The Contracts (Rights of Third Parties) Act 1999 made headlines when it was enacted since it made it possible for a person who is not a party to a contract to take the benefit of it. However, in practice its impact has been minimal, since most commercial contracts exclude the operation of the Act. As a result, there are very few instances in which it has come before the courts. The High Court's decision in Prudential Assurance Co Ltd v Ayres and another (considered in the June 2007 edition of Property Update) has been overturned by the Court of Appeal.

The tenant, a partnership, had taken an assignment of a lease from the defendants. On the assignment the defendants had given an authorised guarantee agreement (AGA) to the landlord, guaranteeing the partnership's obligations under the lease. A supplemental deed was entered into between the tenant and the landlord, under which it was agreed that the landlord's right of recovery against the tenant or any previous tenant would be limited to the assets of the partnership. The aim of the deed was that the individual partners should not incur any personal liability beyond the partnership assets.

Subsequently the partnership fell into financial difficulties, and the landlord sought to recover from the defendants under the AGA. The defendants relied on the words 'or any previous tenant' in the supplemental deed to limit their liability. The defendants were not a party to the supplemental deed and their defence was based on the Contracts (Rights of Third Parties) Act 1999.

The defendants had argued that the intention in including former tenants in the supplemental deed was to prevent the landlord being able to recover in full from the defendants under the AGA. Otherwise, the defendants would in turn be able to pursue the tenant for the full amount under the indemnity which was given to the defendants on assignment. This would circumvent the protection which the tenant had negotiated for itself with the landlord.

The High Court ruled in the defendants' favour, holding that the wording of the deed purported to confer a benefit on them. The Court of Appeal disagreed.

The court held that, against the commercial background to the transaction, the words 'or any previous tenant' in the supplemental deed had clearly been inserted in the wrong place. The relevant clause should have read 'any recovery by the Landlord or any previous tenant against the Tenant shall be limited to the assets of the partnership'. In other words, the clause was actually designed to restrict the defendants' remedies against the tenant, not confer a benefit on them.

The court acknowledged that, since the defendants were not a party to the supplemental deed, the clause was in fact ineffective to achieve this aim. However, it found that the tenant had made it clear from a very early stage that it was only willing to proceed on the basis that there should be no recourse against the personal assets of the individual partners, and that both the landlord and the defendants were willing to accept this. The Court of Appeal noted that the supplemental deed was entered into around the same time as the AGA. The court thought that if the parties had intended that the defendants' liability under the AGA should be limited, the defendants would have been a party to the supplemental deed. In addition, the court would have expected to see the liability in the AGA similarly qualified.

Things to consider

The court showed itself to be willing to rewrite the terms of the supplemental deed to fit with what it thought was the commercial background to the transaction. That background will include any information (other than evidence of negotiations or subjective intention) that was reasonably available to both parties at the time of entering into the contract, which would have affected the way in which the language of the document would have been understood by a reasonable man. The background may enable the reasonable man to conclude that the parties must, for whatever reason, have used the wrong words or syntax.

While there are undoubtedly times when this is the case, these are usually situations in which a rectification claim would be appropriate. Outside this course of action, many will be concerned at the court's apparent willingness to effectively amend the terms of documents which have been negotiated at arm's length between commercial parties with the benefit of legal advice.

The court did make the point that the defendants' construction of the supplemental deed would give rise to great uncertainty. It would be necessary to read it as if it provided that the amount that could be recovered from the defendants should not exceed the value of the assets of the partnership or, perhaps, the amount that could be recovered from the partnership in a liquidation. It would be unclear both how much the landlord was entitled to recover and the date at which that was to be determined. The court therefore concluded that this was not what could have been intended.

There are circumstances in which the Contracts (Rights of Third Parties) Act can be useful. Those advocating the use of the Act may be disappointed by the Court of Appeal's decision. Following this case, it seems that if the Act is to fulfil its purpose of enabling third parties to enforce contracts, very clear wording must be used.