On November 11, 1999 a new law, the Contracts (Rights of Third Parties) Act 1999, came into force. Applying to contracts entered into after May 11, 2000, the Act has the potential effect of opening the liability floodgates and having a major impact on the number of claims that may be brought against professionals. Insurers, to protect themselves, must now be giving the insured guidance on the contractual obligations they may accept.
What are the basic provisions of the Act?
The Act, where it applies, abrogates the principle of English Law known as "privity of contract". Under this principle, only the party to a contract or its lawful assigns may enforce a term of that contract. The effect of this provision is that, if someone suffers loss as a result of a breach of a contract to which he was not a party, he is not able to sue for that loss. The classic example is the tenant who suffers loss when the building contractor fails to complete the building on time. The tenant will have a cause of action against his landlord, because he has a contract with him, but because he is not in contract against the actual miscreant, the contractor, he has no cause of action against him.
This isn't the case in other jurisdictions and, to mitigate the unfairness that this principle led to, the Law Commission recommended the abolition of the doctrine of privity.
In respect of contracts entered into after May 11, 2000, and where the Act is not excluded by the contract, then if the contract expressly confers rights or the contract purports to confer a benefit on a third party, the third party will be able to enforce a term of the contract.
Why is this so important?
The nature of the construction process is that it involves an original product (each building is unique) being constructed often in an innovative manner within a tight deadline. There are many things that can go wrong, all of which have in common that they will involve a cost and usually some other party in loss. The nature of construction, therefore, is that there is a high risk of a problem and of that problem giving rise to a claim.
The construction industry acknowledges that persons other than the parties to the construction contracts can suffer loss as a result of a breach of the contracts. Consequently, in addition to the professional's appointment he will be asked to enter into, or agree to provide in the future, collateral warranties in respect of named persons or classes of people. An example would be to give tenants/purchasers/funders warranties. The purpose of these warranties is to provide a contractual link between a person interested in the building being completed on time and to specification and the original service/product provider.
Collateral warranties are beloved of developers and building owners because they decrease the risk of them being sued or sued alone by a dissatisfied tenant/purchaser et al by providing another party (who has the benefit of professional indemnity insurance) for the tenant/purchaser et al to sue. The corollary is that, as the chance of the developers and building owners being sued decreases the opposite is true for the professional.
The insurance industry always limits the amount of voluntarily assumed additional obligations that a professional may accept. In the case of collateral warranties it had been quick to limit, not the number of warranties that the professional can give but the number of assignees to whom the warranty can be transferred. Warranties therefore provide a commercial expansion of the liability of the professional and his insurer to third parties in a controlled manner.
What will the Act change?
The Act, where it is not excluded, potentially gives greater opportunities for far greater numbers to sue the professionals. Unless the Act is excluded, if the contract grants the third party a right or purports to confer a benefit on him that third party may sue for breaches of contract.
The recitals to contracts (descriptive parts) in use in the construction industry at the moment often acknowledge the interdependence of all those involved in the construction process and as such are likely (unless substantially changed) to confer a benefit on third parties.
Moreover, at the time of the Law Commission report it was said that the presumption of enforceability by third parties was "a strong one" and "that it would not normally be rebutted unless there is a term in the contract - expressly negating the third parties legal rights".
The two third parties whom the professionals' insurers may wish to consider are future owners or users of buildings and contractors.
Prior to the provisions of this Act, third party owners/tenants acquired rights to sue the professionals involved in the buildings construction if they had obtained a collateral warranty. The growth of the collateral warranties arose when, due to a contraction in the law of tort, building owners lost the right to sue the professionals for economic loss in tort. Consequently, there were building owners who, because before the contraction of the law of tort it had not been common to ask for collateral warranties, were without them.
Those building owners might have still been able to sue the original professional, despite not being in direct contract with him by the use of a principle established in St Martins Property that where it was anticipated that the proprietorship of goods might be transferred the original party might be treated (if it was intended by both parties) as entering into the contract for the benefit of third parties. The principle, however, was limited and required both parties intention.
The crucial difference between the preceding law and the current Act is that, in the past either a limited number of new people were given collateral warranties or rights under an existing contract were transferred, again by definition a limited effect.
Third parties have new rights
The effect of this is not only that the number of persons who can sue the professional increases dramatically, but also that the measure of loss that those third parties sue for can be substantially greater than the original parties. With collateral warranties it was common to insert a provision that the professional is liable for no greater loss that he would be to an original party under the appointment. Equally, with the St Martins' principle it was the original contracting parties measure of loss that was the correct measure. Under the new law, as the third party acquires a new right on their own behalf and not a transferred right, it is their loss that matters. An example would be a contract between a professional and developer where third party tenants acquire rights under the Act. Should a business interruption claim ensue then, no matter how great the loss (and subject to exclusion clauses), it is that loss which the professional must pay. This opens whole new vistas of damages for the professionals' insurer.
The position of the professional is an invidious one. He is servant to the client but must maintain professional impartiality in dealing with the contractor and carrying out any certification or condemnation role required by the building contract. Contractors doubt that impartiality and the greatest source of claims are those for under-certification of payments.
Following Sutcliffe v. Thrackrah it was decided that the professional owed no duty of care in tort to the contractor when carrying out his certification function. Consequently (as they had no contractual nexus with the professional) contractors brought these claims against their employers under the building contract. Following the introduction of this Act, if a Contractor acquires rights under the Act there is a strong case for asserting that he will be able to sue professionals direct for under-certification. Not only will this cause professionals great pressure in carrying out their professional obligations but increase dramatically the likelihood of claims being brought against them by disgruntled contractors or contractors who have no other source of redress for their debt.
Remember the purpose of the Act
The Act is there to allow third parties to acquire rights where not excluded. Where the parties are not clear on what rights third parties are intended to acquire one must assume, as the Act does, that those asserting they have new rights will be treated generously by the courts.
In a straw poll of brokers, I was not able to find one whose professional indemnity underwriter had yet mentioned that they wished to include conditions that professionals exclude the Act in contracts that they enter into. Despite still imposing conditions on the number and terms of collateral warranties, professional indemnity underwriters appeared to have no concerns over the far greater liability under the Act.
The disappointment of this is, not only that it exposes the insurer to more claims in the future but that in negotiating his contract one of the greatest weapons that the professional has against an onerous term is that it is not acceptable to his insurer. Clients being interested far more in the insured risk than the personal value of the professional. By not restricting the application of the Act the professional has less bargaining power with his client.
The Act creates new rights that large classes of people can enforce against professionals. As such, until the effect on claims is known, accepting the provisions of the Act is something that professionals should do with the greatest care. Once the Act applies the rights cannot subsequently be rescinded without the third parties consent. When entering into new contracts professionals and their insurers should consider carefully how far they wish third parties to acquire rights and, if they do not wish it, should expressly exclude the terms of the Act.
