Privity

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This article is a topic within the subject Principles of Private Law.

Contents

Required Reading

Paterson, Robertson & Duke, Principles of Contract Law (Lawbook Co, 3rd ed, 2009), pp. pp. 205-222 (chapter 11).

Introduction

[1]The doctrine of privity of contract states that only a person who is a party to a contract can enforce the contract (gain a benefit) or incur obligations (burdens) under it. Thus, a plaintiff must be a Promisee and a party to the contract.

  • Rationale: only parties which agreed to the contract should be bound by it
    • Third-parties haven’t provided consideration
  • Described as fundamental in England
  • Greatly criticised since
  • Can be circumvented in numerous ways
  • Abrogated in numerous jurisdictions

Benefits

[2]Privity is in place to prevent third parties from enforcing contractual promises that benefit them. Applied in:

Burdens

[3]Privity also prevents contracts from imposing legal burdens upon third parties.

  • For example, a manufacturer and wholesaler have an agreement. Manufacturer cannot then impose contractual obligations on retailers who buy the goods from the wholesaler, because the retailer isn’t a part of the contract.

The exception to this is a restrictive covenants regarding land – namely, contracts which bind future owners of the land.

  • This is called ‘privity of estate’,
  • discussed in Tulk v Moxhay.
  • The principle has been modified in Australia by statute law.

Non Application of the Privity Rule

[4]Scenarios in which a seemingly third-party is still a party to the contract:

  • One of the parties to the contract acts as an agent for a non-involved party
  • “One of the parties to the contract transfers contractual benefits for the non involved party by way of an assignment or novation of the contract[5]

In these scenarios, the non-involved party is considered a party to the contract and the privity rule does not apply.

Agency

“An agent is a person who has power to enter into a contract on behalf of another person[6]

If the non-involved party can prove that one of the parties to the contract acted as its agent, it will be considered a party to the contract as well. To prove an agency relationship:

  • The non-involved party (the principal) needs to prove that it expressly or impliedly consented to the party to the contract (the agent) acting on its behalf.
  • The agent needs to prove that, with respect to this particular scenario, it was acting on behalf of the Principal as well (namely, that the agent relationship applied to this particular case).
  • Alternatively, the contract can be subsequently ratified:
    • Ratification: – “adoption or confirmation of a contract by a person who was not originally bound by it[7]
    • Ratification is usually relied upon to circumvent privity rules with regards to Himalaya clauses in contracts of carriage.

Contracts of Carriage and Himalaya clauses

[8]Contracts of carriage usually include clauses which exempt or limit liability in the case of loss or damage to the goods. In addition, they include Himalaya Clauses, which extend that exemption to other non-involved parties, namely subcontractors and stevedores.

In order for a Himalaya clause to apply to stevedores, they must pass this four-stage test (laid down in Scruttons Ltd v Midland Silicones Ltd[9]:

  1. Bill of lading states that stevedore is meant to be protected.
  2. Bill of lading states that the carrier was acting as an agent for the stevedore.
  3. Carrier had authority to enter contract as agent of the stevedore/ stevedore ratified.
  4. Stevedore provided consideration.

This test was discussed in Port Jackson Stevedoring Pty Ltd v Salmond & Spraggon (Aust) Pty Ltd (The New York Star)


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Assignment and novation

[10]There are two ways for a party to transfer its contractual rights and obligations to a third party:

Assignment

A party assigns its rights a under a contract to another party. The original party to the contract now cannot enforce those rights.

  • Whether the contract can be assigned is a matter of construction.

Novation

A party assigns both its rights and obligations to another party. This is effectively the termination of the original agreement and formation of that exact agreement with the new party.

  • Requires an agreement between the original and substituted parties; unless
  • The contract authorises a party to substitute another without agreement.

Circumventing the privity rule

[11]For the purposes of this section, the ‘Beneficiary’ is a third party seeking to enforce a contract.

The ways to circumvent the privity rule are:

  1. Promisee holds a right under the contract on trust for the beneficiary
  2. Beneficiary can press an estoppel against the Promisor
  3. Beneficiary can claim damages in tort.
  4. Beneficiary can claim damages for misleading or deceptive conduct

Trust

[12]A contractual right is a form of property, which can be held on trust for a beneficiary.

The court may discern an intention on the part of the Promisee to hold on trust for the beneficiary the contractual right to enforce a promise. This creates an obligation on behalf of the Promisee to enforce the contractual right.

