The rule of privity of contract and the Contracts (Rights of Third Parties) Act 1999

The general rule at common law is that only parties to a contract can enjoy its benefits or be subject to obligations arising from it. This rule is known as the “privity of contract” rule. As a result of this rule, any party which is not a party to this contract (a “third party”) cannot acquire rights under a contract nor can such party be made liable under it. Consequently, a third party cannot sue or be sued under a contract. The legal justification for this rule is that, so as to be able to sue for a breach of promise, the relevant party should have provided some form of consideration in exchange of this promise, which is not the case with third parties.

A significant exception to the privity of contract rule is introduced through the Contracts (Rights of Third Parties) Act 1999 (the “Act”). Under this Act a third party can enforce a term of a contract, if:

(a) the contract expressly provides that such party may do so (s1(1)(a) of the Act); or

(b) that contractual term confers a benefit upon the third party (s1(1)(b) of the Act) in which case the third party can enforce that term unless the contract indicates a contrary intention (s1(2) of the Act). 

However, it is worth noting that in either case the third party must be expressly identified in the contract by name, as a member of a class (for instance, a reference to a person’s “relatives”) or as answering a particular description (for instance, a reference to a person’s “mother”) (s1(3) of the Act). The third party does not need to exist when the contract is made. In this way, contracting parties can confer benefits on, for example, an unborn child or a company that is not yet incorporated. If the requirements of the Act are met, then the third party can enjoy the same remedies in relation to the benefit conferred upon them as if they have been a party to the contract (i.e. the same rights to damages, injunction or specific performance). If one of the requirements of the Act is not met, then the rules of privity of contract would apply.

However, ultimately any third party's right to enforce a contractual term is subject to the contract's terms. This means that, when drafting the contract, the parties can exclude, limit or place conditions on the third party's right to enforce a contractual term. This might be important, for example, when conferring a benefit on a class of third parties so as to avoid multiple claims or to regulate the conduct of any claims. In the same manner, the parties, when drafting the contract, have a right to completely exclude the application of the Act, in which case the standard rules of privity of contract will apply and the third party will not be able to sue for a contract.

It is also worth noting that some contracts are expressly excluded from the scope of Act by the Act itself, generally in areas which are already regulated by statute. They include the following: 

• duties of employees: Contractual promises made by an employer may be enforceable by a third party, but the workers' promises cannot create an enforceable third party right under the Act. 

• negotiable instruments: Bills of exchange, promissory notes and other negotiable instruments do not create enforceable third-party rights under the Act.

• company articles (and memorandum)

• LLP agreements; and 

• contracts for the carriage of goods: Contracts for the carriage of goods by sea, rail, road and air can create limitations on liability enforceable by a third party, but, save for that, they cannot create any other enforceable third party rights under the Act.

The Act is widely used to give third parties the benefit of intellectual property rights, duties of confidentiality, indemnities, payments and protection from all sorts of liability. These third parties could be, for example, a party's employees, contractors, associated companies, financiers, customers or others which may have an interest or some involvement in the transaction without being parties to the contract.  Finally, it should be clear that, whilst the Act allows third parties to enforce any terms conferring benefits upon them, it certainly does not permit contracts to impose a burden upon, and be enforced against, third parties.

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