UK: Contracts (Rights Of Third Parties) Act 1999

The old general rule was that only a party to a contract could enforce its terms. Anyone else (a "third party") could not. The Contracts (Rights of Third Parties) Act 1999 ("the Act") has changed this in that it enables third parties, in certain cases, to enforce terms in contracts made in their favour.

The Act applies automatically to most contracts entered into on or after 11 May 2000, both written and oral. This will not only capture new business relationships but may affect established ones too, such as the renewal of an existing contract.

Some contracts are excluded from the Act - certain carriage of goods contracts, negotiable instruments, and the memorandum and articles of association of a company. Also, third parties may not enforce terms in employees’ or other workers’ contracts against the employee or worker.

A third party right will arise in a contract if:

• the contract expressly gives the right - for example, if the contract states that XYZ Ltd (the third party) has the right to enforce certain warranty provisions; or
• a term purports to confer a benefit on the third party - for example, if a supply contract between manufacturer and dealer states that consumers (third parties) are protected by a product guarantee.

However, in the latter case, a right will not arise if it is clear that the parties do not intend the term to be enforceable by the third party.

The Act applies to any sort of rights including a right of a third party, such as an employee or sub-contractor, to the protection of limitations on liability.

Any rights which a third party may have under the Act will be in addition to any other rights of the third party which exist independently: if a third party is able to establish a claim in tort, such as a negligence action, or under any other legislation or even another contract, these claims are not affected.

For any right to be enforceable, it must be clear who the intended third party is. This can be a named individual or company, but can also be a whole class of persons; the third party does not even need to exist when the contract is made.

Many businesses, especially groups of companies, will find the Act helpful in allowing them to structure their arrangements more easily:

• central purchasing contracts - by allowing warranties and indemnities to be enforceable by the relevant group member, which may not be the contracting party;
• M & A transactions - for similar reasons and to protect institutional investors;
• supply arrangements - to allow sub-contractors to benefit from exclusion clauses;
• software licensing - to provide rights to software owners in dealer/user licences;

and in many other situations.

On the other hand, businesses need to ensure they do not inadvertently create rights. To avoid being caught unintentionally by the Act, in written contracts, particularly standard terms and conditions, businesses should consider including a clause that disapplies the Act.

Once a third party right exists, it will not be possible for the contracting parties simply to agree to cancel the contract or vary the third party’s right without the prior consent of the third party, unless a right to cancel or vary is previously reserved in the contract. If this is not done, the only other solution is to apply to the court or arbitral tribunal for an order to allow the cancellation or variation.

The Act cannot be used to place positive obligations on a third party, except the third party right can be made subject to conditions. For example, a right for the third party to receive warranty services may be made subject to the third party keeping the product properly maintained.

All businesses need to assess the way the Act may affect them:

• standard contracts need review to ensure that they either exclude the application of the Act, or use it, as appropriate;
• if businesses want to grant third party rights, appropriate conditions and limitations should be imposed in the contract on the exercise of such rights and the liability of the contracting parties, and provisions included to ensure that the contracting parties are free to cancel the contract or vary the rights without the third party’s consent.