By Law Teacher
3.1 Privity of Contract – Introduction
Welcome to the third lesson of this module guide – privity of contract! Privity of contract is a very nuanced doctrine, while there are no straight-jacket solutions, certain principles have evolved over time in common law and statutes, which attempt to provide a direction to the issue. These will be explored further within this chapter.
The chapter begins with a discussion of the general doctrine, as well as the rule of consideration and right of action. The next sections concern the exceptions to this doctrine, specifically the statutory exceptions as well as common law exceptions.
Below are some goals and objectives for you to refer to after learning this section.
Goals for this section
- To understand the nature of the doctrine of ‘privity of contract’
- To be able to define and apply the doctrine
Objectives for this section
- To understand the need for privity of contract
- To understand the general rule of the doctrine
- To understand both the rule of consideration and the right of action
- To understand the exceptions to the doctrine, including statutory and common law exceptions
- To understand the case law in this area and be able to apply it in context
3.2 Privity of Contract Lecture
The general rule at common law states that a contract creates rights and obligations only as between the parties to such contract. As a corollary, a third party neither acquires a right nor any liabilities under such contract. This is what the proclaimed doctrine of “privity of contract” enunciates and establishes as the overarching rule underlying any contractual relation.
Rule of Consideration
Consideration must flow from the promise. In other words, “if a person with whom a contract has been made is to be able to enforce it consideration must have been given by him to the promisor”- Dunlop Pneumatic Tyre Co Ltd v Selfridge Ltd  AC 847, 853. Thus, while this rule of consideration is distinct and separate from the doctrine of privity, as upheld in Kepong Prospecting Ltd v Schmidt  AC 810, it yields the same result so as to be closely connected.
Right of Action
It is worthwhile to highlight that what the doctrine prohibits is the right of action or enforcement in favour or against a third party, and not beyond. That is, a contract may bestow benefits to a third party, although such imposition of liabilities remains a bar. In the former case, a breach may be enforced by the other contracting party for and on behalf of the third party, by way of remedies such as specific performance, stay of proceedings, and damages, as discussed below.
Lloyd’s v Harper (1880) 16 Ch D 290 – Where a contract is made with A for the benefit of B, A can bring an action for benefit of B, and recover all dues as if the contract was made with B himself. The contracting party may, singly or jointly with the third party, have the contract performed by way of a court order for specific performance. Accordingly, the claim of the wife as the administrator (as a contracting party) succeeded to obtain an order for specific performance by way of payment of all dues and arrears.
Stay of Proceedings
This remedy is relevant where a contract provides for a covenant not to sue the third person. Where a party institutes a legal action against the third person in breach of such covenant, the other contracting party may seek to discontinue such proceedings by way of a stay order.
Having said that, the following conditions must be satisfied to obtain a stay- Gore v Van Der Lann  2 QB 31:
(i) The contract must provide for an undertaking by the promisor not to sue the third person, and
(ii) The promisee must have a sufficient interest in the enforcement of the promise.
As a general rule, a contracting party can sue for damages only in respect of his own loss, and not for losses suffered by a third person – Alfred McAlpine Construction Ltd v Panatown Ltd  1 AC 518.
This rule, however, has been applied with exception where the third person had no alternate course of remedy available to make good the loss, commonly referred to as a situation of “legal black hole” Darlington Borough Council v Wiltshier Northern Ltd  1 WLR 68, 79.
Exceptions to the Doctrine
Some of the earliest statutory right of third person to enforce contractual obligation of another can be found in section 56(1) of the Law of Property Act 1925 (invoked in Beswick v Beswick), section 11 of the Married Women’s Property Act 1882, section 14(2) of the Marine Insurance Act 1906, and section 148(7) of the Road Traffic Act 1988 (all of the above relating to policy of assurance/insurance for benefit of family or third persons). Also, section 2 of the Carriage of Goods by Sea Act 1992 bestows a holder of bill of lading with all rights of legal action permissible under the contract of carriage, notwithstanding that he was not a party to it when originally drafted.
The Contracts (Rights of Third Parties) Act 1999
The most frequently invoked statutory exception lies in the Contracts (Rights of Third Parties) Act 1999 (1999 Act).
The 1999 Act prescribes a two-fold test to allow a third person action or enforcement of contract, namely (section 1) –
- Where the contract expressly provides for it, or
- Where the contract purports to confer a benefit on such third person.
For either of the conditions, the third person must be clearly identifiable. Notably, such identification must be specific and express, ruling out any scope for identification by construction or inference- (Avraamides v Colwill  EWCA Civ 1533).
Further, the test (i) if satisfied, also covers negative rights as specified in section 1(6), such as right of exclusion or limitation of liability (Himalaya clause) – the subject matter of much dispute in common law.
The position as regards test (ii) however remains controversial. This is because it indicates towards an implied case of third person right, where no express stipulations exist in the contract. This leaves much scope for subjectivity and lack of predictability, as under the common law exceptions- Trident General Insurance Co Ltd v McNiece Bros (1988) 165 CLR 107.
