UK: Privity Of Contract On The Way Out?

Last Updated: 3 June 1999

Privity of Contract on the Way Out?

New legislation is about to effect a radical change to a fundamental principle of English law, namely that only those who are parties to a contract can enforce rights under that contract.

This rule, which has been part of the common law for over a century, has been under attack from academic and judicial quarters for a very long time. Successive Law Commission reports have emphasized that this rule frustrates the legitimate interests of contracting parties and is out of step with most other jurisdictions, notably those on mainland Europe, not to mention Scotland.

The Contracts (Rights of Third Parties) Bill is likely to become law towards the end of 1999, which allows a breathing space for all those who will be affected by it to review their contractual arrangements in readiness for the new regime.

What are the Bill's main proposals?

The Bill is designed to enable contracting parties to confer benefits on others. It will not permit burdens to be imposed. It sets out two situations in which a third party may be given the right to enforce a term in a contract to which it is not a party.

The first is where the contract expressly states that the third party may do so. The second situation is where a contract term "purports to confer a benefit" on a third party. But this is not to apply if "on a proper construction of the contract...the parties did not intend the term to be enforceable by the third party."

It is the second situation which is likely to cause difficulties in practice. It sets up what the Law Commission calls a "rebuttable presumption" that the third party has an enforceable right unless the contrary can be established. Thus the burden of proof of a negative proposition is squarely placed upon the shoulders of the promisor, i.e., the party under the contract who is providing a service or product.

In the construction industry there will be many contracts which, it will be argued, purport to confer benefits in this way. An everyday example would be a construction contract containing a provision by which the contractor promised not to cause annoyance or nuisance to adjoining occupiers. Can they all now sue as if they were parties to the contract?

It will be essential for developers, contractors and consultants alike to scrutinise their industry standard or bespoke contracts to see if they will be construed as conferring such rights in the future.

How is a third party defined?

The Bill states that a third party may be identified in the contract either by name, as a member of a class or as answering a particular description. In particular, the third party need not be in existence at the time the contract is entered into, so, for example, unborn children or unincorporated companies will comply with the definition. It will therefore be possible to confer rights upon a class such as "all future tenants or occupiers of Blackacre".

What rights will the third party have?

The Bill provides that the third party will be treated as if he had been a party to the contract for the purpose of enforcing any rights given to him. Thus he will be able to sue for damages, or to seek an injunction or order for specific performance. The third party will not, however, be able to terminate the contract.

The Bill also states that the third party will only be able to enforce a term of a contract "subject to and in accordance with any other relevant terms." So if there is a financial cap upon a contracting party's liability that is likely to be binding on the third party as well.

Can the contracting party vary or cancel the right once conferred?

The Bill recognises that once the third party's rights have "crystallised" then the original contracting parties will not be able to alter those rights without the third party's consent.

Unless the contract provides otherwise, the moment of crystallisation occurs when either the third party communicates "his assent" to the promisor, or when he relies upon the term in circumstances where the promisor is or ought to have been aware of his reliance.

This provision may cause confusion in the context of construction contracts. Would a variation to the contract works fall foul of this rule? It is thought that it would not since a distinction is to be drawn between varying the works and varying the contract itself. This distinction may not, however, appeal to a third party occupier who believes the specification for his new office block has been altered to his detriment during the works.

What defences are available to the promisor against the third party?

The Bill allows the promisor to raise by way of defence or set-off to a third party's claim any defences that would have been available to him against the other party to the contract and any defence or counterclaim which is specific to his relationship with the third party.

Is the promisor vulnerable to double recovery, once from the promisee and once from the third party?

The Bill tackles the risk of double liability by addressing the situation where the promisee has already recovered damages and the third party then brings a separate action. In this situation the court is given a discretion to reduce any award in favour of the third party "as it thinks appropriate" to take account of the sum already recovered. Problems might arise in this context where a promisee, having recovered damages representing the third party's loss, becomes insolvent before he has accounted to the third party. Well drawn contracts are likely to deal expressly with risks of this type.

Are any contracts excluded from the Bill?

There are a number of categories of contracts which are already regulated by statutes and which are therefore excluded from the Bill. These include negotiable instruments under the Bills of Exchange Act, contracts for carriage of goods by sea or international carriage of goods by road, rail or air, employment contracts and the Memorandum & Articles of Association of companies.

How will construction contracts be affected?

It will now be possible through amendments in sub-contracts to confer rights upon developers to sue sub-contractors directly for delay or defective work. Similarly, main contracts could confer upon sub-contractors rights to make direct claims for payment against developers. Whether or not such radical changes will be made is an open question.

There has been speculation that collateral warranties will vanish overnight as a result of this new law. This seems most unlikely, bearing in mind the flexibility offered by a separate contract between a contractor or consultant and an end-user. However assignment clauses may be revisited as an attempt is made to confer benefits under collateral warranties upon, for example, all future tenants as a class instead of successive assignees.

Developers may wish to alter their practice by amending their contracts and professional appointments so as to indicate which of their terms will be enforceable by end-users or funders. A specific provision of the Bill will prevent any third party invoking the Unfair Contract Terms Act to challenge, for example, a net contribution clause which gives him lesser rights than the original developer. It remains to be seen whether contractors and consultants will be tempted by this provision to join the movement for the abolition of collateral warranties.

What has the construction industry's reaction been to the new Bill?

The reaction has not been uniform. On the whole developers are happy with the new provision but the supply side have doubts, largely based upon the uncertainties created by the Bill as outlined above. As always, the insurers' reaction will be of particular interest to them.

Will there be any amendments to the Bill before it reaches the statute book?

There are unlikely to be any radical amendments to the Bill on its way through parliament. However, one very important matter to the construction industry may perhaps be dealt with, and that is the Bill's effect upon arbitration clauses. In the original Law Commission report and first draft of the Bill arbitration clauses were expressly exempted from its operation. That is no longer the case, with the effect that a third party will have to accept that enforcing his rights under the contract will involve using the machinery for enforcement, namely, resort to arbitration. Difficulties arise because without express amendments to the Bill such a party will not become a "party to an arbitration agreement" within the meaning of the Arbitration Act. These matters should be put beyond doubt by appropriate amendments to the Bill.

If you would like further information or specific advice, please contact one of the following partners: Tony Blacker or Patrick Holmes.

This note is intended to provide general information about some recent and anticipated developments which may be of interest. It is not intended to be comprehensive nor to provide any specific legal advice and should not be acted or relied upon as doing so. Professional advice appropriate to the specific situation should always be obtained.

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