The answer to this question usually depends on the type of contract in place and its provisions. Generally, third parties may have a claim under a contract if that contract provides for this in its terms. This blog will briefly explore the doctrine of privity (formation) of contracts and third party rights under The Contracts (Rights of Third Parties) Act 1999 together with some practical examples when third party rights may be beneficial.
Doctrine of privity of contracts
When determining third party rights under a contract, the starting point is usually the common law doctrine of privity of contract which prevents a contract from being enforceable in favour of, or against, someone who is not a party to that contract. The doctrine is considered rather harsh and in essence it did not allow:
- a person to enforce any rights under a contract to which such a person was not a party to;
- contractual remedies to compensate third parties.
The Contracts (Rights of Third Parties) Act 1999
Since the implementation of The Contracts (Rights of Third Parties) Act 1999, third parties have been allowed to enforce contractual terms if so agreed and contracted between the original parties. This means that the parties to the contract should consider and contemplate whether any third parties should have rights under the contract – if they do or if they do not, should be set out explicitly within the contract terms.
In theory, a contract can allow third parties to have full rights to enforce, rescind or vary the contract. However, in practice, this is not very common. By contrast, it is more common to exclude third parties rights completely in contracts or limit them if appropriate. This is because the contracting parties do not usually intend for a third party to be able to enforce the contract unless there is a specific purpose to do so and the third party cannot be made a party to the contract.
Some practical examples…
Common examples when third party rights might be allowed but limited are commercial transactions- i.e. mergers and acquisitions- when the buyer is part of a group of companies.
In a share sale transaction, the sellers would often be the individual shareholders selling their respective shares to the buyer. The share purchase agreement will therefore be between each individual shareholder and the buying entity; the company in which the shareholders hold their respective shares (target company) is therefore not a party of the transaction and would be considered a third party.
On completion, the buyer would acquire control over the target company. The buyer would usually have the right to sue any of the sellers if a breach of contract occurred. However, in certain circumstances, it may be more advantageous for the buyer if the target company also acquired a right to enforce the terms of the contract and sue the sellers if a breach occurred or indeed, if the sale and purchase agreement allowed another company in the same group of the buying company, to enforce the terms of the contract.
Third party rights may therefore be allowed but limited in the above circumstances, subject to the parties’ bargaining powers and final agreement.
Other examples may include allowing third parties for group companies- i.e. allowing subsidiaries or holding company to have a right under the contract. Again, this will depend on the parties’ bargaining power and final agreement.
The Corporate & Commercial Department here at Fisher Jones Greenwood LLP can assist you with the preparation or variation of a contract, offer you advice on current contracts and their legal implications or any other related services; as well as assist you with the preparation of any other documentation required and guide you through the transaction.
Should you require any information or assistance do not hesitate to get in touch. Please call 01206 700113 or email [email protected].
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