Doctrine of Privity of Contract & its Exceptions

The doctrine of Privity of contract states that any third party, which is not even distinctly related to the two involved parties, does not have a right to initiate a suit against the said parties to the contract even though he/she is the beneficiary. Apart from promisor(s) and promisee(s), all persons constitute the third party. Thus, the third party cannot sue the contracting parties for the enforcement of the beneficiary clause in the contract.

History of Privity of Contract

Despite the fact that the convention of privity was perceived and built up on account of Tweddle v. Atkinson[1], its establishments had been laid by the English courts throughout the years, beginning from as ahead of schedule as the finish of sixteenth century. In any case, in these cases, it can be seen that the Courts fairly settled on them by remembering the supposed ‘Interest Theory’. As per this theory, the courts said that “He that hath interest in the promise shall have the action”, or in other words, only that person can bring up an action who had an interest in the promise and not by anyone who was completely alien to the promise.

“The first recorded case of such an instance was decided upon in 1599. This was the case of Levettv. Hawes[2]. In this case, a father brought an action of assumpsit upon a promise made directly to him that marriage money would be paid to his son. The court was of the opinion that the action ought to have been brought by the son”, “for the promise is made to the son’s use and the ordinary covenants of marriage are with the father to stand seized to the son’s use; and the use shall be changes and transferred to the son, as if it were a covenant with himself; and the damage of non-performance is thereof to the son.”

Another important decision is that of Hadves v. Levit[3] (1632). In this case, the bride’s father (the defendant) had promised the groom’s father (the plaintiff) that he would be paying a sum of 200 pounds to the plaintiff’s son if he agrees to marry her and thus, owing to this very proposition, the plaintiff gave his consent for the marriage. But, after the marriage, the defendant failed to pay the required sum to the son which resulted in the plaintiff bringing and action in assumpsit. This claim was rejected by the Court of Common Pleas. Richardson, J. stated that the action should have been “more properly” brought by the son, for he was the person “in whom the interest is”.

“In Dutton v. Poole[4], a son promised his father that, in return for his father not selling a wood, he would pay 1000 pounds to his sister. The father refrained from selling the wood, but the son did not pay. It was held that the sister could sue, on the ground that the consideration and promise to the father may well have extended to her on account of the tie of blood between them.”

Position of the Doctrine of Privity of Contract in England

This doctrine was developed in Tweddle v. Atkinson[5] and affirmed in Dunlop Pneumatic Tyre v. Selfridge and Co. Ltd.[6] The Dunlop Co. manufactured tyres of motor-car and sold them to Dew & Co. There was a price maintenance agreement, the terms were that the company will not resell the tyres below a certain fixed price and the same undertaking would be taken by the company in case of sale to another trader. The Dew & Co. sold the tyres to the defendant who in turn agreed not to sell the tyres at less than list price and further agreed to pay liquidated damages to the Dunlop Co. in case of breach of this undertaking. However, the defendant sold them to customers at less than list price and Dunlop sued them for breach of contract.

The court stated two principles:

• Only a person who is a party to a contract can sue on it. A stranger to a contract does not have a right to enforce the contract in personam.
• Consideration must have been given by promisee to the promisor or to some other person at the promisor’s request.

The House of Lords reaffirmed in the doctrine of Privity of Contract in Beswick v. Beswick. Peter Beswick agreed to transfer his business to the defendant in consideration of the promise to employ Peter as ‘consultant’ during his lifetime and after his death, to pay an annuity of £ 5 a week to his widow. The defendant breached the promise to pay the annuity to the wife. She sued him in her personal capacity as the beneficiary of the contract and also in her capacity as administratrix of her deceased husband’s estate. It was held she could only sue as administratrix but not in her personal capacity.

In 1937, the Law Revision Committee recommended the abolition of this doctrine in its sixth interim report. The position in England regarding the doctrine of Privity of contract changed with the enactment of The Contracts (Rights of Third Parties) Act, 1999. Section 1(1)(2) of the act states that a third party could enforce the beneficiary clause of the contract.[7] Thus, the common law now recognizes the right of third party to enforce contractual term.