Also, the condition does not enable a third person action where the intention of the contracting parties appears to the contrary in the contract (section 1(2)). This rebuttal was invoked in the case of Nisshin Shipping Co Ltd v Cleaves & Co Ltd  EWHC 2602, where it was asserted on the ground that the third person had a right of action otherwise, so that such right under the 1999 Act was not necessary.
Moreover, the 1999 Act prevents the variation or rescission of a contract where such third person right to action is established, except by way of consent of the third person (section 2).
All in all, the 1999 Act (although an exception) does not abrogate the doctrine of privity of contract, which continues to remain the predominant overarching rule governing contractual relations. Additionally, the 1999 Act does not alter the legal position, including the exceptions, under common law, which continue to be applied by courts alongside.
Common Law Exceptions
This exception is much conflicted as it depends upon the finding of the court of a contract in existence where the claimant is an actual contracting party, and not a third person. Whether or not such collateral contract exists depends upon evidence of the generally applicable constituents of a valid contract, namely – offer, acceptance, intention to create legal relations and consideration- Gravy Solutions Ltd v Xyzmo Software GmbH  EWHC 2770. Where any of such elements is absent, the exception enabling third person action will not be triggered- Independent Broadcasting Authority v EMI Electronics (1980) 14 Build LR 1.
The way for this exception was paved by the ruling in Dunlop Pneumatic Tyre Company Ltd v Selfridge and Company Ltd  AC 847, 959, where it was held that although privity of contract does not allow third person action, such a “right may be conferred by way of property, as for example, under a trust”. This was affirmed in Les Affreteurs Reunis v Walford  AC 801. In this case, Walford (broker) negotiated a contract between the charter party and the ship owner, containing a stipulation as regards certain commission payable to Walford. Upon failure of such payment, Walford sued the ship owner. The court found a trust to have been created owing to Walford receiving benefit under the agreement.
Caution should, however, be exercised to not confuse this exception with that of a simple contract executed for benefit of a third person. Not in every such contract involving third person beneficiary is a trust of contractual right created. This was highlighted in the case of Re Schebsman  Ch 83, 89. Schebsman employment was terminated with a company, following which he entered into an agreement with the company for certain payments against such termination. The payments, in the event of his death, were to be made to his wife and daughter. Upon his death and failure of payments by the company, it was argued that the contract between Schebsman and the company created a trust in favour of the wife and daughter.
A contracting party can assign his rights (not liabilities, except by way of consent) under the contract to a third person. Having said that, a mere right to litigate or sue for damages cannot be so assigned, unless the third person has a commercial interest in assuming such right, as enunciated in Trendtex Trading Corporation v Credit Suisse  AC 679. Moreover, defences of the promisor and the extent of remedy available to the third person would be as what was contemplated and applicable under the original contract – Offer Hoar v Larkstore Ltd  EWCA Civ 1079.
This exception can be traced from the Dunlop Pneumatic Tyre Company Ltd case, i.e., a principal not named in the contract may sue upon it if the promisee really contracted as his agent, and consideration was directed personally or via the promisee in the capacity of an agent. In other words, the real right of action then rests with the principal as the contracting party, as the agent (promisee) then moves out of the arrangement so as not to sue or be sued- Wakefield v Duckworth  1 KB 218.
Action in Tort
In the event of a breach of duty of care, an independent claim for negligence can be instituted by the person having suffered the loss, regardless of any contractual arrangement otherwise. This can be best asserted through the case of Donoghue v Stevenson  AC 562, where despite the claimant having no contractual relation with the ginger beer manufacturer, a claim in tort could be successfully sustained.
In an example of sale and purchase of land, any terms of conveyance will generally be confined to the seller and the buyer, and not extend to subsequent buyers/owners. Having said that, a restrictive or negative covenant such as bar on use of the land for commercial purposes or on constructing permanent fixtures on the land, may be carried forward with the land and enforced by the seller against subsequent owners. This was upheld in Tulk v Moxhay  41 ER 1143.
The question whether or not a third party could take benefit of an exclusion or limitation clause (popularly known as the Himalaya clause) in a contract, more particularly, in a contract of carriage, has been subject to much judicial bargain- E McKendrick, Contract Law (Oxford University Press 2012).
In the early case of Elder Dempster v Paterson Zochonis  AC 522, where oil was damaged by bad stowage in relation to a contract between the claimant and the carrier, the court extended the exclusion in the bill of lading to the ship owner, notwithstanding the absence of any direct contract of the ship owner with the claimant. This was so because the clause expressly mentioned ship owners, reckoned to have operated as the agent of the carrier. This stance was, however, soon refuted in Scruttons Ltd v Midland Silicones Ltd  AC 446, which enumerated several requirements for such an extension of exclusion clause to a third person, such as stevedore, namely- (i) declaration of agency in the clause itself that the carrier had contracted as agent of the stevedore for the purpose of securing the benefit, and (ii) carrier must have the authority from the stevedore to do so (even if by later ratification). In this case, drums of chemicals were damaged by stevedore during carriage under a contract between the carrier and the claimant. The court ruled that, as the stevedores were not parties to the carriage contract, they could not avail the exclusion clause.