  • In practice, the beneficiary can then sue the Promisor if the Promisee joins as co-defendant.

Court discerning intention to create a trust

There is no general rule whether the intention must be explicit or inferable. This was discussed in Trident General Insurance Co Ltd v McNiece Bros Pty Ltd:

  • Trust should be inferred if it clearly appears that the Promisee intended the third party to insist on the performance of the promise; and
  • If trust appears to be the appropriate legal mechanism to this intention.

This uncertainty has invited criticism as to whether trust is an adequate tool to circumvent the privity rule.

Estoppel

Equitable Estoppel

[13]Equitable Estoppel will prevent injustice arising from the application of the privity rule when a beneficiary relies (to its detriment) to an expected entitlement from the contract.

This doctrine also entails that it is possible for a non-involved party to incur a burden (contractual obligation) under a contract.

Estoppel by convention

“Operates where parties adopted a particular set of affairs as the basis of their relations[14]”. The beneficiary needs to show that all parties shared an assumption that the beneficiary will gain benefits under the contract, and that it relied on this assumption to its detriment.

  • Used to establish who the parties to the contract are.

Tort

Sometimes a beneficiary can enforce an obligation imposed on the Promisor by the law of tort. This is possible when all of the following conditions are satisfied:

  • Contractual obligation in question is a “duty to take care to avoid harm to the beneficiary.[15]
  • “There is a relationship of proximity between the Promisor and the beneficiary which gives rise to a duty of care under the law of negligence.[16]

This issue came up in Hill v Van Erp:

  • High Court accepted that a Promisor may owe a duty of care to a non-involved party.
  • In the breach of that duty of care, the non-involved party can sue for damages under tort.

Misleading or deceptive conduct

[17]Promises can sometimes amount to misleading or deceptive conduct, which are prohibited by the Trade Practices Act 1974 (Cth) and the State and Territory Fair Trading Acts. A person who suffered due to such conduct is entitled to receive damages from the person who engaged in the misleading or deceptive conduct.

Thus, a beneficiary who suffered as a result of such conduct can claim damages under a statutory right to damages (the enforcement of the contract is not necessary).

This was discussed in Accounting Systems 2000 (Developments) Pty Ltd v CCH Australia Ltd:

  • Court ordered damages for the third party under statutory law.
  • “the misleading conduct is found in the making of a contractual provision, and the complainant does not have contractual privity with the defendant[18]

The statutory rights to damages sometimes overlap with equitable estoppel in the case of future conducts.

Remedies available to the Promisee

Even when a Promisee decides to sue a Promisor to enforce a benefit upon a beneficiary, the remedies available to the Promisee are often insufficient to ensure that the beneficiary obtains the promised benefit. Whilst substantial damages and specific performance can be given, there are situation in which they will be unavailable or doubtful.

Damages

Contract[19] damages are in place to compensate the damages suffered by the Promisee. So when the beneficiary is the one suffering the damages, and not the Promisee, the Promisee will only receive nominal damages.

  • The Promisee will be able to obtain full or substantial compensation only when he holds the relevant contractual rights on trust for the beneficiary.

Specific performance

[20]Specific performance is the best remedy available for a beneficiary because it ensures he obtains the promised benefit. However, specific performance is only available when:

  • The court agrees damages are inadequate
  • The Promisee is willing or obliged by a trust to sue on behalf of the beneficiary.

Specific performance will not be available when:

  • The case involves performance of personal services
  • Performance is required at a certain time
  • Defective executed performance

Reasons for abolishing the privity doctrine

[21]The reasons as summarised by Law Commissioner Burrows[22]:

  1. Privity rule thwarts intentions of the parties. Third parties can’t sue even if parties manifested intention to allow this. Privity is a constraint on freedom of contract.
  2. Privity rule causes injustice to the third party.
  3. Third party who suffered damages not allowed to sue, whilst Promisee who suffered no damages is – this is unfair. Remedies available to the Promisee suing for a third party are limited and unjust.
  4. Even when adequate compensation is possible, this depends on the will and ability of the Promisee to sue.
  5. The ways to circumvent privity demonstrate that it is unjust. None of them really resolve the injustice though.
  6. Those exceptions make the law uncertain and complex
  7. Privity doctrine has been abolished by civil-law systems and increasingly modified and eroded in many common-law jurisdictions too.
  8. The inconvenience of this rule has been long recognised.
  9. Creates difficulty in many particular commercial situations.

