Privity of Contract Flashcards
What is privity of contract?
It is a fundamental principle of the common law that no person can sue or be sued on a contract unless they are a party to it (Dunlop Pneumatic Tyre Co. v Selfridge
& Co. [1915] AC 847). This is known as privity of contract.
What are the common law methods of circumventing privity of contract?
- Agency
- Assignment
- Collateral contract
- Actions in tort
- Other judicial attempts to avoid the doctrine
What constitutes agency?
An agency relationship occurs where one party, the agent, is authorised either expressly or by implication, by the principal, to contract on behalf of the principal. In practice, businesses selling goods sometimes appoint agents to find customers, negotiate sales and/or enter into contracts with customers on their behalf. If an agent enters into a contract with Party A on their principal’s behalf, it is as if the contract were made between the principal and Party A. The basic requirements necessary to establish an agency relationship are as follows:
(a) The principal should be named (usually by the agent) and it should be clear that the agent is contracting on the principal’s behalf;
(b) The agent should be authorised to act as agent. In the vast majority of cases, the agent’s authority will be limited by the principal – eg the agent may be authorised to sell certain of the principal’s goods within a certain range of prices. The agent does not have freedom to enter into any contract it wishes to on behalf of the principal. The principal is only bound by acts of the agent which are within the agent’s authority (or, in certain circumstances, by acts which appear to be in the agent’s authority); and
(c) Consideration has moved from the principal. It could be argued that this is an exception to the doctrine of privity since the principal and Party A do not deal directly with each other. However, it can be cogently argued that this is not a true
exception to the doctrine of privity since it is the principal rather than the agent who is a party to the contract with Party A. It is the principal who can sue and be sued on the contract. The agent is not a party to the contract and, once the contract has been concluded, the agent’s existence is
no longer relevant. The principle of agency in this sense is simply a method of getting around the doctrine of privity, otherwise it would lead to difficulties in a business context.
What constitutes assignment?
Where A is under a contractual obligation to B and B assigns their contractual rights to C, it may be possible for C to sue A on their promise to B. Crucially, because B is simply passing their rights to C, the extent of C’s rights can never exceed the rights of B.
If there is a prohibition against the assignment in the main contract, then any attempted assignment is likely to be unsuccessful.
When the parties agree that assignment of rights is prohibited this is called a ‘non-assignment’ clause, and is quite common.
As an alternative to a total prohibition on assignment or sub-contracting (as set out above), the parties may agree to allow limited assignment of the benefit of the contract or sub-contracting of the work, for example, within a group of companies or to a named person or persons.
What is a collateral contract?
The court may find a collateral contract between the promisor and the third party to provide an exception to the doctrine of privity. The case of Shanklin Pier v Detel Products Ltd [1951] 2 KB 854 is a good factual illustration of this device.
Shanklin Pier employed contractors to paint the pier. It was a term of the contract that Shanklin Pier was to specify the paint to be used. Detel informed Shanklin Pier that their paint would last for at least seven years. Shanklin Pier instructed the contractors to buy and use Detel’s paint. The paint lasted three months. Shanklin Pier sued for breach of contract. However, the contract was between Shanklin Pier and the contractors. Mr Justice McNair held that there was a collateral contract between Shanklin Pier and Detel, the consideration for which was, on the one hand, the
warranty by Detel that the paint would last for seven years and on the other, the instruction by Shanklin Pier to the contractors to buy the paint.
This shows that if the court can establish the existence of a separate collateral contract between the promisor and the third party, it can avoid the difficulties of privity. It should be noted that the
promisor and the third party had communicated which each other, and also that the court found consideration for the bargain between them.
How can actions in tort circumvent privity of contract?
During the development of the (tort) law of negligence, a critical question arose as to whether a person, C, who is not a party to the contract between A and B, may be owed a duty of care, so that conduct amounting to a breach of contract on the part of one of the contracting parties will constitute a breach of the duty of care owed to C, giving a third party (C) the right to sue that
contracting party for damages in tort.
In the landmark case of Donoghue v Stevenson [1932] AC 562, the majority of the House of Lords (led by Lord Atkin) held that, in principle, a claim of this kind was available. In fact, in Donoghue, the plaintiff (C) was not only a third party in relation to the contract of sale between the manufacturer of the bottle of ginger beer and the retailer (the contract between A and B) but was also a third party in relation to the contract of sale between the retailer and the purchaser of the bottle of ginger beer (the contract between B and Y). Nevertheless, it was held that the plaintiff, as the ultimate consumer of the goods, could bring a claim in the tort of negligence directly against the manufacturer (A). In effect, this seminal decision held that the privity principle that restricted the range of claims for breach of contract did not also restrict the range of claims in tort. In so
doing, it opened up the possibility of a far more extensive liability regime for negligence.
What are the judicial attempts to avoid the doctrine of privity of contract?
The doctrine of privity came under direct criticism from the House of Lords in the case of Woodar v Wimpey [1980] 1 WLR 277.
