Enforcement of a term in a contract can be positive (i.e. a third party is given the right to bring an action to enforce) or negative (i.e. a third party can enforce exclusion or limitation clauses).
Section 2 of the Act deals with variations and rescission of contract. Subject to certain provisions a third party has the right to enforce a term of the contract. The parties to the contract cannot rescind the contract or alter it as a means of extinguishing or altering the rights of the third party where the third party has assented to the term or relied upon it and the promisor knows or should have known this. Both the promisor and the promisee and obliged to adhere to that particular term and alterations to a relevant term can only be made with the consent of the third party.
Section 3 deals with defences available to the promisor. The rights of a third party to enforce any term/s of the contract does not affect the rights of the promisee to enforce the terms of the contract. The Act therefore sets out the defences available to the promisor to meet any claim brought by a third party and also the means by which they can be protected from double liability (Section 5). The promisor has available all defences against a third party that would be available to him if the claim were brought by a promisee. Sub-section (5), of the above section, allows the parties to limit the range of defences or set-offs available if these are expressly stated in the contract.
Section 5 protects the promisor from double liability. If, for example, the promise sues the promisor in respect to loss incurred by the third party in relation to an appropriate term; or the expense of making good the default by the promisor to the third party, then if the third party seeks to enforce in arbitration or in court the contract term the arbitral tribunal or the court will reduce the award so as to take into account the sum recovered by the promisee.
Section 6 deals with exceptions to the Act and confers no rights on a third party in relation to bills of exchange, promissory notes or other negotiable instruments, section 14 of the Companies Act 1985, terms of employments and carriage of goods by sea, rail or road etc.
Section 7 outlines the position of a third party in relation to the Unfair Contract Terms Act 1977, the Limitation Act 1980 and any other Act.
Section 8 states where a term in the contract is subject to a written arbitration agreement the third party shall be treated as a party to that agreement.
Will it Achieve its Objectives?
The 1999 Act does not replace the old rule of privity of contract and its established exceptions. These remain intact with the new implanted onto the old. As such, the Act should be considered as an addition too, rather than the abolition off, the old rule.
One problem that will arise, in my opinion, and will undoubtedly require clarification by the courts relates to the ambiguous nature of the phrase “purports to confer a benefit on him” (section 1 (1) (b)). A third party might interpret the terms of a particular clause in one way while the party to the contract might argue for a completely different interpretation.
The voluntary nature of the Act, in my opinion, is one of its major weaknesses and already a number of standard forms of contract now exclude the Act including JCT 1998 Amendment 2, RIBA Conditions of Engagement 1999, ACE Conditions of Engagement 1998, ICE 7th Edition of Conditions of Contract (Sept 1999). Accordingly the construction industry will still rely upon the use of collateral warranties.
A contract draftsman can limit the rights of a third party by inserting into the contract a term which limits or excludes the rights of a third party in relation to particular contract terms. Indeed, they can go further by inserting a clause which excludes the Act itself. A skilled draftsman by inserting the following clause could achieve both objectives:
“A person who is not a party to this agreement shall have no right under the Contracts (rights of Third Parties) Act 1999 to enforce any of its terms [except and to the extent that this agreement provides for such Act to apply to any of its terms].” (1)
The Act under section 2 (3)(a) allows for the parties to the contract to rescind or vary the contract without the consent of the third party. The parties to the contract can therefore insert a clause which expressly allows them to rescind or vary the contract.
The introduction of a clause into a contract which limits or removes third party rights together with, if necessary, a clause which states that the parties to the contract are free to rescind or vary the contract as they see fit without the prior consent of a third party effectively neuters the Contracts (Rights of Third Parties) Act 1999.
Whenever rights are conferred upon a third party under a contract it is likely those rights will be curtailed by reference to, for example:
- Restrictions on the class of third party.
- Restrictions on the number of future beneficiaries.
- Clear definitions as to which terms are capable of being enforced by third parties.
- Insertion of a clause limiting the need for the parties to the contract to seek the consent of the third party to vary the terms of the contract.
