Considering the Contracts (Rights of Third Parties) Act 1999: no need for collateral warranties?

Despite being in its twentieth year and, at least in principle, being the key statutory exception to the common law doctrine of privity of contract, Contracts (Rights of Third Parties) Act 1999 ("the Act") has not proven as popular as first envisaged. In fact, the Act is excluded within contracts more than most other statutes. 

Typically, where an individual is in some way interested in (but is not party to) a contract, that individual will seek to enter into a collateral warranty as a beneficiary in order to protect their interest instead of simply relying on the Act.

However, a recent decision of the Court of Appeal ("CA") in Chudley –v- Clydesdale Bank Plc [2019] EWCA Civ 344 has highlighted the usefulness of the Act as a mechanism for third parties to enforce the terms of a contract. Despite the case not actually involving a construction contract, this decision may pave the way for the Act to be more widely utilised by third parties in the construction sector in the future.

Background

In 2007, Clydesdale Bank Plc ("Clydesdale") agreed a letter of instruction with Arck LLP ("Arck"). Arck were the operators of an investment scheme; namely, a holiday resort to be developed in Cape Verde.

Under the letter of instruction, Clydesdale were required to open a "segregated client account". Arck's clients who were investing in plots at the holiday resort development ("the Investors") would then deposit their investment monies into this account, which would be held by Clydesdale on terms specified in the letter of instruction. These terms restricted Clydesdale from withdrawing the investment monies unless a solicitor's undertaking was received, stating that the withdrawn investment monies would be repaid.

In return for their investments, the Investors would later sell back their plot(s) to Arck for a profit on a specified redemption date. The Investors were not individually named in the letter of instruction. 

Clydesdale failed to open the required "segregated client account". From August 2007 onwards, the Investors' monies were paid into a separate account at Clydesdale, named in the judgment as the "074 account". The "074 account" was not governed by any letter of instruction. Arck subsequently withdrew the investment monies, but failed to repay the investments with the agreed profit rate on the redemption date.

A group of the Investors sought to recover their lost investment monies by relying on the Act in pursuance of a breach of contract claim against Clydesdale. The Investors argued that the letter of instruction formed a contract between Clydesdale and Arck, which Clydesdale breached by failing to open the "segregated client account". By this time, Arck had gone into liquidation and its founders were subject to criminal proceedings (beyond the scope of this article), so Arck could not be targeted by the Investors' claim.

Relying on the Contracts (Rights of Third Parties) Act 1999

There are two key criteria contained within the Act which must be noted. Firstly, you can enforce a term of a contract as a third party under the Act only if you are, "expressly identified in the contract by name, as a member of a class or as answering a particular description".

Secondly, the relevant contract must confer some benefit on you as a third party.

High Court Decision

In his decision in 2017, Judge Hancock QC decided that the letter of instruction did not form a contract between Clydesdale and Arck. The Court was of the view that the letter of instruction was subject to a condition precedent which had not been fulfilled. Further, it was held to be no more than, "a promise to those third parties that their monies [would] not be released unless specific contingencies [were] met". 

Judge Hancock QC went on to say that, if a contract did exist, then the Investors would have been entitled to enforce its terms under the Act. However, in any event, Judge Hancock QC decided that Clydesdale's actions had not caused the Investors to lose their investment monies.

The Investors appealed this decision.

Court of Appeal Decision

The CA (comprising in this case Flaux LJ, Longmore LJ and Moylan LJ) disagreed with Judge Hancock QC's assessment that the letter of instruction did not form a contract between Clydesdale and Arck. In giving his decision, Flaux LJ stated his view that, "[I]n concluding that the [letter of instruction] was subject to a pre-condition and therefore not binding, the judge made a finding which was unsupported by evidence and he erred in law". Thus, the letter of instruction did amount to a binding contract between Clydesdale and Arck.

The CA also disagreed with Judge Hancock QC on the issue of loss. Flaux LJ held that, "if [Clydesdale] had not been in breach the monies would have remained in the account and the [Investors] would not have suffered the loss they did".

Fortunately for the Investors, the CA did agree with Judge Hancock QC on one crucial point. It was unanimously decided that the Investors could rely on the Act to enforce the terms of the letter of instruction. In reaching this decision, the CA found:

  1. For the purposes of relying on the Act, the Investors were "expressly identified" as a class in the letter of instruction.  As Clydesdale were required to open a "segregated client account", the class in this instance was that of the Investors (as clients).
  2. Reference in the letter of instruction to a "segregated client account" simultaneously fulfilled the second criteria for relying on the Act – that the contract in question conferred a benefit on the expressly identified class of third parties.  The benefit conferred was the segregation and protection of the Investors' monies; which was the primary purpose of the required account.

In making this assessment, Flaux LJ disagreed with the conclusion drawn in the recent 32nd and 33rd editions of Chitty on Contracts, at [18-097], that the two criteria "are separate and cumulative… so that reasoning which satisfies the first of these requirements cannot, of itself, satisfy the second." Flaux LJ contested that, "it does not follow that the same term cannot satisfy both requirements". It was therefore held that the two key criteria for reliance on the Act can be fulfilled by the same contractual provision. 

Additionally, Flaux LJ confirmed that a third party beneficiary does not need to know that an underlying contract exists in order to rely on it in a breach of contract claim under the Act. In this case, the Investors were not aware of the existence of the letter of instruction at the outset of proceedings but this did not preclude them from relying on its terms.

What does this mean for you or your business?

Given the CA's fairly flexible approach to the application of the Act, this decision may encourage reliance on the Act as an alternative to collateral warranties. By avoiding the need to negotiate a collateral warranty, third parties affected by the provisions of a contract may save time and expense and bring claims under the Act instead.

Additionally, the ability for third parties to rely on the Act even where the third party has no awareness of the existence of the underlying contract could make claims under the Act more attractive. Third parties would of course be advised to take advice before attempting to enforce the terms of a contract on the basis of the Act.

Contracting parties may be slightly unnerved by the prospect of being more easily targeted by third parties who suffer loss as a result of a contracting party's breach. Importantly, however, reliance on the Act to enforce a third party right can only be made, "subject to and in accordance with any other relevant terms of the contract". This preserves the contracting parties' right to contractually 'exclude' the Act to the effect that third parties would not be able to rely on it.

If you require advice in connection with construction contracts and third party rights, or indeed any construction related query, please contact chris.hoar@michelmores.com or alan.tate@michelmores.com or any other member of the Construction and Engineering Team.