The contract (Rights of Third Parties) Act 1999 application to oil industry indemnities

The Contracts (Rights of Third Parties) Act comes fully into force on 11th May 2000. Since 11th November, 1999 it has been possible to apply the Act by expressly providing in your contract that it is to apply. Now it will apply unless you expressly exclude it. The Act will be useful to the upstream oil and gas industry in solving old problems of the enforceability of the mutual indemnities often used in offshore contracts where these extend to group companies or subcontractors but contracts will need careful drafting to ensure that these third parties do not also acquire wider rights than intended and/or a veto over contractual amendments.

Reform of the privity of contract doctrine: The Act modifies the legal rule that you can only enforce rights under a contract if you are a party to it (or are enforcing by right of a party - for example, as a party's successor or assign). Now a contract can validly contain a promise by one party to another that the promising party will be liable under the contract to someone who is not a party. As long as the contract is enforceable on normal principles, the third party will be able to enforce his rights directly against the contracting party who granted the rights.

The Act provides that a third party right will be enforceable not only if the contract expressly says so, but also if it "purports" to confer a benefit on the third party. No such benefit is enforceable, however, if "on a proper construction of the contract it appears that the parties do not intend the term to be enforceable by the third party". For this reason, contracting parties should in future give careful consideration to whether they are conferring benefits on third parties, and if so whether they wish those third parties to be able to enforce them directly. If not, they must exclude the Act in clear words.

Benefits, not burdens: It is still not possible for a contract to impose a burden on a person who is not a party to it. It is, however, possible to provide that the third party right will only be enforceable once the third party has complied with some pre-condition. The difference is that the third party is not contractually obliged to do whatever it is, and can simply choose to forego his third party right. This provision may be used for instance to confine the benefit of indemnities to those giving reciprocal indemnities.

What sort of rights? The Act imposes no limit on the sort of rights that can be conferred on third parties. Also, it expressly says that granting a right to a third party includes giving him the protection of an exclusion or limitation of liability.

In offshore contracts it is common for one party to use a "hold harmless mechanism" in order to indemnify the other and the other's group (however defined) against injury or damage to the first party's personnel and property. Until now, it has been necessary to use concepts of trust and agency, through so-called "Himalaya clauses", in order to make such indemnities effective. In future, contracting parties can use the Act to extend the benefit of indemnities with certainty. They can restrict the rights granted, and their liability in relation to them, as much as they please. The reasonableness test in the Unfair Contracts Terms Act 1977 does not apply, for example, if the relevant contracting party excludes his liability to the third party for negligence. While any exclusion in respect of death or personal injury resulting from negligence would be void, an indemnity in respect of the same loss would not be..

What sort of remedies? The third party has the the right to go for any court-awarded remedy which would have been available to him in an action for breach of contract if he had been a contracting party. This means that he can apply, for example, for damages, injunctive relief, a declaration or specific performance. The normal rules (eg causation, remoteness, mitigation) apply, including limitation of actions.

Contracting party's defences: The relevant contracting party has certain defences. For example, he can assert any set-off or counterclaim which he could have asserted against the other contracting party (whether from the contract or another wholly unrelated contract) and he can invoke any rights of set-off or counterclaim he happens to have in relation to the third party. The contract can expressly waive these rights of defence, set-off or counterclaim.

In contrast to the position of the third party (see above), a contracting party can also attack the contractual term invoked by the third party (it might, for example, be an exclusion of liability) on the grounds that it fails the reasonableness test under the Unfair Contract Terms Act 1977.

Also, he could resist the third party's claim on other grounds which would have been available if the third party had been party to the contract - for example, that the contract was invalid for fraud, duress, undue influence or failure of consideration.

Variation and rescission of the third party right: Unless the contract provides otherwise, the third party right is automatically entrenched and cannot be varied or rescinded without the third party's consent if the third party has communicated his assent to the term or the third party has relied on the term and the contracting party knows this or should reasonably have expected it. As it will generally be unacceptable in offshore contracts for members of a contracting party's group to have such controls over the contract, it will be necessary to exclude in clear terms the third party's right to consent to variation or rescission.

Summary

When drafting an indemnity clause you should address the following issues:

• Which benefits are to be extended to group members? Consider confining third party rights to indemnities only.
• How wide is the benefit to be extended? Consider the definition of 'group'.
• Consider restricting the requirement to get consent of group members before varying or rescinding the contract.
• Consider whether the extended right should be assignable.
• Consider restricting the remedies which group members may claim to damages. For further information contact Judith Aldersley-Williams at jalw@cms-cmck.com or on (+44) (0)1224 6422002.