Managing Lender Liability in Equator Principles Implementation - Third Party Beneficiary Rights in Contract Law

Managing Lender Liability in Equator Principles Implementation - Third Party Beneficiary Rights in Contract Law



I read an interesting and provocative journal article by Marissa Marco, published in the Fordham International Law Journal in 2011, entitled "Accountability in International Project Finance: The Equator Principles and the Creation of Third-Party Beneficiary Status for Project-Affected Communities". The article discusses the law on third party beneficiary rights under US contract law and considers whether the provisions of the Equator Principles (EP) relating to Affected Communities might create enforceable rights for those communities under those principles.

This article will discuss this issue and suggest a risk management strategy for EP Financial Institutions (EPFI - i.e. EP signatories) addressing and managing such risks in Equator Principles implementation.

There is a presumption in the English and United States common law systems that contracts are a private arrangement intended to be enforceable between the parties to the contract. This concept is referred to as "privity" of contract, which prevented third parties from obtaining benefits or having responsibility for the terms and conditions of a contract that they were not a party to.

While this limits third party rights under contract, there are numerous possible avenues for third parties to enforce their rights vis-a-vis contracting parties. The most obvious source for third party rights is through "tort" law, which creates free standing rights (i.e. not tied to contractual terms) for third parties regarding the acts of persons (including companies) that owe the person what is called a "duty of care" to the third party. For example, while a contract to deliver a product may be between a retailer and an end-user, if that product is defective and it injures the end-user there may nevertheless be recourse for the for the injured person against the manufacturer of the product. This is even though there was never a contractual relationship between the end-user and the manufacturer.

A less well known source of rights and obligations is the "third party beneficiary" right that can arise under certain contractual arrangements, including lender-borrower contracts.

Law of the United Kingdom on Third Party Beneficiary Rights

The law in the United Kingdom for example (a legal regime often applied to international financing documents) on third party beneficiary rights is largely defined by a statute called the Contracts (Rights of Third Parties) Act 1999 (the "RTP Act"). Generally speaking, the RTP Act changed the law on third party beneficiary rights, and allows a third party to a contract to enforce rights under the contract where:
The third party is specifically mentioned in the contract as someone authorised to enforce rights under the contract, or;
The contract "purports to confer a benefit" on the third party.Importantly, the third party must either be identified by name or as a member of a particular group in the contract itself, although the person or group need not exist when the contract was made. The RTP Act creates restrictions on how the contracting parties can amend a contract to remove third party benefits, particularly where the third party has relied on those rights. Improper removal of third party rights could give rise to a claim for damages by the third party.

Where third party rights exist, the third party could be entitled to sue to enforce the contract, including requesting monetary damages or even specific performance of contractual obligations.

Examples from the US Context

The law in the US is discussed in detail in Marissa's paper, but it is not dissimilar to the UK law, with "intention" to confer a benefit on a third party being critical to a finding of a third party beneficiary right. Marissa discusses some interesting case examples where this right has been found that has profound application to the implementation of the Equator Principles.

For example, the case of Chen
v.
Street
Beat
Sportswear,
Inc.
(the "Chen" case) is discussed as a
useful
illustration
of
the
third-party-beneficiary
rule.
Chen
involved
a
suit
against
a
domestic
clothing
manufacturer,
Street
Beat
Sportswear,
Inc.,
by
its
workers
who
alleged
that
they
were
third-
party-beneficiaries
of
a
contract
between
the
defendant
and
the
Department
of
Labor
("DOL").

Through
this
contract,
the
defendant
had
entered
into
an
Augmented
Compliance
Program
Agreement
("ACPA"),
which
required
the
defendant
to
review,
monitor,
and
report
on
its
contractors' compliance
with
the US
Fair
Labor
Standards
Act.

Applying
the
three-pronged
test
under
New
York
law,
the
court
agreed
with
the
plaintiffs'
contract
claim.
The
court
reasoned
that
the
parties'
intent
to
benefit
the
plaintiffs
was
clear
from
the
ACPA
because
every
provision
to
evaluate
and
monitor
factories
was
for
the
sole
purpose
of
protecting
the
factoryworkers.
Thus,
the
court
rejected
the
argument
that
the
ACPA
was
only
evidence
of
intent
to
benefit
the
contractors,
rather
than
the
workers. In
addition,
the
court
disagreed
with
the
argument
that
the
plaintiffs
were
merely
incidental
beneficiaries,
noting
that
intent
may
be
established
either
by
demonstrating
that
only
the
third
party
would
recover
or
by
the
express
language
of
the
contract.'