To be effective the Act relies upon the intention of the contracting parties both in relation to the existence and the scope of the third party right of action. It is therefore important for those intentions to be stated clearly and precisely if they are not to be subject to a legal challenge in the courts. A possibility, over the coming years, is that the Act simply becomes the second foundation upon which the rules in relation to privity of contract are established and similar to the older, foundation it too will be subject to a variety of exceptions. The 28th edition of Chitty of Contracts (paragraph 19-2002) states “while the Act will no doubt improve the law it will scarcely simplify the law on this topic” (2) This lack of simplification with the old rule and its many exceptions operating in conjunction with the recent Act together with differences of opinion in relation to the meaning of a particular clause might very well see, in the coming years, a significant rise in the number of court cases determining this issue. The Law Commission report in 1991 in some respects encourages this. Paragraph 5.00, of the report states that the courts should continue to be free to develop, where appropriate, the common law.
Section 8 of the Act relates specifically to arbitration and fails to address adjudication which under Part II of the Housing Grants, Construction and Regeneration Act 1996 becomes a legal requirement for construction contracts (subject to certain conditions). In effect any party to the contract can require the other party to seek an adjudicated solution as a mean of resolving a dispute. In my opinion, adjudication will supersede the need for arbitration in domestic contracts with arbitration clauses still playing a vital role in international contracts. The failure to reinforce the role of adjudication in the Contracts (Rights of Third Parties) Act 1999 and to ensure that a third party will be conferred the benefits of adjudication if that is the intention of the contracting parties will result in a number of cases, unnecessarily being settled in a court of law.
Should the legislation, with suitable modifications be introduced to Scotland?
Jus Quaesitum Tertio:
A number of leading English judges, notably Lord Denning, have argued persuasively for the adoption of the Scottish principle of jus quaesitum tertio. However Viscount Simonds in Midland Silicone Ltd v Scruttons Ltd 1962 AC 466 stated unequivocally that for such a principle to be adopted by the English legal profession it should be Parliament and not the courts that introduce such a change.
In respect of third party rights the law of Scotland is further advanced than that of England. While privity is an important principle of contract law in Scotland this principle yields to one more fundamental principle, that of jus quaesitum tertio meaning ‘rights acquired by a third party’. The doctrine does not apply under English Law and its basis is to be found in Stair:
“It is likewise the opinion of Molina, CAP. 263 and it quadrats to our customs, that where Parties Contract, if there be any Article in favour of a Third Party, at any time, est quaesitum tertio, which cannot be recalled by both the Contractors, but he may compel either of them to exhibit the contract, and thereupon the obliged may be compelled to perform”. (3)
Three important aspects are identified in Stair:
- The contracting parties cannot revoke the agreement.
- The third party can compel the contracting parties to display the contract to him.
- The third party can enforce the provisions in his favour.
If upon interpretation of the contract it is determined that the parties to the contract intended to confer rights upon a third party the law would give effect to that intention (subject to certain requirements) and allow a third party to make a claim under the contract.
It is not enough for a third party right to come into existence where a term in the contract purports to create such a right; the parties to the contract must have intended that the creation of a third party right was irrevocable. In other words the parties to the contract actively deprive themselves of their fundamental right to adjust their relationship with each other. The intention to create a third party right was intended to be irrevocable. The leading case in this field is Carmichael v Carmichael Executor 1920 SC (HL) 195
Irrevocability can be shown in a number of ways and includes:
- Intimation or delivery of the contract to a third party.
- Putting the contract out of the power of the contracting parties.
- Registration of the contract i.e. in the Book of Sessions.
- The content of the term itself.
- The third party’s knowledge and reliance upon the contract term in their favour.
In Love v Amalgamated Society of Lithographic Printers of Great Britain and Northern Ireland the society operated a scheme which benefited relatives of sick members. A clause also allowed for the rules of the scheme to be changed which in effect meant that the scheme was not irrevocable. When a relative claimed a benefit under the scheme, the court found a jus quaesitum tertio in her favour since the rules had not been changed and therefore revoked. In line with Love the courts, in recent cases, have placed less emphasis on the need to show irrevocability of the benefit.
The Contracts (Rights of Third Parties) Act 1999 follows the line held by Scotland in relation to the identification of third parties. Identification may be of a particular individual, through membership of a class of persons and the third party need not be in existence at the time the contract is made. Identification of the third party may be express or implied. There must also be an intention to confer an enforceable benefit on the third party.
To satisfy the criteria to establish a jus quaesitum tertio there must be:
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An intention to benefit the third party as opposed to an intention to promote the convenience of the contracting parties – Henderson v Stubbs 1894 22 R 51.
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An intention to confer a benefit on a third party which can be discerned from an objective examination of the contract – Aberdeen Harbour Board v Heating Enterprises 1857 3 Macq. 75.
