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Legal Dictionary

privity of contract

Legal Definition of privity of contract

Related terms


Definition of privity of contract

Further reading

The doctrine of privity in the common law of contract provides that a contract cannot confer rights or impose obligations arising under it on any person or agent except the parties to it.

The premise is that only parties to contracts should be able to sue to enforce their rights or claim damages as such. However, the doctrine has proven problematic due to its implications upon contracts made for the benefit of third parties who are unable to enforce the obligations of the contracting parties.

Third-party rights

Privity of contract occurs only between the parties to the contract, most commonly contract of sale of goods or services. Horizontal privity arises when the benefits from a contract are to be given to a third party. Vertical privity involves a contract between two parties, with an independent contract between one of the parties and another individual or company.

If a third party gets a benefit under a contract, it does not have the right to go against the parties to the contract beyond its entitlement to a benefit. An example of this occurs when a manufacturer sells a product to a distributor and the distributor sells the product to a retailer. The retailer then sells the product to a consumer. There is no privity of contract between the manufacturer and the consumer.

This, however, does not mean that the parties do not have another form of action e.g. Donoghue v. Stevenson - here a friend of Ms. Donoghue bought her a bottle of ginger beer, which was defective. Specifically, the ginger beer contained the partially decomposed remains of a snail. Since the contract was between her friend and the shop owner, Mrs. Donoghue could not sue under the contract, but it was established that the manufacturer has a duty of care owed to their consumers and she was awarded damages in tort.

Privity is the legal term for a close, mutual, or successive relationship to the same right of property or the power to enforce a promise or warranty.

Exceptions

- Common law exceptions

There are exceptions to the general rule, allowing rights to third parties and some impositions of obligations. These are:

  • Collateral Contracts (between the third party and one of the contracting parties)
  • Trusts (the beneficiary of a trust may sue the trustee to carry out the contract)
  • Land Law (restrictive covenants on land are imposed upon subsequent purchasers if the covenant benefits neighbouring land)
  • Agency and the assignment of contractual rights are permitted.
  • Third-party insurance.a third party may claim under an insurance policy made for their benefit, even though that party did not pay the premiums.
  • Contracts for the benefit of a group where a contract to supply a service is made in one person's name but is intended to sue at common law if the contract is breached; there is no privity of contract between them and the supplier of the service.

Attempts have been made to evade the doctrine by implying trusts (with varying success), constructing the Law of Property Act 1925 s. 56(1) to read the words "other property" as including contractual rights, and applying the concept of restrictive covenants to property other than real property (without success).

- Statutory exceptions

The Contracts (Rights of Third Parties) Act 1999 now provides some reform for this area of law which has been criticised by judges such as Lord Denning and academics as unfair in places. The act states:

  1. (1) Subject to the provisions of this Act, a person who is not a party to a contract (a "third party") may in his own right enforce a term of the contract if-
    (a) the contract expressly provides that he may, or
    (b) subject to subsection (2), the term purports to confer a benefit on him.
    (2) Subsection (1)(b) does not apply if on a proper construction of the contract it appears that the parties did not intend the term to be enforceable by the third party.

This means that a person who is named in the contract as a person authorised to enforce the contract or a person receiving a benefit from the contract may enforce the contract unless it appears that the parties intended that he may not.

The Act enables the aim of the parties to be fully adhered to. Taking the situation in Beswick v Beswick whereby the only reason why Mr Beswick and his nephew contracted was for the benefit of Mrs Beswick. Under the Act Mrs Beswick would be able to enforce the performance of the contract in her own right. Therefore, the Act realises the intentions of the parties.

The law has been welcomed by many as a relief from the strictness of the doctrine, however it may still prove ineffective in professionally drafted documents, as the provisions of this statute may be expressly excluded by the draftsmen.

- Third-party beneficiaries

In Australia, it has been held that third-party beneficiaries may uphold a promise made for its benefit in a contract of insurance to which it is not a party (Trident General Insurance Co Ltd v. McNiece Bros Pty Ltd (1988) 165 CLR 107). It is important to note that the decision in Trident had no clear ratio, and did not create a general exemption to the doctrine of privity in Australia.

Queensland, the Northern Territory and Western Australia have all enacted statutory provisions to enable third party beneficiaries to enforce contracts, and limited the ability of contracting parties to vary the contract after the third party has relied on it. In addition, section 48 of the Insurance Contracts Act 1984 (Cth) allows third-party beneficiaries to enforce contracts of insurance.

Although damages are the usual remedy for the breach of a contract for the benefit of a third party, if damages are inadequate, specific performance may be granted (Beswick v. Beswick [1968] AC 59).

The issue of third-party beneficiaries has appeared in cases where a stevedore has claimed it is covered under the exclusion clauses in a bill of lading. In order for this to succeed, four factors must be made out:

  • The bill of lading must clearly intend to benefit the third party.
  • It is clear that when the carrier contracts with the consignor, it also contracts as an agent of the stevedore.
  • The carrier must have had authority by the stevedores to act on its behalf, or the stevedores must later endorse the actions of the carrier.
  • Any difficulties with consideration moving from the stevedores must be made out.

The last issue was explored in New Zealand Shipping Co Ltd v. A M Satterthwaite & Co Ltd [1975] AC 154, where it was held that the stevedores had provided consideration for the benefit of the exclusion clause by the discharge of goods from the ship.

New Zealand has enacted the Contracts Privity Act 1982, which enables third parties to sue if they sufficiently identified as beneficiaries by the contract, and in the contract it is expressed or implied they should be able to enforce this benefit.

References:

  1. Wiktionary. Published under the Creative Commons Attribution/Share-Alike License.



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