3.3 Privity of Contract Lecture – Hands on Example
The following scenario seeks to assess your understanding of the concept of “privity of contract” and “third person action or enforcement” on a practical standpoint.
In answering the issues, you should apply the theory and principles, alongside the cases discussed above. While referring back to the notes may be helpful, not all of the content will be relevant here. Hence, you should be able to identify the applicable heads and related case law. Further, given that the notes do not (and cannot possibly) capture all decided cases until date, you should be able to research on, review and understand other relevant cases on the subject, and apply them to the scenario. This, however, should be done once you have obtained a thorough conceptual understanding, for which the notes should help.
While the solutions may be quite subjective and case-specific, probable answers are provided at the bottom of the page. Start by identifying the legal issues involved in each problem.
Given that you have now gained expertise on the topic, go ahead solving the problem. A few guidelines may help:
- Is the claimant a party to the contract? Does consideration flow from the claimant?
- Whether the contract expressly allows a third person action?
- Does the contract purport to confer any benefit to a third person?
- If yes, whether the parties still intended in the contract to not allow third person action?
- Did the third person have trust of contractual right? Was the promisee an agent of the third person in the context of the execution of the contract?
- Is there any collateral contract, express or implied, between the third person and the promisor?
The facts concern the following two transactions between Panaroma Ltd (P), Lily Ltd (L), and Motion Line Ltd (M), all companies registered in the UK:
- P acquired another company Crossword Ltd (C) in the services sector from L. In the share purchase agreement, a non-compete covenant was included as follows-
“7.1L will not engage in any competing business or transactions for a period of five years from the closing of the share purchase deal. Competing business will mean the business of C, or related business in which any of P’s affiliate companies is engaged. For the purpose of this clause, “affiliate” shall include all of P’s subsidiaries and group companies.”
L nevertheless starts a joint venture with Stephen (as a second shareholder) next year for the construction of flats- akin to the business of M engaged in residential building construction, in the same locality. M is a wholly owned subsidiary of P. As a result, M suffers significant losses in terms of cancellation of flat bookings against construction already commenced.
M sues L for breach of the non-compete clause 7.1, and losses suffered. Can M succeed in its claim? In the alternate, would P be able to seek remedy for M?
- P owns a land, on which certain construction is to be undertaken by L. For certain logistics and taxation purposes, P routes the contract via M, such that the contract is executed between M and L. L undertakes the work on site and produces periodic invoices to M. M fails in making part payment of the bills, following which L terminates the contract and sues P for restitution against benefits already accrued to P from the portion of construction already completed. P denies L’s claim stating that the contract between M and L is not binding on P, which is not privy to the agreement. Would L be able to enforce the contract and the claim for restitution against P?
- The issue is whether M (as a third person to the share purchase agreement) can enforce clause 7.1 against L.
At the outset, the agreement does not expressly provide for such right of enforcement to M. Hence, the first condition of the test under the 1999 Act is not fulfilled in the given facts.
Next, on the second condition of benefit being conferred upon M, it is clear that the non-compete sought to purport the protection to not only C, but also to the business of any of its other group companies. Thus, although M is not expressly stated, it is identified by way of description as an affiliate/subsidiary company. Accordingly, the protection extended to M- a 100% subsidiary of P.
Now being a beneficiary under the agreement, M has a right to seek enforcement of the clause in its own capacity under section 1(1)(b) of the 1999 Act, if not otherwise intended by the contracting parties (section 1(2)). In the absence of such contrary intention, it may be concluded that M has a right of action against L.
In the alternate, M, through P, can seek an order of specific performance by way of divesture of L’s joint venture. P, as the promisee, may sue L for such an order, alongside damages for the losses suffered by M. The above results may be affirmed by the case of Axon Well Intervention Products Holdings AS v Craig  CSOH 4.
- The issue is whether L may have an enforceable claim of restitution against P, which is not a party to the contract under which the claim arises. Inferring from the case of MacDonald Dickens & Macklin v Costello  EWCA Civ 930, it may be concluded that such a claim would fail. This is because, although P benefitted from the work done by L on its site, allowing such a direct claim would undermine the foundation of contractual arrangements premised on free will and voluntary intention between the parties. The fact that L agreed to contract with M, and not P, clarifies the intention of both parties, more particularly, the knowledge of L regarding its counter party.
This conforms to the general rule of party autonomy in contract law as per which parties define, allocate and restrict their mutual obligations by way of an agreement- a sound policy towards legal and commercial certainty, as upheld in Pan Ocean Shipping Co Ltd v Creditcorp Ltd (The Trident Beauty)  1 WLR 161 and Lumbers v W Cook Builders Party Ltd (In Liquidation)  BLR 581. Thus, L may bring an action against M (and not P directly) to claim restitution, and recover damages. In such a suit, discretion however lies upon the court to pierce the corporate veil and reach out to P, if situation so warrants.