- The ability to identify the third party.
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The inability of the contracting parties to vary or cancel the third party’s rights by the contracting parties – Strathford East Kilbride v HLM Design 1912 S.C. 1078.
- The third party can sue the defaulting party for damages as well as for payment and for the implementation of the obligations.
It is important to note that the contracting parties can only confer a benefit, and not a duty, upon a third party without that party’s consent. If such a duty is agreed between the contracting party and the third party in effect a second contract has been created and as such would not be considered jus quaesitum tertio.
In the absence of such legislation what contractual provisions may be inserted into construction contracts to which Scots Law applies?
There are a number of provisions available to the individual under Scots Law that could be effectively inserted into a contract, including:
Concurrent Liability in Contract and Delict:
In common law there are limits on the damages that can be recovered if there is a breach of the common law duties of care. However, in certain circumstances , the law of delict may give rise to a duty of care independently of any contract where there is a close relationship but no actual contractual relationship. In Henderson v Merritt Syndicates Limited 1994 3 ALL ER. 506 (HL) it was held that a concurrent duty of care in contract could co-exist with the duty in contract however the scope of the duty in tort (delict) could not be wider than the scope of the duty in contract.
Delictual duties are only available where physical harm in the form of death or injury is caused by one party to another. The law is rather unsettled in the area. The Construction Law Journal 15 1999 succinctly states the problem:
“Decisions have veered from allowing recovery for losses where the defect in the property was dangerous to allowing recovery where the defect could not be categorised as dangerous, and then reverting to the orthodox approach, but the loss incurred in such situations is “purely economic” and therefore irrecoverable”
In the case of Murphy v Brentwood District Council 1990 2 ALL ER 908 a dividing line was drawn between the original owners of a building (who were able to use a tortious or delictual remedy to enhance their contractual claim against the contractor and design team professionals) and purchases, tenants and funders of a building (who were unable to show the necessary degree of proximity with the construction team members). As a result, purchasers, tenants and funders cannot rely on delict/tort as a method of recovering pure economic loss in relation to latent defects in buildings.
The case of Alfred McAlpine Construction Ltd v Panatown Limited 1996 1 SLR113 illustrates that economic loss remains very difficult to recover on the basis of delict rather than contract unless they are sufficiently close to the contract short of actual privity of contract.
Clearly this area of the law needs to be addressed.
Collateral Warranties:
The decision in Murphy reinforced the practice of applying collateral warranties. The treatment of third party rights under contract law and delict have developed in such a way that it was not possible for the parties who have an interest in the building (e.g. Tennants, Purchasers and Funders) to sue the Designes and/or the Contractors for losses resulting from defects in a building on the basis of negligence. They should have a contract with these parties allowing the party to sue, if necessary, for breach of contract. A Collateral Warranty is a contract which gives a third party rights on an existing contract entered into by two separate parties. It imposes duties and obligations on part of the contractor, sub-contractor or a consultant in favour of the third party who is not the original building owner or employer but who nevertheless may suffer loss in event of a design or construction defect.
Assignation:
Assignation is distinguishable from jus quaesitum tertio since the latter is a creation of the original contract whereas the former requires a further and independent juristic act by one of the parties to the contract. Assignation is a form of transfer of rights. However the assignee can acquire no better rights under the contract than those possessed by the assignor. Problems might arise where property is sold or leased for full value and a warranty is subsequently assigned. A ‘no loss’ argument might arise since the assignor received full value and had suffered no loss when they signed the collateral warranties. Under the warranty, the assignee acquires the assignor’s rights to recover the loss the assignor suffers due to defects in the property. However, if the assignor obtained full value for the property they have suffered no loss and as such no right of recovery is assignable.
There are a number of practical considerations in assigning a collateral warranty to a third party.
Contractors Obligations:
These must be clearly defined with in the contract if the assignee is to benefit from these obligations via the collateral warranty. However, Contractors/Consultants may try to exclude that part of the warranty which relates to their obligations under the building contract.
Limitations:
Warranties are often qualified by provisions that the contractor shall have no greater liability to the beneficiary, nor of longer duration than the contractor would have had if the beneficiary had been named as the employer or client. The purpose of this limitation is to ensure that the warranty does not extend the underlying obligations thereby allowing the obligations in the warranty to be insured.