Although
the
language
of
the
ACPA
provided
for
a
recovery
only
by
the
DOL,
the
court
rejected
the
assertion
that
the
parties
never
intended
to
permit
enforcement
by
outside
parties.'
Though
the
ACPA
was
silent
on
the
issue
of
enforcement
by
third
parties,
the
intent
to
benefit
the
plaintiffs
could
be
interpreted
from
the
contract
as
a
whole.
The
court
also
found
that
the
third
requirement
of
a
"sufficiently
immediate"
benefit
had
been
satisfied.
Because
the
ACPA
required
the
defendant
to
evaluate
and
report
on
violations
and
to
compensate
workers
within
a
specified
period,
the
court
found
the
scheme
to
be
sufficiently
immediate.
Ultimately,
the
court
held
that
the
plaintiffs
were
the
intended
beneficiaries
of
the
ACPA,
the
parties
had
specific
intent
to
benefit
the
plaintiffs
and,
as
a
result,
the
plaintiffs
had
standing
to
sue
for
breach
of
the
contract.
compliance
with
the
Fair
Labor
Standards
Act.

In another fascinating case, Jane
Doe
v.
Wal-Mart
Stores,
Inc., the
company's
published
code
of
conduct
and
alleged
failure
to
comply
with
the
code
led
non-US
plaintiffs
to
file
an
action
against
Wal-Mart
in
California.
The
plaintiffs were
employees
at
factories
in
Bangladesh,
China,
Indonesia,
Nicaragua,
and
Swaziland
that
supplied
products
directly
to
Wal-
Mart.'
Wal-Mart's
code
of
conduct,
which
was
expressly
part
of
the
contract
between
Wal-Mart
and
its
supplier
factories,
required
that
all
suppliers
comply
with
local
labor
laws
and
allow
Wal-Mart
to
audit
the
factories
to
ensure
compliance
with
the
code.'

The
plaintiffs
argued
that
because
the
code
was
for
the
benefit
of
the
workers,
Wal-Mart's
contract
with
their
employer
provided
them
with
third-party-beneficiary
status
and
standing
to
sue
Wal-Mart
for
failing
to
enforce
the
standards.

Both
the
United
States
District
Court
for
the
Central
District
of
California
and
the
Ninth
Circuit
Court
of
Appeals
disagreed
with
the
third-party-beneficiary
claim
for
two
reasons:
First,
Wal-Mart's
reservation
of
rights
to
inspect
the
suppliers'
factories
did
not
amount
to
a
promise
by
Wal-Mart
to
uphold
its
code
of
conduct.
Second,
the
court
noted
that
a
promise
creates
a
duty
of
performance
in
the
promisor,
not
the
promisee.
Because
the
Wal-Mart
contracts
required
a
promise
by
the
supplier
to
comply
with
local
labor
laws,
Wal-Mart
was
in
fact
not
the
promisor - rather,
the
suppliers
were
the
promisors.'
Thus,
the
plaintiffs
sought
performance
from
the
incorrect
party
to
the
contract.
Because
the
plaintiffs
did
not
allege
sufficient
facts
to
show
third-party-beneficiary
status,
the
court
dismissed
the
plaintiff's claim.Application to the Equator Principles

The foregoing principles and cases are very important for consideration in the context of the Equator Principles and the issue of Lender (or borrower) liability for EP implementation. The question is begged, could Equator Principles terms and covenants which are incorporated into the contractual documentation underpinning an EP financing give rise to third party beneficiary rights? These are not easily answerable questions and require special attention in the implementation of the EP by EPFI and their borrowers.

For example, a recent Facility Agreement draft I reviewed for a Category A EP project, applying UK law, dealt with third party beneficiary rights by reference to the RTP Act and contained no express limitations on third party rights that may arise from the application of the Equator Principles. I flagged this as an issue for further consideration, in light of the foregoing principles. This highlights the fact that precedent agreements of EPFI may not have clearly addressed this issue, despite the possible liabilities that exist.

The avenue for third party beneficiary claims under the EP is quite evident. It derives from the express statements found in the EP itself, which are incorporated by reference into most contractual documents structuring EP financings.

For example, the preamble language of the new EP III states:

"Large infrastructure and industrial
Projects
can have adverse impacts on people and on the
environment. As financiers and advisors, we work in partnership with our clients to identify, assess
and manage environmental and social risks and impacts in a structured way, on an ongoing basis.