Reasons for retaining the privity doctrine

[23]There are both practical and theoretical considerations to the retention of the privity doctrine. Practical considerations The practical considerations were considered in Trident General Insurance Co Ltd v McNiece Bros Pty Ltd:

  1. If both the Promisee and he beneficiary can enforce the contract, double recovery from the Promisor is possible
    • However, this can be easily solved by requiring joinder of all parties i first action or creating a law against double recovery.
  2. Privity doctrine protects Promisor from being sued by a large amount of potential plaintiffs.
    • For example, imagine a government contract – third party lawsuits would be innumerable.
  3. Allowing beneficiaries to sue would constrain the freedom of action of the involved parties.
    • Promisee usually enjoys ability to modify the agreement etc. This would be jeopardised by the abolition of the privity doctrine.

Theoretical Considerations

[24]According to Kincaid, there are theoretical arguments against the abolition of the privity doctrine:

  • Obligations are privately assumed, not imposed by the law.
  • The essence of a contract is a bargain – an exchange between two people.
  • The third party has not participated in this bargain and has not given consideration
  • Accordingly, no relationship between third party and Promisor
  • Accordingly, no enforceable obligation by the third party.
  • Contract law should balance private interests of the parties, not public interests.
  • Third party recognition would put public interests over private

Kincaid also refutes the reasoning of the English Law Commission:

  • Giving intention to parties intention does not in itself justify the imposition of an obligation
  • Obligation is not only based on intention, but on bargain too
  • If reliance is the justification, then remedies lie outside contract law anyways (estoppel)

Statutory modification of the privity doctrine

[25]The privity doctrine has been modified by statutes in some places. Burrows[26] pointed out five issues which need to be resolved:

  • The test of enforceability[27] - When should a beneficiary be able to enforce a contract?
  • Variation and rescission[28] - to what extent should the Promisee still be able to vary rescind or terminate the contract?
  • Defences, set-offs and counterclaims[29] - Should the Promisor be entitled to raise the same defences or counter-claims against the beneficiary as he can against the Promisee?
  • Promisee’s right to sue[30] - should the Promisee retain the right to sue, as well as the beneficiary?
  • Preservation of the third party’s other rights[31] - should the other remedies available to the beneficiary, namely, estoppel or trust, still be available?

References

Textbook refers to Paterson, Robertson & Duke, Principles of Contract Law (Lawbook Co, 3rd ed, 2009)

  1. Textbook, p. 205 [11.05]
  2. Textbook, p. 206 [11.10]
  3. Textbook, p. 209 [11.25]
  4. Textbook, p. 210 [11.30]
  5. Textbook, p. 210 [11.30]
  6. Textbook, p. 210 [11.35]
  7. Textbook, p. 210 [11.35]
  8. Textbook, p. 210-12 [11.35]
  9. [1962] AC 446
  10. Textbook, p. 212-3 [11.37]
  11. Textbook, p. 213 [11.38]
  12. Textbook, p. 213-4 [11.40]
  13. Textbook, p. 214-5 [11.45]
  14. Textbook, p. 215 [11.47]
  15. Textbook, p. 215 [11.50]
  16. Textbook, p. 215 [11.50]
  17. Textbook, pp. 215-6 [11.55]
  18. (1993) 42 FCR 470, 506
  19. Textbook, pp. 216-8 [11.65]
  20. Textbook, p. 218 [11.70]
  21. Textbook, pp. 218-9 [11.75]
  22. Burrows, ‘Reforming Privity Of Contract: Law Commission Report No. 242’ [1996] Lloyd’s Maritime and Commercial Law Quarterly 467, 468-71
  23. Textbook, pp. 219 [11.80]
  24. Textbook, p. 220 [11.90]
  25. Textbook, p. 220-2 [11.95-11.20]
  26. Burros, “Reforming Privity of Contract: Law Commission Report No. 242’ [1996] Lloyd’s Maritime and Commercial Law Quarterly 467, 471-81
  27. Textbook, p. 221[11.100]
  28. Textbook, p. 221[11.105]
  29. Textbook, pp. 221-2[11.110]
  30. Textbook, p. 222[11.115]
  31. Textbook, p. 222[11.120]
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