Professional Indemnity Insurance:
By restricting cover for collateral warranties, the insurer can dictate, to a significant degree, the scope and extent of the terms. Since many small contractors and consultant firms have limited assets it is in both parties interests (the insured and insurer) that the terms of the warranty fall with in the risks covered by a Professional Indemnity policy.
Collateral warranties can prove costly in terms of time and money where the need to ensure that the liability trail is fully covered with warranties available from all of the construction team members in favour of those at risk from defects in the development. Commercial considerations may have an adverse effect upon the quality and value of a collateral warranty where the relative bargaining strength between the parties is decidedly one-sided. As such, it will be the third party who may have to suffer the consequences.
‘Step-in’ Rights:
These allow the beneficiary (i.e. Funders and freehold Purchasers) the ability to ‘step-in’ and complete a development in the event of, for example, the termination of the contractor or the insolvency of the developer. Such clauses should take place by way of novation of the contract to the beneficiary and where this is not adhered to they might prove difficult to enforce.
Novation:
Novation results in the beneficiary becoming a party to the contract in place of the employer or client. Novation involves a tri-partite agreement where the existing contract between two parties is discharged and a fresh contract is made between one of the parties to the contract and a third party, usually on the same terms as the original contract. Thus, the status and/or existence of the original contract are changed. This distinguishes novation from assignation where the contract is assigned without affecting the status or existence of the original contract.
What are the implications for Part II of the Housing Grants, Construction and Regeneration Act 1996 under Scots and English Law, if different?
While the Contracts (Rights of Third Parties) Act 1999 came into being after the Housing Grants, Construction and Regeneration Act 1996 there is no reference in the former to the latter. The former, does however refer to arbitration. Scotland unlike England does not, as yet, have an arbitration act, instead the legal basis of arbitration is based on common law.
Would a clause in the main contract which refers to adjudication and which is stepped down to a third party have the same legal rights as an arbitration clause?
In England the Woolf Reforms actively encourages alternative dispute resolution forms (A.D.R.). In Dunnett v Railtrack the Court of Appeal refused to order costs in favour of the successful litigant because of their refusal to consider the court’s suggestion that they seek mediation. This action has sent a signal to all litigants that those parties who ignored the A.D.R. process do so at their pearl.
The answer is probably yes, though it would be for the courts to decide this matter conclusively. If we can assume that the adjudication process as laid out in Part II of the HGCR Act would be transposed for arbitration, from the point of view of a third party it would be beneficial to learn the lessons associated with the stepping-down of such clauses to third parties. In Haskins (Shutters) Limited v Ogilvie Builders 1988 S.L.T. 64 the sub-contract stated the terms and conditions in the main contract were applicable to the sub-contractor. In the main contract there was an arbitration clause but the sheriff held the arbitration clause had not been incorporated into the sub-contract. However, Lord Jauncey in Parklea Ltd v W & J.R. Watson Ltd 1988 S.L.T. 605 held that even where there was repetition and some contradictions the sub-contract could be capable of performance within, but not necessarily upon, the terms of the main agreement. To incorporate an arbitration clause it is advisable to make it explicit.
Section 107 Part II of the Housing Grants, Construction and Regeneration Act states that the Act will only apply to those contracts in writing and then goes on to illustrate what is meant by the word “writing”. Notably sub-section (6) states that “References in this Part to anything being in written or in writing include its being recorded by any means”. In other words the contract need not be a written form. It is this section of the Act, which in my opinion, will prove most troublesome with regards to defining the intentions of the contracting parties. However, inherent weakness in the construction of this section might prove beneficial to a third party. For example, from reading section 107 (5) it would appear that where the parties have made an oral agreement (to which the Act does not apply) and both parties hold that view in written submissions, then their oral agreement becomes a written agreement (to which the Act does apply). In the case of Grovedeck Limited v Capital Demolition Limited [2000] Build L.R. 181 at 183-184, the former sought an adjudicated settlement to a dispute. The adjudicator found in their favour and ordered Capital Demolition to pay a sum of money to Grovedeck, due in respect of breaches of contract. Capital Demolition sought to resist enforcement of the decision and argued before His Honour Judge Bowsher Q.C.that the HGCR Act did not apply as the contracts were not in writing. Grovedeck argued that the contracts were in writing pursuant of section 107 (5) by virtue of Grovedeck’s referral notice and Capital Demolition’s response in the adjudication. Capital Demolition did not deny there were oral agreements relating to the two projects. The parties were, however, in dispute about the terms of those oral agreements. The judge was of the opinion that section 107 (5) applied and the dispute was subject to the HGCR Act. He took the view that the wording of sub-section (5), which is limited to an allegation of an agreement not denied by the other party, should be read as though it referred to both the existence and the terms of agreement. A third party might be able to avail themselves of the HGCR Act where the originating parties to the contract failed to take comprehensive measures to exclude the application of the Act in relation to their dealings. Alternatively, a third party, through their relationship with one of the contracting parties might find themselves in an adjudication for which they are an unwilling participant.