Position of the Doctrine of Privity of Contract in India

In India, there has been a divergence of opinions in the courts regarding the doctrine of Privity of Contract. The rule in Tweddle v. Atkinson[8] is as much applied in India as it is in England. However, there is no provision for the same in the Indian Contract Act,1872.

The English doctrine of Privity of contract was applied by the Privy Council in Jamna Das v. Ram Autar Pande.[9] Here, the debtor disposed of the mortgaged property to the purchaser. The purchaser, in return, agreed to pay off a mortgage debt. The judicial committee held that the mortgagee was not entitled to enforce this undertaking as he was not the party to the contract and thus, could not sue purchaser to pay off the debt.

The courts balancing the rights of the third party and the contracting parties has recognized certain exceptions which are equitable.

Position of the Doctrine of Privity of Contract in Malaysia

In Malaysia, the Contracts Act 1950 does not expressly provide for this principle but it is firmly acknowledged that the doctrine has been transplanted into laws of Malaysia. It is a fundamental rule of the common law that apart from special circumstances, for example in cases of agency, trust, assignment or statutory exception, a person who is not a party to a contract has no right to sue on a contract. The decision of Privy Council in Kepong Prospecting Ltd &Ors v Schmidt[10] affirmed that the rule applies in Malaysia. The Court of Appeal and the High Court also uphold the application of the doctrine throughout all these years.This rule has been criticised particularly in cases where the contract is for the benefit of the third-party. At this time there has been no statute introduced and the rule persists in Malaysian Law to prevent a third-party enforcing contractual provisions made in their favour.[11]

Position of the Doctrine of Privity of Contract in Australia

The doctrine of privity of contract applies only to contractual rights and obligations; if the contract involved gives rise to non-contractual rights and obligations then it is possible for these to be enforced against, or in favour of, those who are not parties to the contract.

In Trident General Insurance Co Ltd v McNiece Bros Pty Ltd [12] the High Court cast doubt upon the extent of the doctrine. Two judges said the doctrine of privity of contract produced injustice where third parties were intended to benefit from the contract and could not enforce it directly. They allowed the intended beneficiaries in this case to get the benefit. The Court highlighted that often, damages are not suffered by contracting party. If A breaches contract, B might have suffered no damages compared to C and C can’t enforce the contract. Although B can enforce contract for benefit of C, specific performance is discretionary and may not be granted in these circumstances. One way around this situation is to say B entered into the contract as trustee for C – but it’s often an inadequate remedy.[13]

Position of the Doctrine of Privity of Contract in Canada

The doctrine of privity of contract provides that, as a general rule, a contract cannot confer rights or impose obligations arising under it to any person who is not a party. The Supreme Court of Canada created a “principled exception” to the doctrine. Subsequent lower courts decisions, however, have tended to limit the application of this “principled exception” holding that it cannot be used by third parties as a sword, but only as a shield. The result is a complex series of exceptions and judicial devices which, although mitigating the application of the privity doctrine, have not precluded the possibility of injustice occurring.

In failing to reform the doctrine of privity of contract with respect to third-party beneficiaries, Canada is out of step with other common-law jurisdictions. In Australia (Western Australia and Queensland), the United Kingdom, New Zealand, the U.S., and Singapore the privity doctrine has been reformed through legislation. Further law reform commissions in Hong Kong and Ireland recently recommended legislative reforms to address this issue.[14]

Exceptions to the Doctrine of Privity of Contract

1. Charges over some immovable property

When charges over immovable property are transferred, the person acquiring the charge acknowledges to take the obligation related to the property, the beneficiary can enforce the clause and the doctrine of Privity of contract doesn’t apply. In, Khirod Behari Dutt v Man Gobinda and Ors[15] the tenant and sub-tenant made an agreement that the sub-tenant would pay the rent directly to the landlord. Thus, the landlord was entitled to receive rent from sun-tenant and sub-tenant cannot escape from liability on account of Privity of Contract.

