Only two more months to get used to the Contracts (Rights of Third Parties) Act

United Kingdom
From 11 May 2000 the Contracts (Rights of Third Parties) Act 1999 will potentially apply to a new contract unless the contract excludes the Act. Until then, it only applies if the contract expressly applies it.

The Act modifies the legal rule that you can only enforce rights under a contract if you are a party to it (or are enforcing by right of a party - for example, as a party’s successor or assign). Since 11th November, 1999 a contract can validly contain a promise by one party to another that the promising party will be liable under the contract to someone who is not a party. As long as the contract is enforceable on normal principles, the third party will be able to enforce his rights directly against the contracting party who granted the rights.

The Act provides that a third party right will be enforceable not only if the contract expressly says so, but also if it “purports” to confer a benefit on the third party. No such benefit is enforceable, however, if “on a proper construction of the contract it appears that the parties do not intend the term to be enforceable by the third party” (section 1(2)).

Here are some key points to bear in mind.

Benefits, not burdens: It is still not possible for a contract to impose a burden on a person who is not a party to it.

It is, however, possible to provide that the third party right will only be enforceable once the third party has complied with some pre-condition. The difference is that the third party is not contractually obliged to do whatever it is, and can simply choose to forego his third party right.

What sort of rights? The Act imposes no limit on the sort of rights that can be conferred on third parties. Also, it expressly says (in section 1(6)) that granting a right to a third party includes giving him the protection of an exclusion or limitation of liability.

While this means that the contracting parties can design whatever they like in terms of third party rights, it also means that they can restrict the rights, and their liability in relation to them, as much as they please. The reasonableness test in the Unfair Contracts Terms Act 1977 does not apply, for example, if the relevant contracting party excludes his liability to the third party for negligence, or for breach of the third party’s rights under the contract (sections 7(2) and 7(4)). (Any exclusion in respect of death or personal injury resulting from negligence would, however, be void).

Normal contractual principles apply, so the third party right will not be enforceable if, for example, its terms are uncertain, or the third party’s identity cannot be ascertained when the relevant contracting party has to perform the obligation to the third party.

What sort of remedies? The third party has the right to go for any court-awarded remedy which would have been available to him in an action for breach of contract if he had been a contracting party (section 1(5)). This means that he can apply, for example, for damages, injunctive relief, a declaration or specific performance. He cannot, however, assert self-help remedies (for example, by purporting to terminate the contract when the contract does not give him that right).

The normal rules (eg causation, remoteness, mitigation) apply, including limitation of actions (section 7 (3).

Contracting party’s defences: The relevant contracting party has certain defences. For example,

- if he can claim damages for breach of the contract by the other contracting party, he can also assert a set-off against the third party (in other words, set-off arising from the contract);

- the contract might provide that he can set off against his obligation to the third party an amount due to him from the other contracting party under a wholly unrelated contract; and

- he can invoke any rights of set-off or counterclaim he happens to have in relation to the third party.

The contract can expressly waive these rights of defence, set-off or counterclaim. (sections 3(2) to (5)).

In contrast to the position of the third party (see above), a contracting party can attack the contractual term invoked by the third party (it might, for example, be an exclusion of liability) on the grounds that it fails the reasonableness test under the Unfair Contract Terms Act 1977. Also, he could resist the third party’s claim on other grounds which would have been available if the third party had been party to the contract - for example, that the contract was invalid for fraud, duress, undue influence or failure of consideration.

Variation and rescission of the third party right: Unless the contract provides otherwise, the third party right is automatically entrenched and cannot be varied or rescinded without the third party’s consent (section 2). But (again, unless the contract provides otherwise) this protection only applies if:

- the third party has communicated his assent to the term to the relevant contracting party (by words, conduct or writing received by that party); or

- that party is aware that the third party has relied on the term, or

- he can reasonably be expected to have foreseen that the third party would rely on the term and the third party has relied on it.

There is a limited right of recourse to the court for an order dispensing with the third party’s consent - for example, if the third party’s whereabouts cannot be ascertained or he is mentally incapable. The court can order that the third party be compensated for loss of his prohibition.

Excluded contracts: The Act applies to all documents or arrangements intended to create legally binding obligations except contracts of the sort referred to in section 6: basically, negotiable instruments, the memorandum and articles of association of a company, employment contracts, and carriage of goods contracts.

See also the following articles (with particular focus on issues for the Construction industry) stored in Law Now’s archive:

- The Contacts (Rights of Third Parties) Act 1999 - Caroline Cummins 10 Nov 99

- The Contracts (Rights of Third Parties) Bill - Paul J Cowan, 01 Nov 99

- The Contracts (Rights of Third Parties) Bill - Ann Minogue 01 Nov 99.

For further information on how the Contacts (Rights of Third Parties) Act affects you, please contact Simon Howley on 0171 367 3000 or by e-mail on sqh@cms-cmck.com.