The Scottish Executive is looking at ways of improving the operation of the adjudication process under Part II of the HGCR Act and Part I of the Scheme for Construction Contracts (Scotland) Regulations 1988 while a separate exercise is being conducted in England and Wales.
The Scottish Executive asked the Construction Industry Board and later the Construction Umbrella Bodies’ Adjudication Task Group to look into the matter. The C.I.B. noted that parties to a contract would introduce bespoke adjudication processes which were designed to avoid parties in the supply chain benefiting from adjudication, and recommended the enshrinement of a single adjudication procedure in legislation. Should this recommendation be adopted the implications for a third party would be to guarantee the right of adjudication which some would consider the intention of the Act in the first place. However, the Scottish Executive considers this measure premature as the HGCR and the Scheme had only been in operation for a few years.
In Scotland the HGCR Act is subject to the Construction Contracts (Scotland) Exclusion Order 1998. The exclusion order further narrows the scope of the HGCR Act by excluding contracts entered into under the private finance initiative, finance agreements and development agreements. Third parties who have step-down entitlements in any of theses categories are therefore unable to take advantage of the act.
Conclusion:
The ability of parties to a contract to neuter the effectiveness of the Contracts (Rights of Third Parties) Act 1999 is one of the Act’s major weaknesses. With the deficiencies inherent in the Act, in its current form, I would think it highly unlikely that the law of Scotland would wish to introduce the act north of the border. Scotland through the principle of jus qaesitrum tertio (rights acquired by a third party) in conjunction with a number of contractual provisions already protects the interests of third parties.
The absence of any reference to adjudication in the Contracts (Rights of Third Parties) Act will, in my opinion, require the courts to decide whether or not adjudication will be given the same latitude as arbitration. I believe it will, but this issue should have been addressed in the act itself. As highlighted by the C.I.B. and rejected by the Scottish Executive a single legal adjudication procedure would make it binding on the parties to a contract to step-down the right of adjudication to an interested third party.
Quotations
- Timothy Smith Contracts (Rights of Third Parties) Act 1999 p.28
- Simon J. A. Tolson ‘The Contracts (Rights of Third Parties) Act 1999 and its implications for the Construction industry’ P.2
2. Stair – Vol 3 Institutions 1.x.5
Bibliography
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Hector L. MacQueen Contract Law in Scotland Butterworth 2000
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Allan Ashworth Contractual Procedures Longman 2002
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James P. Connolly Construction Law W. Green/Street & Maxwell 1999
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John Uff Construction Law Street & Maxwell 2002
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Stair Memorial Encyclopedia The Law of Scotland Law Society of Scotland Vol 3
Articles (Internet)
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Scottish Executive Consultation document ‘Improving Adjudication in the Construction Industry’
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David Swarbrick ‘Contracts (Right of Third Parties) Act 1999
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Sarah McMaster-Christie ‘Third Party Rights – The New Privity Act
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Institute of Structural Engineers ‘Contracts (Rights of Third Parties) Act 1999
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Freshfields ‘Contract (Rights of Third Parties) Act 1999 – The impact on the construction industry Feb 2000
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Timothy Smith ‘Contracts (Rights of Third Parties) Act 1999
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Neil Price ‘Rights of Third Parties’
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Not attributed ‘Acquiring rights under someone else’s contract’
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Simon J. A. Tolson ‘The Contracts (Rights of Third Parties) Act 1999 and its implications for the Construction industry’
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Sweet & Maxwell Limited and Contributors ‘Construction Act Review’ Construction Law Journal – cite as: Const.L.J. 2001. 17(4), 308-321
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James Shaw ‘Third Party Rights in Contract – Protecting your Position’
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Not attributed ‘Contracts (Rights of Third Parties) Act 1999 – Trimming the Privity Hedge’
- Mark Hubbard ‘Contracts (Rights of Third Parties) Act 1999 – An arid introduction’ [email protected]