2. Covenants running with the land

When there is a transfer of property, the owner of the property now obtains all the benefits running with the land and is also bound by the obligations imposed by an agreement affecting the land, even though he is a stranger to the agreement. In SAIL v. State of M.P.,[16] it was held that the central government transferred the land along with rights, liberties, privileges, etc., pertaining to the land given to the company.

3. Trust

Trust is considered to be an exception to the Privity of Contract for the recognition and enforcement of the right of the third – party beneficiary created by a contract to which he is no party.[17]  While creating trust in favour of a person, the owner of property transfers the managing rights to the trustee and there are certain obligations imposed upon the trustee. This is based on the fiduciary relationship unlike charge given. The beneficiary may enforce the rights conferred upon him by the trust deed. The genesis of this rule is that his rights are equitable and not contractual.[18]

4. Marriage settlement, partition or other family arrangements

A third – party beneficiary is entitled to enforce a contractual obligation coupled with a charge on an immovable property.[19] A person entitled to take benefit of the beneficiary clause in the marriage settlement, partition or other family arrangements. For example, in Nawab Khwaja Muhammad Khan v. Nawab Hussaini Begum,[20] the plaintiff, as per marriage settlement had been given Rs.

500 monthly as betel leaf expenses in perpetuity out of the income of certain properties, was held entitled to sue although she was not a party to the contract.

5. Assignment

Another exception to Privity of contract is that an assignee under an assignment made by the party or by operation of law, for example, death or insolvency, can sue upon the contract to enforce his rights, title and interest.[21]

6. Consumer

The definition of consumer in the Consumer Protection Act, 1986 encompasses not only the party who buys goods or ordered for services but also the user of such goods or beneficiary of such services.[22] Thus, even though consumers are complete strangers to the contract, the doctrine of Privity of Contract doesn’t apply and they have right to enforce it.

7. Acknowledgement or Estoppel

Where a party enters into an undertaking to pay a certain sum of money to a third person and he acknowledges it to that third person, the third person can enforce it.[23] In Deb NarainDutt v. Ram Sadhan Mandal,[24] a transferee of debtor’s liability had acknowledged his obligation to the creditor for the debt and the same was communicated to the creditor. When a suit was initiated by the creditor for the recovery of debt, the transferee had undertaken the obligation for the benefit of the creditor and thus the doctrine of Privity of Contract is not applicable here.

 Illustrations of Privity of Contract

Illustration 1: A had rented a land to B for 5 years. B opened a shop there and had taken certain permissions from A to run a certain business. After 2 years of opening it, B expired and B’s son carried on the business. A sued B’s son for failing to seek permission to run the business on the property being privity to the contract between A and B. The suit shall fail because this doctrine shall not apply here as B’s son inherited the rented property of his father and also acquired all the charges and privileges on the immovable property.

Illustration 2: A opened a college and made B the trustee. The terms of the contract that B during the lifetime of A would give returns to A and after his death to his wife. After the death of A, B failed to do so and assumed the ownership of the college. A’s wife being a beneficiary of the contract can enforce her rights as it’s a trust deed and A transferred only managerial rights to B on the fiduciary basis not the ownership of the college.

Illustration 3: A bought a pack of chocolates for B that were manufactured by X. On consuming the chocolates, B fell ill as the chocolates were made up of stale fruits. When B sued X, the defence put up by him was that B was a stranger to the contract. This argument cannot stand as B is the consumer and consumer have right to sue and the doctrine doesn’t apply.

Illustration 4: A took a loan from B. Later, on A’s request B agreed to accept the repayment of the loan from C. Now, B can sue C for the repayment and the doctrine of privity of contract does not apply here.

Illustration 5: A and B enter into a contract of supplying cement. A agrees to supply B with 10  sacks of cement on every Monday for a year. B dies after 4 months. The Contract will terminate. C, who is B’s son cannot receive the sacks on B’s behalf as the contract was between A and B. If C wishes to continue getting the sack, he may enter into a new contract with A for the supply of the same. But he will not be a beneficiary of the contract between A and B. A and B share a privity of contract.

Illustration 6: A pays B to paint a portrait of him. B dies midway while painting. The Contract will terminate. B’s heir cannot come and paint on B’s behalf because the contract was between A and B. Here, A and B share a privity of contract.

