Under the new Contracts (Rights of Third Parties) Act 1999 the parties to a contract may be required to consider the rights of those who are not parties. The parties would traditionally have considered these people to be foreign to their arrangements but under this new Act certain third parties will be entitled to rely on provisions of the contract, limit the parties' decisions as to variations and generally affect the agreement between the parties.

Traditionally, parties to a contract could largely rely on the certainty that their agreement was a "fenced area" within which no one but they could intervene. This is a straightforward application of the privity of contract rule under which a person could only enforce a contract if (s)he was a party to it. It allowed each party a reasonably accurate assessment of the commitments made, the risks taken and the profits to be expected. This is essential in a day and age where transactions involve increasingly complex structures.

However, the Contracts (Rights of Third Parties) Act 1999 - which received Royal assent on 11 November 1999 - has reformed the privity of contract rule and will, for all contracts entered into on or after 11 May 2000, give certain third parties rights to enforce and interfere in contracts that would have otherwise been beyond their reach.

This will call for particular caution when drafting and entering into a contract. The rights of such non-contracting parties may not only derive from express clauses, but may also be implied from certain provisions of the contract and those parties need not necessarily be named, as long as they are identifiable.

• the contract expressly provides that such non-contracting party has a right to enforce it; or
• a provision of the contract confers a benefit on that person (unless the contract shows that the parties did not intend the term to be enforceable by that third party).

The latter may well receive the widest interpretation where the existence of a benefit may not be obvious but could be construed from the wording of a provision. The conferring of a benefit may also include taking advantage of any exclusion or limitation clause. It will therefore be advisable for the parties to make it clear in the contract whether or not any terms are designed to be enforceable by a third party.

Examples of third party rights that may be enforceable include:

• where an exclusion of liability applies to officers, employees and affiliates of a contracting company;
• indemnities in favour of insolvency practitioners who do not sign the contract in their personal capacity;
• superior landlords may wish to have enforceable rights against sub-tenants and vice versa; and
• companies who take out insurance policies for the benefit of another could use the Act to allow the beneficiary to enforce the policy directly.

How will the non-contracting party be identified?
The third party must be sufficiently identified in the contract to benefit from any of its terms. However, this identification may not necessarily be by name. A mere reference to a class of people may be sufficient to entail benefits for all members of that class. Similarly, it will be enough for the contract to describe certain specific characteristics for any third party fulfilling such characteristics to fall within the scope of the Act.

How will the intervention of a non-contracting party affect the contracting parties?
Apart from the obvious implications for the parties i.e. finding themselves committed to persons who are not parties to the contract, they may also find that their contractual rights and their freedom in the way they decide to manage the contract are affected. Once a third party's right has ‘crystallised’ the parties cannot rescind or vary the contract in such a way as to adversely affect that right. Usually a right will have crystallised if the third party has relied upon it.

It is also worth noting that there will be no "reciprocity" and that the parties will not be able to use clauses of their contract to impose obligations on a non-contracting party!

Will the Act apply to all contractual arrangements?
The intervention of a third party may not always be appropriate and may even defeat the purpose of a contract. Therefore certain contracts are expressly excluded from the Act including:

• contracts of employment,
• a company’s Memorandum and Articles of Association; and
• negotiable instruments such as bills of exchange and promissory notes.

Furthermore contracts already in existence will not be affected although the position of contracts completed after 11 May 2000 where exchange took place prior to that date is unclear.

What can you do?
Before full implementation of the Act all businesses need to review their standard contracts and generally any type of contract they usually enter into and identify those where the operation of the Act should be excluded and those where it is intended to grant rights to non-contracting parties. In the first case a specific exclusion of the Act should be included and in the second the person to benefit and the clauses containing the benefit to be conferred should be clearly identified. An express term can be included allowing the contracting parties to vary or rescind the contract without the consent of the third party. The contracting parties should also consider whether to prohibit the assignment of rights by the third party.

Emma Shipp Partner, Company / Commercial Department 020 7544 5550 emmas@sghlaw.com