Such collaboration promotes sustainable environmental and social performance and can lead to
improved financial, environmental and social outcomes.
We, the Equator Principles Financial Institutions (EPFIs),
have adopted the
Equator
Principles in
order to ensure that the
Projects
we finance
and advise on
are developed in a manner that is socially
responsible and reflects
sound environmental management practices.
We recognise the importance
of climate change, biodiversity
,
and human rights
,
and believe
negative impacts on
project
-
affected
ecosystems
,
communities
, and the climate
should be avoided where possible
.
If these impacts are
unavoidable
they should be
minimised,
mitigated,
and/
or offset
.

We believe that adoption of and adherence to the
Equator
Principles offers significant benefits to
us
,
our
clients,
and local stakeholders through our
clients
engagement with locally
Affected
Communities
. We therefore recognise that our role as financiers affords us opportunities to promote
responsible environmental stewardship and socially responsible development
, including fulfilling our
responsibility to respect human rights by undertaking due diligence
in accordance with the Equator
Principles
.

The
Equator
Principles are intended to serve as a common baseline and framework
.
We commit to
implementing the Equator Principles in our
internal
environmental and
social policies, procedures
and standards
for
financing
Projects
. We will not provide
Project Finance
or
Project
-
Related
Corporate
Loans
to
Projects
where the
client
will not
,
or is unable to,
comply
with the Equator
Principles.
As
Bridge Loans
and
Project Finance Advisory
Services
are provided earlier in the
Project
timeline, we request the
client
explicitly communicates their intention to comply with the Equator
Principles."

As this preamble language clearly states, the EP is seen by EPFI to "offer significant benefits" to "local stakeholders". As well, many of the substantive requirements of the EP, the IFC Performance Standards and EHS Guidelines are drafted with the clear purpose of protecting the rights of stakeholders affected by the environmental and social impacts of a project. This is particularly evident, for example, in the language of Performance Standard 2 pertaining to Labor and Working Conditions and Performance Standard 7 pertaining to Indigenous. Performance Standard 2 is drafted to confer rights on workers that they might not otherwise be entitled to by local laws. Similarly, Performance Standard 7 confers rights of consultation and even Free Prior and Informed Consent of Indigenous Peoples communities that may go beyond legal consultation requirements. While the EP was likely not intended to be legally enforceable by third parties like workers or Indigenous communities or otherwise Affected Communities or local stakeholders, the implication of the legal principles discussed suggests there is a risk this might be possible.

This possible risk is particularly heightened since the language and requirements of the Equator Principles, including this preamble and substantive requirements of the IFC Performance Standards and EHS Guidelines, are expressly incorporated into the terms and conditions of an Equator Principles loan or financing. Unfortunately, the wording of the EP goes beyond and may therefore be distinguishable from the type of commitments to merely "audit" that were found in the Wal-Mart case (noted above). This could create enhanced risks for EPFI that their commitments in relation to the EP could be found to confer a benefit on third parties, who may then be entitled to enforce such commitments as third party beneficiaries.

As well, if financing contracts do not specifically address this issue, the application of the common law or statute (which looks only to the intent to confer a benefit expressed in the actual wording of the contract - rarely considering "extrinsic" evidence like the testimony of those who drafted it) could easily result in a finding of EPFI or borrower obligation in relation to a third party to the contract.

Strategies for Addressing Third Party Beneficiary Rights Risks

This issue presents a difficult legal problem for EPFI, since many of their EP related financing contracts may not have addressed this issue adequately when they were originally drafted. This could mean there are substantial liability risks on EPFI books that a prudent EPFI may wish to assess and deal with. These issues should also be dealt with on a going forward, by EPFI reviewing their practices in implementing EP III, which takes effect June 4, 2013.

Some strategic considerations in dealing with these issues include:Considering how past agreements can be revised (taking into account restrictions on removing or rescinding third party beneficiary rights) to address the risk that third parties may have rights to enforce EP commitments under contractual terms;
Consider revising third party beneficiary language in EP related contracts, on a going forward basis, to ensure that third party beneficiary rights are expressly excluded, to reduce the possibility that there is an inference of such rights should a claim be made;
Consider how indemnities can be used to shift monetary consequences of third party claims from EPFI onto borrowers, who are ultimately responsible for managing environmental and social issues;
Ensure legal oversight of public reporting and stakeholder engagement and consultation activities, to ensure the risks of third party beneficiary rights is effectively managed as part of that process.These strategies emerge from a high level consideration of this issue. EPFI may be well advise to seek advice on what unaddressed risks they may already have on their books, and the best methods for dealing with them.

Should you have any questions about this issue or wish to discuss further please contact me at michael.torrance@nortonrosefulbright.com.