Illustration 7: A lends his car to B for a specific purpose. B agrees to adhere to the conditions put forth by A. B cannot further lend the car to C, his daughter, because the contract is between A and B. A and B share a privity of contract with regard to the car.

Illustration 8: A and B enter into a partnership to sell bags. A dies. B will not send the proceeds to A’s heir because A and B shared a privity of contract with regard to the profit. 

 Frequently Asked Questions

1. When does privity of contract apply?

The doctrine of privity of contract applies when a contract has the beneficiary clause. If the contracting parties failed to discharge the obligations towards the third person, that person has no right to sue the parties for the enforcement of rights in the beneficiary clause. As per this doctrine only the promisor(s) and the promisee(s) have right to enforce the rights and obligations enshrined in the contract.

2. What is privity of contract in a lease?

In a real estate context, it is the legal relationship between parties whose estates constitute one estate in law. Privity of estate exists when two or more parties hold an interest in the same real property.  In a leasing context, a lease agreement is both a conveyance of an interest in real property and a contract. The landlord and tenant have both privity of estate and privity of contract under a lease agreement. If the tenant assigns its interest in the lease to an assignee, and then the assignee assumes the tenant’s obligations under the lease, as of the effective date of the assignment:

• The original tenant no longer has privity of estate with the landlord and it cannot occupy the premises any more.
• The original tenant most likely retains its privity of contract with the landlord and remains liable for the tenant’s obligations under the lease, unless:
  1. The landlord expressly releases the original tenant; or
  2. There are state or local laws that establish the tenant’s privity of contract terminated when the tenant’s privity of estate terminated.
• The assignee and the landlord will have privity of estate and privity of contract as of the effective date of the assignment and assumption of the lease.If, however, the tenant subleases all, or a portion, of its leased premises to a subtenant, then as of the effective date of the sublease:
• The original tenant retains its privity of estate and privity of contract with the landlord.The subtenant does not have privity of estate or privity of contract with the landlord.The subtenant has privity of estate and privity of contract with the original tenant.

3. What is privity of contract in Insurance?

A contract of Insurance is a form of contract whereby the insurer undertakes to indemnify the insured in the event of the happening of an occurrence. For liability Insurance contracts, the insurer undertakes to indemnify the insured in case of liability to a third party, thus the insurance contract is taken for the benefit of the third party. Contracts of insurance made for the benefit of third parties cannot in principle be enforced by them, unless a trust is created in their favour.

It has been stated in Australian decisions that this may be too cautious and that there is the ‘considerable scope for the development of trusts’ particularly in the context of insurance policies for the benefit of third persons.The Motor Vehicle (Third Party Insurance) Act, 1956 and the Insurance Act, 2003 whittles down the application of the doctrine of privity of contract to insurance contracts in Nigeria. At common law, the third party would have no claim against the insurers.

4. What is privity of contract and its exceptions?

The doctrine of Privity of contract states that third party does not have a right to initiate a suit against the parties to the contract even though he/she is the beneficiary. Apart from promisor(s) and promise(s), all persons constitute the third party. Thus, the third party cannot sue the contracting parties for the enforcement of the beneficiary clause in the contract. This principle originated from England. However, in India, as per section 2(d) of the Indian Contract Act, consideration can be furnished by either by the promise or any other person, “at the desire of the promisor” .The doctrine is however, neither rigid nor absolute. Certain exceptions to the doctrine are :

1. Charges over some immovable property
2. Covenants running with the land

• Trust

1. Marriage settlement, partition or other family arrangements
2. Assignment
3. Consumer

• Acknowledgement or Estoppel

5. Is privity of contract valid in India?

In India, there has been a divergence of opinions in the courts regarding the doctrine of Privity of contract. The judiciary has followed the principles of the doctrine of privity of contract but also recognized some exceptions to the doctrine to provide equity, fairness and justice to third parties. The Indian Contract Act, 1872 though being silent about this principle yet does not encourage the idea that contract can be enforced by a person who is not a party to the contract.  Further, this notion is excluded by the definition of “promisor” and “promisee” in Section 2 of the Act.The English doctrine of Privity of contract was applied by the Privy Council in Jamna Das v. Ram AutarPande .

