Third party pooper

The Contract (Rights of Third Parties) Act 1999 came into force at the beginning of the millennium and was heralded as the death knell for “privity of contract”, the doctrine preventing a party from enforcing rights conferred upon them in a contract between others.

There was sound commercial sense behind the act, coupled with a desire to move away from what some considered the archaic industry of warranty drafting. However, 10 years on, it seems the act is failing to gain ground and everyone from institutional funders to traditional developers have sought the comfort of a collateral warranty over the novelty of third party rights.

Aiding this reluctance has been the drafting of the act itself. It does not apply in circumstances where the parties agree they did not intend for the terms of a contract to be enforceable by a third party. In practice, therefore, standard amendments have developed to ensure that in most contracts the act simply does not apply.

There have been few reported cases involving the act and its application. Those that there are have given some limited pointers as to why it is not more widely applied.

The court in the early case of Nisshin Shipping vs Cleaves & Co held that “mere silence or neutrality” would not defeat a third party’s entitlement, and in Laemthong International Lines Co vs Artis it was held that there would have to be evidence of an intention to exclude a relevant third party’s right to enforce the terms for it to take effect. Another court found, albeit reluctantly, in Avraamides vs Colwill that “policy” dictated that a particular third party or class of third party must be identified to avoid uncertainty. All of these decisions show a desire to allow the act to apply wherever possible and to avoid its frustration.

Recently, however, it seems that there has been a shift of emphasis. In the decision in Prudential Assurance Company vs Ayres and Another, it was stated that, in a “normal commercial context” it would not be usual for a party to rely on the uncertainty of the act. Although the position in Prudential is entirely consistent with the general rules on contract interpretation, and the court’s reluctance to interfere in commercial bargains between parties of equivalent strength, it is seemingly at odds with its earlier emphasis on the act.

The decision exposes the flaw at the heart of the legislation. By allowing parties to contract out of the act, there is uncertainty

What the decision does do is expose the fundamental flaw at the heart of the legislation. By allowing parties room to contract out of the act, there is uncertainty. If the courts now require a clear contractual statement that the act applies, rather than looking at whether the contract acts to confer a benefit on a third party, it is no surprise that given the choice between reliance on “the uncertain effect” of the act, and the certainty of being able to sue on a contract by virtue of being a party to a collateral warranty, the latter course of action will almost always be preferred. In the current climate, it is difficult to imagine many funders being content to rely on their ability to enforce a building contract by virtue of the act, in preference to the certainty of being named as a party to a contractual document.

Parties are assumed to have written what they intended to be the terms between them, and if they choose not to include an explicit right under the act for a specific party, then the court is reluctant to imply it by statute.

So what will the next 10 years hold? Although the rights of third parties act is being used in limited circumstances in certain sectors, in most projects little appears to have changed.

Despite the legislature’s best intentions and notwithstanding the potential cost savings in using the act, take-up has been subdued. Although this may change, for the moment at least, most parties still want the comfort of collateral warranties.

The general reluctance to confer the benefit of a contract on a party that has not provided consideration, and the courts’ reservations about the general use of the act as a means of circumventing the doctrine of privity of contract, have missed the fundamental point that this was exactly what the act was intended to do.