The law in Scotland changed in 2018 regarding the creation of enforceable third party rights in contracts. The Contract (Third Party Rights) (Scotland) Act 2017 came into force on 26 February 2018.
We're often asked by companies about the impact of the Act on their commercial contracts.
What is a "third party right"?
A third party right arises where someone who is not a party to a contract has a benefit conferred on them by the contract.
For example, A and B might agree that A will pay £100 to C. C is the third party.
Examples in practice include:
- an individual books a holiday with a tour provider on behalf of a group but only that one individual is party to the contract;
- a spouse takes out a life assurance policy and the lump sum would be payable to the other spouse;
- a software supplier enters into a licence agreement with a client company and the licence is for the benefit of the client and all its subsidiaries.
Can third parties enforce their rights under a contract?
The general rule is that only the parties to a contract can enforce its terms.
So, if A and B agree that A will pay £100 to C, and A fails to do so, C would not be able sue A for the £100. Although the contract has conferred a right on C, C cannot enforce it because C is a third party.
However, many legal systems - including Scotland - have exceptions to this rule.
The rules in Scotland were unclear and not very user-friendly. The 2017 Act replaced the old rules and made it easier to create enforceable third party rights under Scots law.
Creating enforceable third party rights
There are three conditions which must be satisfied to create an enforceable third party right under Scots law under the Act:
- the contract must contain an undertaking that one or more of the parties to it will or will not do something for the benefit of a third party;
- that third party must be identified in the contract, or be capable of being identified (e.g. "the Client's subsidiaries from time to time"); and
- the contracting parties must intend that the right is to be enforceable by the third party.
There is no need for the contract to refer specifically to the Act: if the above conditions are met, an enforceable third party right will be created.
Can third party rights be varied or taken away?
Yes, third party rights can be amended or revoked subject to certain conditions being met.
However, the Act contains provisions that protect third parties from having their rights changed or taken away in certain situations without their consent, so care needs to be taken when drafting the contract.
Can you prevent a third party from having an enforceable right?
Yes. The contract can expressly exclude the Act.
So, if A and B agree that A will pay £100 to C, and the Act is excluded under the terms of the contract, C would not be able sue A for the £100 if A failed to pay.
How does this impact my business?
The first thing to note is that the Act only applies to contracts entered into after the Act came into force. Contracts entered into prior to 26 February 2018 will not be impacted and will instead remain subject to the old Scots law regime.
For contracts entered into from that date, it's all about working out what your - and the other contracting party's - intentions are to ensure that the third party rights clauses accurately represent what you want to achieve.
It may be that none of your contracts confer any third party rights at all - in which case the Act is irrelevant.
But, if they do, you need to think about whether you want to take advantage of the Act to ensure that the third party rights are enforceable by the third party - or (conversely) to exclude the Act altogether.
If you want the contract to confer an enforceable third party right, what flexibility do the contracting parties need to be able to change or remove that right? Extra drafting is likely to be needed to ensure you have the required flexibility. This is an area where your legal adviser can help.
Bear in mind that other legal systems have their own rules on third party rights. In particular, while the 2017 Act is similar to the English Contracts (Rights of Third Parties) Act 1999, there are a number of subtle differences. This means that it won't be appropriate to just copy over an English law clause into a Scots law contract.
How can Brodies help?
Our Corporate and Commercial Team can help you to ensure that your contracts achieve the third party rights position that you require. You may also wish to review any template agreements that your organisation uses.
If you would like any further information relating to the creation or exclusion of third party rights under Scots law, please do not hesitate to get in touch.