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Third party rights

Since the House of Lord's decision in Murphy v Brentwood District Council [1991] 1 AC 398;
HL generally removed the possibility of claiming in the tort of negligence for the cost of repair
and/or reinstatement of defective building works on the basis that such cost was pure
economic loss, until the emergence of the Contract (Rights of Third Parties) Act 1999 (the
Act), the only recourse available to interested third party beneficiaries against the perpetrators
of such defects was in contract, through the use of collateral warranties.

The Act provides an alternative to the use of collateral warranties. It overturns the principle of
'privity of contract' in that it enables third-party beneficiaries such as funders, purchasers,
tenants to enforce a term of a contract, such as a consultancy agreement or building contract,
to which they themselves are not a party.

The Act cannot impose obligations through a contract on a third party; it can only be used to
confer a benefit.

Where contracting parties wish to avoid the possibility that a contract might give a third party
rights by implication, they should draft the contract to contain a statement that excludes the
operation of the Act.

The key provision of the Act is section 1 . It provides that a person who is not a party to a
contract may in their own right enforce a term of that contract if the contract expressly states
that they may or the contract purports to confer a benefit on them.

If on a proper construction of the contract it appears that the parties did not intend to confer the
benefit of a contractual term on a third party, the presumption is negated (section 1(2)).

In order to have directly enforceable rights, where parties wish the contract to benefit a third
party, that third party must be identified either by name or as a member of a class or by
answering to a particular description (section 1(3)). For example, in a contract using the Act,
'all tenants' could be permitted to enforce a term of the building contract, even though at the
date of the contract the names of the tenants are not known and may not even exist as a
corporate entity at the time the contract was entered. This circumvents the need for
assignment as a property is passed on, as would be necessary if a collateral warranty were
used; any third party fitting the description in the main contract would automatically be entitled
to enforce their interest under the contract.

For the purpose of enforcement of the relevant terms of the contract, the third party has the
same contractual remedies available as the parties to the principal contract and which include
damages, injunctions and specific relief (section 1(5)).

However, section 1(4) makes clear that any claims made by a third party are subject to any
limitations on liability contained in the contract. For example, any claim by a third party could
be met by any defence or set-off which would have been available to the party being sued had
the claim originated from the other original contracting party (section 3).

Set-off

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In the interests of the third party, it may be prudent to exclude 'set-off' as it could have the
effect that a negligent contractor could rely on the defence of set-off to reduce the sum they
owe to the third party beneficiary by the amount which the contractor may, in turn, be owed
from the employer.

A third party's agreement is required to rescind the contract or to vary the contract where the
variation would impact on the third party's rights, where the third party has 'communicated his
assent to the term' or has relied on the term and the party knows or ought reasonably to have
foreseen such reliance.

Ultimately, whether a third party's rights are provided to it under the Act or by a collateral
warranty will be determined by the funder's demands. To secure its investment a bank will
always reserve the right to specify the contractual mechanism and may prefer collateral
warranty as a means of safeguarding its interest.

Use of third party rights

Practical benefits of using the Act rather than collateral warranties were envisaged by the
drafters of the Act. An end to the extra time and cost of the preparation and negotiation of an
extra contract, and having to chase it up, is an obvious one. It is also easier to have 1 main
contract that contains the required rights, rather than a contract-and-warranty combination,
which might be lost or become separated over time. Execution of the main contract validates
the third party rights, avoiding the inevitable need to chase the parties again to sign a separate
collateral warranty.

Uptake within the industry has been slow, however, with resistance to the change being
attributed to beneficiaries' preference for a physical warranty signed by the warrantor, and
contractors' and consultants' reluctance to grant rights to classes of unknown beneficiaries.

That said, confidence in the Act's power to protect a third party has undoubtedly been boosted
by the inclusion of third-party rights provisions in the JCT 2005 suite of contracts (and
subsequent versions), which was included to encourage greater use of the Act as an
alternative to collateral warranties.

Amendments

It is worth noting that the provision within JCT will in many cases require amendment, to
address, for example, the inclusion of the requirement to hold professional indemnity
insurance or the exclusion of the net contribution clause (found, for instance, in JCT Standard
Building Contract 2005 at Part 1 (Purchasers and Tenants) 1.3.3, and Part 2 (Funders) 1.1.3)
or to exclude the right to 'set-off' discussed earlier.

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