There are numerous parties who will have an interest in, or receive benefit from, building newly constructed or refurbished – however, they are not signatories to the construction contract. These range from funders to buyers and tenants who will use the building but do not have construction security or legal rights under the contract if they suffer a loss as a consequence of design or construction failure. Although the principle of third party rights, jus quaesitum tertio, is enshrined in common law in Scotland, it is only under the protective umbrella of a contract where such liabilities can be pursued, determined and remedied, where appropriate in England and Wales. The judicial criticism of this anomaly has been demonstrated in numerous court case decisions, with Lord Denning calling it: “commercially inconvenient and fundamentally unjust”. The result was a proliferation of collateral warranties and bonds of all shapes and sizes, which meant that there was often a lack of clarity as to what was being warranted, and under what terms.

The Contracts (Rights of Third Parties) Act 1999 was enacted in response to the problem; a brief outline of its main points is worthy of mention below:

Under the doctrine of “Privity of Contract” only the parties to the contract can confer rights or impose obligations under it. There are two limbs to this rule:

  • If a party is not in a contractual relationship, they cannot be subject to any burden by that contract
  • If a party is not in a contractual relationship, they cannot benefit by the contract even though the contract may have been entered into for their benefit.

Contracts (Rights of Third Parties) Act 1999

The Act has provided an exception to privity of contract rule. It refers to the following:

“the promisor”: party to the contract against whom the term is enforceable by the third party, and
“the promisee” party to the contract by whom the term is enforceable against the promisor

Section 1 of the Act defines the “Right of third party to enforce contractual term”. This is a person who is not a party to a contract but is able to enforce a specific contract term(s) the parties intended him to benefit from. However, there are two limbs to this right. The right applies if:

  • There is an express term providing them with such right and;
  • The term within the contract confer a benefit on them.

The Act provides further regulatory mechanism and limits the application of the second limb in two ways. Firstly, it states that the contract should “appear” to demonstrate that the parties intended a term to be enforceable by the third party. Subsequently, it states that the third party “must be expressly identified in the contract by name, as a member of a class or as answering to a particular description”, and then goes on to state that the third party need not be in existence at the time the contract is entered into. The express (not implied) term identifying the third party able to enforce a contract term was reinforced in Avraamides and Another v Colwill and Another [2006] EWCHA Civ 1533. The court held that the beneficiary was not identified within the contract under the express term of “customers”, and hence was not able to enforce an agreement.

The third party can only enforce the term under which the contracting parties have provided. This right to enforce is limited to “no greater duty” provision than ones placed upon the original contracting parties and an “equivalent right of defence” as would have been available to the original parties to the contract limits by the parties against any actions brought against them. The “variation and rescission of contract” within the Act underlines the fact that without the consent of the third party, the original contracting parties can not vary or rescind the contract so as to alter or omit the third party’s entitlement.

In order to ensure the promisor remains protected from “double liability”, section 5 sets out a provision whereby stopping the same loss being claimed twice by the promisee and the third party in England & Wales.

Construction Projects

In construction terms the Act provides greater security for parties like the funder, the buyer or a tenant who sits outside the contractual relationship but is still affected by it in a number of different ways. For example, a party outside the contract, troubled by defective design or workmanship will not normally be able to recover for losses suffered by claiming against the person responsible, so unless third party rights are granted to these groups of people, they have no route to recovery. With such rights, the third party is in effect given any remedy which would have been available in an action for breach of contract, however subject to the same rules governing remedies in contract. The alternative route is a claim in tort. However, there are limitations as to the extent of recovery for what is known as “pure economic loss”. This means that the third party is unable to recover against the cost of repairs to the building itself, but is able to recover for personal injury and damage to other property like the neighbouring property. This is why it is important for the third parties to be identified within the contract so as to be able to make a successful claim for damage received.

It is important from the outset to consider whether the third party should be given enforceable right, and if so to what extent. With the same token, it is also important to decide the extent to which the right of the contracting parties should be protect once third party has been granted enforcement right(s). This can be achieved by clearly expressing the extent to which the third party is able to enforce, vary or rescind a contract term.

Construction Industry Response

The Act was intended to take the place of collateral warranty but the construction industry has been slow in its uptake. However the general consensus is that it is gradually becoming more popular. There are some key factors, acting as hindrance, for the Act’s slow uptake. Some insurers and in particular funders prefer the familiarity in the use of collateral warranties. Others are concerned with the lack of case law and also with the potential uncertainties the act creates in so far as the exact nature of obligations placed on the original contracting parties. The RIBA Appointments and JCT contracts both employ Third party rights schedules, but they still have some way to go to supplant the use of collateral warranties.