract between the three parties and then the Contractor will give instructions to the Subcontractor under the contract between the two of them. This means that each has a Contract with the Principal or the Contractor and a separate contract with any party above them .
This 3 way Contract system is beneficial because it clearly sets out the expectations of each Contracting Party which helps simplifies the relationships between those parties. Even more important, is that the contractual agreements provide the framework for resolution of those expectations through the availability of Legal Rights and Obligations derived from the terms and conditions of the Contracts.
This allows any of the parties, including the Principal or the Owner of the Project, to seek recourse through the Courts if there are decisions that deviate from the expectations of the Contracting Parties as set out in the respective contracts.
3 Way Contracts differ from 2 Party Contract. For example a verbal agreement between an owner and a on-site resident manager about a paint job may be sufficient and acceptable, but the obligations and requirements of bringing 3 Party Contracts together could help clarify the scope and obligations expected by all for a successful outcome.
In North America, the most frequently used Contractual Agreements are those provided by the American Institute of Architects (AIA) and General Contractors Association (GCA) documents. Certain states and jurisdictions may have specific forms and stipulations that must be addressed and should be done with qualified legal advice and representation.
Essential Elements of a 3 Party Contract
A typical 3 party contract will include several important elements:
Parties Involved
Collegial Contracting: In a true collegial model, each party has equal standing. No one party has any more authority than the other party and all parties have individual input in the contract negotiations. Similarly, all parties are beholden to the same terms, descriptions, scopes of work, etc. In a true collegial contract, the liability is spread equally to all parties and no one individual or group is singled out due to one party’s failure to meet requirements.
Contract Characteristics
It is not uncommon for contracts to contain joint and several liabilities, listing each party and outlining each parties’ individual responsibilities. This model is often used to protect a subcontractor from various risks on a project, as the subcontractor will be held equally responsible for any changes to the scope of work, error in design or plans, etc.
Terms and Conditions
Often times, joint and several liability is grouped together with other party-specific clauses, but we will save that explanation for another day. Equally as important in a joint and several liability contract is the terms used to identify a "default" or "failure to perform". The terms should include contract breaches, design errors, unforeseen circumstances, human error, etc.
Dispute Resolution
Typically, disputes are handled on a contractual basis, meaning the parties expected to perform under the contract are responsible for resolving any issues that may arise within the agreed terms and conditions.
Advantages of a 3 Party Contract
A 3 party contract is beneficial to all parties involved in the agreement. For instance, the original party benefits in that they are more likely to receive prompt payment if the contract or agreement is attached to the incentive program directly. Furthermore, the third party usually pays the first party directly. This is very attractive because it guarantees that the first party will be paid, as opposed to trying to collect from the second party in the event they default and are unable to pay.
The second party also benefits from the agreement because they have become part of the incentive program. The second party no longer has to worry about paying the first party. Oftentimes, if the contract is very specific, the second party does not even have to pay the first party ever again. The third party benefits in that if they offer a business incentive program, the third party desirably has more potential to sign new clients which will further their business in the long run. Secondly, the third party benefits from signing the 3 party contract because it protects them from potential liabilities from the first party in the event the second party decides to cease their business dealings with the first party.
Common Applications of 3 Party Contracts
In construction, 3rd party contracts can be used for all of the standard construction phases such as the pre-development phase, pre-construction phase, in construction phase etc. There are also different types of agreements that are used in the construction industry such as sub-subcontractor agreements, subcontractor agreements and master subcontracts. These are typically used in a large construction project where there will be multiple sub-subcontractors and subcontractors working on the same site.
A Development Agreement is typically used for development partners. In most circumstances, development partners will not be a party to a construction contract on the actual project, but they may have a development agreement that governs the project. Master subcontractor agreements are used with subcontractors that either have a certain specialized skill such as electrical work , plumbing work, mechanical work etc. Broader master subcontractor agreements can also be used with subcontractors where the scope of work is not limited to a specific trade.
With respect to finance agreements, there may be a master form of agreement between the owners and the lenders or between the owners and the financial partners. Master finance agreements for construction financing may also be used, which will typically contain individual project schedules with the specific terms of the loan or financing for a specific project.
For supply chain agreements the most common 3rd party contract is that between the general contractor and their suppliers and individual supply contracts between the suppliers and the owner. The typical categories of these agreements are the material supply agreements for building materials, equipment rental agreements and tooling leases.
How to Draft a 3 Party Contract Effectively
It is imperative that all parties to the agreement take an active role in drafting the 3 party contract. The agreement should be drafted so that all parties receive the same protections they would receive in any other contract. Too often, the primary party negotiates the major terms and conditions of the contract, leaving the joint venture or subcontractor to either accept or reject the final draft of the contract. Though this process may be acceptable in 2-party contracts, it may not be the best approach to take when drafting 3 party contracts. All parties to the contract, i.e. the Principal, Subcontractor and Joint Venture, must play a role in drafting the contract. The parties should agree upon the details of the contract (e.g. scope of work, compensation, etc.) and commit these details to writing. A division of labor must be agreed upon to determine which party will perform certain aspects of work, providing each party with the accountability it needs to fulfill its obligations under the contract. Further, the contract should include maximum (not minimum) performance requirements and penalties for deviations from the contract schedule or budget.
Challenges and Common Issues of 3 Party Contracts
3 party contracts can be a bit more complicated than 2 party contracts. No matter how many parties are involved, however, the foundations of forming a legally enforceable contract are the same. This means that you will want to have certain elements present in order for it to be binding:
All parties must have a mutual agreement between all of them. The first step is for your lawyers (if you are retaining separate lawyers, since this is typically more expensive and not necessary for the majority of 3 party contracts) to draft out an agreement that clearly states the offer, the acceptance of the offer, and the terms of that contract being agreed to.
Capacity of all parties to enter into an agreement. Each of the parties involved must be of sound mind and capable of understanding the terms of the contract. All parties should be aware of what they are signing, and should voluntarily agree to the terms without coercion or duress. While capacity can be hard to prove , typically if all parties are mentally competent and over the age of majority, this element is fulfilled.
Legality of the contract. The contract must not violate any laws or regulations and it cannot be for any illegal services.
You will also need to ensure that all the parties are acting within the scope of their legal authorization when they are signing. What is going to make these contracts a little more difficult to navigate than a more typical 2 party agreement, is that you may have to deal with some additional challenges.
These challenges include:
Because of the number of parties involved there is potential for poor communication, and some of the parties having different interests when it comes to the negotiations. You may also have parties that already have a relationship before the contract is formed, and some of them may come into a negotiating table with some shared expectations or previous agreements, which could make negotiation between the two parties more difficult.