What is privity of contract?
What is the rule of privity under contract law?
What are third party rights in a contract and are there exceptions?
In this article, we will break down the notion of privity of contract so you know all there is to know about it.
We will first define the doctrine of privity of contract, briefly look at its history, understand its purpose and go over some of its exceptions.
By reading this article, you will gain a good foundational knowledge to understand the scope and purpose of the rule of privity and how it applies to contracts.
Are you ready?
Let’s get started!
What is the doctrine of privity of contract?
Privity of contract is a common law doctrine stating that a person not a party to a contract cannot invoke rights or obligations outlined in the contract.
In other words, the rights and obligations stemming from a contract can only benefit the contracting parties.
Based on the doctrine of privity of contract, even though a third party may have been given certain rights by the contracting parties, the third party cannot sue the contracting parties to invoke those rights.
In the UK, the Contracts (Rights of Third Parties) Act 1999 reformed the privity of contract doctrine to allow third parties to invoke and enforce their rights in certain specific circumstances.
Fundamentally, the enforcement of contractual terms is reserved to the contracting parties.
If a third party has suffered damages or wishes to invoke certain rights against another party, the third-party party to a contract cannot use the contract as a legal basis to assert a claim, invoke certain rights or demand specific performance.
History of the doctrine of privity
The principle of privity has its roots in common law from the United Kingdom.
In the matter Tweddle v Atkinson, in 1861, the doctrine of privity was linked to the doctrine of consideration in contracts.
Under the doctrine of consideration, the rule was that a promise for consideration in exchange for nothing cannot lead to a legally binding contract unless it is recorded as a deed.
In the case of Tweddle and Atkinson, the court considered that the plaintiff did not have recourse against the executor of his father-in-law who had promised his father a payment.
Relation of the doctrine of privity and rule of consideration
The rule of consideration and the doctrine of privity are different legal concepts but produce a similar end result.
As such, they are considered to be closely related to one another.
The rule of consideration states that a person can enforce a contract when the other party has promised a consideration.
In the case Dunlop Pneumatic Tyre Co Ltd v Selfridge Ltd of 1915, the court states that a consideration can be enforced when a person has specifically made a promise of a consideration.
Without a consideration, a person cannot enforce the contract.
Similarly, the doctrine of privity says that if a contracting party did not promise the third party a consideration, the third party cannot enforce the contract.
Generally, the rule of consideration provides that only the parties to a contract have agreed to give and receive a consideration when entering into a contract.
What are the exceptions to the privity of contract?
The common law has evolved where the privity of contract doctrine has been relaxed in certain circumstances.
In certain instances, the privity doctrine would lead to an inequitable outcome or even be problematic.
As mentioned previously, the Contracts (Rights of Third Parties) Act 1999 in the UK allowed for third parties to enforce certain rights in a contract the third party is not a party to.
Implied warranty and strict liability
The doctrines of implied warranty and strict liability allow third parties to sue a manufacturer of a product should it cause damages or injury due to defects.
When you buy a product, you expect that it works as intended.
That’s the implied warranty.
Strict liability means that a person or manufacturer will be responsible for the harm caused by its products even if it had no intention to cause harm to consumers or potential users of its product.
In this context, a consumer (third-party) may have the right to sue manufacturers for damages caused for defective products.
Otherwise, the application of privity would lead to an unfair outcome for a consumer.
For example, imagine a manufacturer sells its products to a distributor, the distributor to a retailer and a retailer to the consumer.
Should the consumer suffer damages caused by a defective product, the doctrine of privity would prevent the consumer from asserting a claim against the manufacturer for breach of warranty.
An exception has been made to allow a third party to invoke the manufacturers’ warranties even though the consumer had not purchased the product directly from the manufacturer.
Insurance contracts
Life insurance is one area where privity was in conflict with the objective and purpose of the insurance contract.
For example, if a person took life insurance designating a third party as a beneficiary, in the event of the person’s death, the doctrine of privity would prevent the beneficiary to enforce the payment of indemnity under the insurance policy.
This outcome would not be equitable and will conflict with the purpose of having life insurance designating a third party beneficiary.
As such, an exception to privity is to allow third-party beneficiaries in an insurance contract to submit a claim against an insurance provider to invoke rights under a contract they are not a party to.
