A preview of The Contracts (Rights of Third Parties) Bill

United Kingdom

Caroline Cummins previews a new Bill

The Contracts (Rights of Third Parties) Bill has recently been sent to Committee after having been debated in the House of Lords. This Bill has been brought before the Houses of Parliament as a result of the Report of the Law Commission (No. 242) (published in 1996) on the doctrine of privity of contract. The Report recom-mended that legislation be enacted to amend the doctrine so that third parties to a contract could enforce rights conferred on them by it (although it also recom-mended that the rule that parties to contracts cannot impose burdens on third parties should remain intact).

The Bill follows the form and substance of the draft Bill attached to the Law Commission Report. It will come into force six months after receiving the Royal Assent (although it will not affect contracts entered into before that date).

If it is enacted in its current form, the Bill will mean that third parties can enforce rights in contracts where the contract expressly provides that they may do so or where there is a contractual term which purports to confer a benefit on them. This right is subject to the following provisions:-

The third party must be expressly identified in the contract by name, as a member of a class or as answering a particular description (although it need not be in existence at the time the contract is entered into).

The promisor will be able to rely both on defences and set-offs which arise from the contract and which could have been relied on by him in answer to a claim by the other party to the contract. It may also rely on defences, set-offs and counterclaims which relate specifically to the third party and which arise otherwise than by reason of the contract.

Once the third party has a right under the contract and either the third party has communicated its assent to it or the promisor knows that the third party has relied on that right or could reasonably be expected to foresee that the third party would rely on it, then the parties cannot amend or cancel that right without the third party's consent (unless the contract expressly enables them to do so).

This reform is long overdue - reforms to the privity doctrine have been considered by reform committees since 1937 - and is to be welcomed as bringing English contract law into line with other common law jurisdictions. However, for the construction industry, two questions immediately spring to mind:-

Does the Bill abolish the need for collateral warranties?
The answer is potentially yes, for the most straightforward of collateral warranties, if the contract is drafted carefully enough. However, some forms of "collateral warranty" will undoubtedly need to be retained (for example, where the warranty is given in favour of the funder and includes step-in rights) although these warranties might less confusingly be categorised as "direct agreements".

There may, of course, be third parties who cannot benefit from the Bill and will therefore have to rely on their rights in tort or the common law. For example, there may be tenants of a building who have suffered losses due to breaches of contract by the Contractor that built it but who cannot pursue their claims under the terms of the new Bill because the Employer did not anticipate letting the building and so made no adequate provision in the contract to give rights to third party tenants. However, in these circumstances, the Employer is equally as unlikely to have made provision in the construction contract for collateral warranties in favour of tenants either so such third parties will be no worse a position.

Can a third party take advantage of the dispute resolution processes set out in the contract?

Under the original Bill attached to the Law Commission's Report, arbitration agreements were to be expressly excluded from the operation of the Act. The Law Commission thought it unsatisfactory to allow third parties to take the benefit of arbitration clauses unless the entitlement to enforce also carried a duty to submit to arbitration. However, to impose the burden of an arbitration clause on the third parties would have been contrary to the policy of the reform. Arbitration agreements were, therefore, expressly excluded to avoid this problem.

However, that exclusion has now been deleted, the rationale being that a third party will not be able to obtain a stay of Court proceedings in favour of arbitration unless it has shown a willingness to arbitrate so, in practice, the problem should not arise in any event.

It seems, therefore, that third parties falling within the ambit of the Bill will have an option whether or not to arbitrate their claims. The same principle must apply in respect of most alternative dispute resolution clauses. There is, however, an additional question in respect of adjudications under the Housing Grants, Construction and Regeneration Act 1996: will a third party be entitled to adjudication under that Act? The answer is no (although it would be possible to provide otherwise in the contract) - Section 108 of that Act gives the right of adjudication to a "party to a construction contract" and Section 7(4) of the Bill provides that the third party is not to be treated as a party to the contract for the purposes of any other enactment.

It remains to be seen, of course, whether the Bill will be enacted in its current form.