The problem is that in some cases, A contracts with B to provide something of benefit to C. If B fails to do so, C has suffered a loss, but cannot bring a claim because it is not party to the contract. A is a party to the contract, but has suffered no loss. Lord Scarman stated:
I regret that this House has not yet found the opportunity to reconsider the two rules which effectually prevent A or C recovering that which B, for value, had agreed to provide These rules have the potential to operate harshly and in some cases the courts have taken a rather flexible approach to the doctrine of privity. A notable example can be seen in the case of
Jackson v Horizon Holidays [1975] 1 WLR 1468. The claimant booked a holiday for himself, his wife and his two children at a total cost of £1,200. The defendant’s brochure described the holiday
hotel as having excellent facilities. This proved not to be the case and the claimant brought an action for breach of contract. At first instance, the judge made an award of £1,100 damages, which was just less than the full cost of the family holiday, despite his assertion that he would only consider the mental distress of the claimant and not that of his wife and children. The defendant appealed against the amount of damages. The Court of Appeal upheld the award. As
clarified by subsequent authorities (in particular Woodar v Wimpey) the proper interpretation of the decision is probably that either:
(a) Mr Jackson’s own losses were £1,100. The basis for reaching that conclusion is not really explained clearly in any of the judgments that suggest it; or
(b) The case is an exceptional type of contract ‘calling for special treatment’ and an example of one of the many situations ‘which require some flexibility in the law of contract’ (as per Lord Wilberforce in Woodar v Wimpey).
What are the circumstances in which a third party may enforce a term of a contract to which they are not a party?
Note that ss 1(1)(a) and s 1(1)(b) create alternative circumstances in which a third party can enforce a term.
Under s 1(1)(a), the contract must specifically provide that the third party can enforce a term of the contract. For example, s 1(1)(a) would apply if the contract specifically stated: ‘X has the right
to enforce this contract’ or ‘X has a right to sue on this contract’.
Under s 1(1)(b) in conjunction with s 1(2), it need not be stated specifically that the third party has the right to enforce a term. However, it must be established that:
(a) The agreement purported to confer a benefit on the third party; and
(b) It was not the case that the contracting parties ‘did not intend the term to be enforceable by the third party’.
In what circumstances does s 1(1)(b) not apply?
In essence, where a term ‘purports to confer a benefit’ on a third party, s 1(1)(b) creates a rebuttable presumption that the third party will be able to enforce the term. Section 1(2) provides that this presumption will be rebutted 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’. The indications are that
the courts will be slow to hold that, where the contract does purport to confer a benefit on a third party, there is no intention that the third party should have a right to enforce the term. In other
words, once it is held that the contract purports to confer a benefit on a third party, there will be a rebuttable presumption in favour of the third party having a right to enforce the term and it will
be difficult to rebut that presumption.
It is of course possible that the parties do not want any third parties to have any rights under the contract. To avoid any possibility that an agreement has ‘purported to confer a benefit on the
third party’, the parties can explicitly exclude this. A possible boiler plate ‘exclusion of third-party rights’ clause is provided below.
For the purpose of the Contracts (Rights of Third Parties) Act 1999, this Agreement does not and is not intended to give any rights, or any right to enforce any of its provisions, to any person who is
not a party to it. Importantly, it should be noted that the Act also allows third parties to rely on exemption or limitation clauses in contracts to which they are not a party in the same way in which it allows third parties to enforce contractual terms (s 1(6)).
What are the remedies available to the third party?
The rights conferred by s 1 would be of less use if the contracting parties were able, without the consent of the third party, to vary or rescind the contract so as to extinguish or alter the third party’s rights. Consequently, s 2(1) states:
Subject to the provisions of this section, where a third party has a right under section 1 to enforce a term of the contract, the parties to the contract may not, by agreement, rescind the contract, or vary it in such a way as to extinguish or alter his entitlement under that right, without his consent if:
(a) the third party has communicated his assent to the term to the promisor,
(b) the promisor is aware that the third party has relied on the term, or
(c) the promisor can reasonably be expected to have foreseen that the third party would rely on the term and the third party has in fact relied on it.
For the purposes of s 2(1)(a) the third party may communicate assent by ‘words or conduct’ (s 2(2)(a)) but, if the assent is sent by post, s 2(2)(b) stipulates that such communication will not be effective until received by the promisor.
If the contracting parties wish to allow variation or rescission without the consent of the third party or in circumstances not provided for in s 2(1), they can do so by including an express term in the contract (s 2(3)).
Section 2 also provides that the court can dispense with the third party’s consent where their whereabouts cannot reasonably be ascertained (s 2(4)(a)), where they are mentally incapable of giving their consent (s 2(4)(b)) or where their reliance on the term cannot be reasonably ascertained (s 2(5)). In such circumstances, where the court or arbitral tribunal sees fit to dispense
with such consent, it may impose such conditions, for example a requirement to pay compensation, as may be thought fit (s 2(6)).
By virtue of s 3, the promisor’s defences against the third party are both the same as they would be against the promisee and anything specific that they may be able to claim against the third party.
Section 3(6) provides that a third party is not, by virtue of s 1, to be placed in a better position than if the third party had been a party to the contract themself. If, as such a party, they would not for whatever reason have been able to enforce the term (including, in particular, a term to exclude or limit liability) then they may not enforce it under s 1. Obvious examples would include where the benefit to be given would have been illegal under the contract or where the third party lacks contractual capacity.
How does s 1 affect the right of the promisee to enforce the contract?
As a breach of a relevant term could expose the promisor to actions by both the promisee and the third party, s 5 sets out to protect the promisor from double liability. It provides that any award to a third party may be reduced by the court or arbitral tribunal to such extent as is thought
appropriate if the promisee has already recovered a sum in respect of the third party’s loss or the expense incurred by the promisee in making good to the third party the default of the promisor.