We used the example of life insurance but the same analogy can be used in common law jurisdictions where a person gets into an automobile accident.
In the context of a car accident, the injured person may be able to pursue the insurance company in certain circumstances.
Agency contracts
An agency contract is a contract where a party, the principal, designates another party, the agent, to act on his or her behalf.
As such, the agent will enter into legally binding commitments for the benefit of the principal.
In this case, the notion of privity would conflict with the role of the agent who is acting on behalf of the third party.
In this context, the principal who is a third party to a contract can sue or be sued under the contract entered into by its agent.
Collateral contracts
The doctrine of privity will not apply in cases where a collateral contract or collateral warranty binds third parties.
The most notable example is when work is done by a contractor who in turn hires subcontractors.
If a client hires a contractor to do some renovation in the basement and the contractor brings a plumber and electrician, should they fail in properly delivering the work, the client can pursue the subcontractors even though there are no contracts directly linking the client to the subcontractors.
Consumer protection
Generally, in consumer protection cases, just like the example of implied warranty and strict liability, privity of contract may impose unwanted or unfair limitations.
As a result, the laws have evolved to grant a third party, often vulnerable from a consumer protection point of view, the right to invoke contractual obligations entered into between other individuals or entities.
Statutory exceptions
The most often cited statutory exception is the Contracts (Rights of Third Parties) Act 1999.
Under this statute, the law provides for a two-tier test to determine whether or not a contract can be enforced by a third party.
The law will accept a third party to enforce contractual terms if the parties to the contract agreed to grant the third party certain rights and the contract expressly stipulates that a third party may exercise such rights.
When the third party is clearly identified, the parties to the contract expressly agree to grant the designated third party certain rights and the rights are clearly defined, the courts will allow the third party to enforce its terms.
What is the lack of privity of a contract?
The lack of privity of a contract is essentially the reverse of privity.
When there is no contract between two parties, the parties cannot enforce contractual rights and obligations against one another.
As a result, there is a lack of privity.
Non-contractual parties do not owe one another any duties.
Privity exists between the contracting parties.
However, between a third party and the contracting parties, there is a lack of privity.
Can a third party invoke a limitation of liability?
What happens when two contracting parties agree to limit the liability of a third party in a contract?
Can the third party invoke the limitation of liability provision?
This is called the Himalaya clause.
In 1924, in the case Elder Demptser v Paterson Zochonis, the court ruled that third parties, such as a carrier, can benefit from an exclusion provision in a bill of lading between the ship owner and the client.
The court came to this conclusion on the basis that the carrier was acting as the agent of the ship owner.
This position was overturned in the case Scruttons Ltd v Midland Silicones Ltd in 1962 where the court outlined specific conditions required for a third party to benefit from an exclusion provision.
The court required that the contract have a declaration of agency and that a carrier must have the authority to act on behalf of the principal.
In this case, the court considered that the stevedores were a third party to the carriage contract and cannot benefit from the exclusion of liability clause.
Takeaways
Privity of contract means that a person who is not a party to a contract cannot benefit from the contractual rights or have any duties towards the contractual parties.
In other words, the contract will produce rights and obligations strictly limited to the parties to the contract.
Although this rule sounds good in principle from a contract law perspective, in some cases, it may produce an unwanted or even unfair outcome.
For example, in the case of an insurance contract, the rule of privity has shown to be problematic.
If you enter into a life insurance contract with an insurance provider designating a person as the beneficiary, privity will prevent the third party beneficiary from invoking rights under the insurance policy.
This may not be a desired outcome.
As a result, in dealing with insurance claims, the rule of privity has been relaxed to allow beneficiaires, who may be third parties to the contract, to assert rights against the insurance carrier.
Another example is in the context of an agency contract.
The objective behind an agency contract is to for a principle to authorize an agent to act on its behalf with third parties.
The agent is essentially acting on behalf of the principle.
In this case, the doctrine of privity can be problematic once more.
The courts have considered that the principle, who is a third party to a contract signed by its agent, should be able to invoke certain rights as the agent was acting on its behalf.
We hope this article helped clarify the rule of privity so you can get a better understanding of its benefits and possible consequences.