The courts balancing the rights of the third party and the contracting parties has recognized certain exceptions which are equitable in various cases of trusts, assignments, covenants running with the land, acknowledgement or estoppel, marriage settlement, partition or other family arrangements. Moreover, the principle of the doctrine of privity of consideration is also not applicable in India. As per the Indian Contract Act, 1872 the consideration may move from promisee, or some other person, if the promisor has no objection, from any other person.

6. Why is privity of contract important?

The doctrine of privity of contract law states that only binding on the parties signing the contract, and that no third party can enforce the contract or be sued under the contract. This is important to protect the interests of the contracting parties and prevent third parties to take undue benefit of the contractual terms..

7. What is privity of contract in construction?

Collateral warranties create direct contractual relationships between parties that would not otherwise exist. Collateral warranties are agreements which are associated with another ‘primary’ contract. They provide for a duty of care to be extended by one of the contracting parties to a third party who is not party to the original contract. A typical example would be where an architect of a new office development owes a duty of care to an occupier of the development in so far as any subsequent defects which may arise are concerned. Privity of contract would prevent any liability arising between the architect and occupier without the existence of a collateral warranty.

Collateral warranties bypass the rule by creating separate independent contracts collateral to the consultancy or construction contract. It allows future owners of developments to sue consultants or contractors for defects in the design or construction under the collateral warranty. There would be no cause of action under the original consultancy or construction contract.It allows the party to the contract to sue for his loss but does not allow him to sue for the loss caused to a third-party.

8. What does the term privity of contract mean?

Privity is a legal relationship that exists between two people or groups who have both signed a contract or who are involved in the same business arrangement. Privity of contract is the relationship that exists between the parties to an agreement. The doctrine of Privity of contract states that third party does not have a right to initiate a suit against the parties to the contract even though he/she is the beneficiary.

[Edited by – Ms. Ankita Jha]

Reference

[1] 30 LJ QB 218

[2] Cro. Eliz. 654.

[3] (1632) Het. 176

[4] 83 ER 523

[5] Tweddle v. Atkinson(1861) 1 B&S 393.

[6] Dunlop Pneumatic Tyre v. Selfridge and Co. Ltd.[1915] AC 847.

[7] The Contracts (Rights of Third Parties) Act, 1999.

[8] Supra Note 2.

[9] Jamna Das v. Ram AutarPande(1916) ILR 38 All 209.

[10] Kepong Prospecting Ltd v Schmidt [1968] AC 810

[11] https://simplymalaysia.wordpress.com/articles/common-law-and-legal-concepts/privity-of-contract-explained/

[12] Trident General Insurance Co Ltd v McNiece Bros Pty Ltd (1988) 165 CLR 107

[13] https://www.australiancontractlaw.com/law/scope-privity.html

[14] https://www.ulcc.ca/en/annual-meetings/216-2007-charlottetown-pe/civil-section-documents/574-privity-of-contract-and-third-party-beneficiaries-2007?showall=&limitstart=

[15] KhirodBehariDutt v Man Gobindaand OrsAIR 1934 Cal 682

[16] SAIL v. State of M.P. AIR 1999 SC 1630.

[17] Jang Bahadur v. Rana Uma  Nath Bakhsh Singh AIR 1937Oudh 99.

[18] M.C. Chacko v State Bank Of Travancore 1970 SCR (1) 658

[19] V. Kesava Rao, Contracts I: Cases and Materials (Lexis Nexis Butterworths 2004).

[20] Nawab Khwaja Muhammad Khan v. Nawab Hussaini Begum (1910) 12 BOMLR 638.

[21] V. Visalakshi, &Bhupathi, Government contracts 56 (EBC, Lucknow 2014).

[22] Consumer Protection Act, 1986§ 2(d).

[23] Supra note 14.

[24] Deb NarainDutt v. Ram Sadhan Mandal AIR 1914 Cal 129.