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Published : October 11, 2010 | Author : shuchi.lawstudent
Category : Contracts laws | Total Views : 17582 | Rating :

shuchi pandey, final year law student at university of burdwan

Privity of contract & third party beneficiary in a contract

1.What is the doctrine of privity of contract
As per the dictionary meaning privity of contract means:
Legal doctrine that a contract confers rights and imposes liabilities only on its contracting parties. They and not any third-party, can sue each other (or be sued) under the terms of the contracts. Privity is the legal term for a close, mutual, or successive relationship to the same right of property or the power to enforce a promise or warranty.

As per the legal definition of privity of contract:
The doctrine of privity in contract law provides that a contract cannot confer rights or impose obligations arising under it on any person or agent except the parties to it.

The doctrine of privity of contract means that only those involved in striking a bargain would have standing to enforce it. In general this is still the case, only parties to a contract may sue for the breach of a contract, although in recent years the rule of privity has eroded somewhat and third party beneficiaries have been allowed to recover damages for breaches of contracts they were not party to. There are two times where third party beneficiaries are allowed to fall under the contract. The duty owed test looks to see if the third party was agreeing to pay a debt for the original party. The intent to benefit test looks to see if circumstances indicate that the promisee intends to give the beneficiary the benefit of the promised performance. Any defense allowed to parties of the original contract extend to third party beneficiaries[1]. A recent example is in England, where the Contract (Rights of Third Parties) Act 1999 was introduced.

Indian law is practically same as the English common law. However, under the Indian law ‘consideration may move from the promisee or any other person .’ In the chinnaya vs. rammayya[2] case, an old lady by a deed of gift, gave over certain properties to her daughter under the direction that she should pay her aunt a certain sum of money. The same day the daughter refused to pay her aunt the money on the plea that no consideration has moved from her aunt to her. It was held that sister of the old lady (aunt) was entitled to maintain the suit as consideration had move from the old lady, for her sister to the daughter.

2.Who is a third party beneficiary
A third party beneficiary, in the law of contracts, is a person who may have the right to sue on a contract, despite not having originally been a party to the contract. This right arises where the third party is the intended beneficiary of the contract, as opposed to an incidental beneficiary. It vests when the third party relies on or assents to the relationship, and gives the third party the right to sue either the promisor or the promisee of the contract, depending on the circumstances under which the relationship was created.

In English law, the doctrine was not recognized at common law, but a similar concept was introduced with the Contracts (Rights of Third Parties) Act 1999.

In order for a third party beneficiary to have any rights under the contract, he must be an intended beneficiary, as opposed to an incidental beneficiary. The burden is on the third party to plead and prove that he was indeed an intended beneficiary.

A third party beneficiary, in the law of contracts, is a person who may have the right to sue on a contract, despite not having originally been a party to the contract. This right arises where the third party is the intended beneficiary of the contract, as opposed to an incidental beneficiary. It vests when the third party relies on or assents to the relationship, and gives the third party the right to sue either the promisor or the promisee of the contract, depending on the circumstances under which the relationship was created.

Intended beneficiary
An intended beneficiary is that one party - called the promisee - makes an agreement to provide some consideration to a second party - called the promisor - in exchange for the promisor's agreement to provide some product, service, or support to the third party beneficiary named in the contract. The promisee must have an intention to benifit the third party - but this requirement has an unusual meaning under the law. Although there is a presumption that the promisor intends to promote the interests of the third party in this way, if party A, contracts with party B, to have a thousand killer bees delivered to the home of A's worst enemy, party C, then C is still considered to be the intended beneficiary of that contract.

There are two common situations in which the intended beneficiary relationship is created. One is the creditor benificiary, which is created where A owes some debt to C, and A agrees to provide some consideration to B in exchange for B’s promise to pay C some part of the amount owed.

The other is the donee beneficiary, which is created where A wishes to make a gift to C, and A agrees to provide some consideration to B in exchange for Bethany's promise to pay C the amount of the gift. Under old common law principles, the donee beneficiary actually had a greater claim to the benefits this created; however, such distinctions have since been abolished.

An incidental beneficiary is a party who stands to benefit from the execution of the contract, although that was not the intent of either contracting party. If the contract is breached by either party, an incidental third party has no rights to recover anything under the contract.

3. When can a third party overcome the doctrine of privity of contract?
A third party even though an intended beneficiary can over come the doctrine of privity of contract only when-
1. The parties to the contract have not otherwise agreed;
2. Recognition of a right to performance in the beneficiary is appropriate to effectuate the intention of the parties; and
3. The terms of the contract or the circumstances surrounding performance indicate that either-
a. the performance of the promise will satisfy an obligation or discharge a duty owed by the promisee to the beneficiary; or
b. the promisee intends to give the beneficiary the benefit of the promised performance."

Under Indian contract Act 1872 exceptions to the doctrine of privity of contract are contracts executed-
a. for natural love and affection
b. marriage partition and family disputes
c. time barred debt
d. trust, and
e. agency.

There are a number of general law principles which enable a third party, to overcome the doctrine of privity under English common law are-
(a) Agency

The rule here is that if one of the contracting parties contracts as an agent, then either the agent or the principal, but not both, can sue to enforce the contract. In our example, if B is C’s agent then either B or C can enforce the contract against A. In these cases it is immaterial as to whether A knew that B was C’s agent.

(b) Trusts
The law of trusts can enable a third party beneficiary to initiate action that will enforce the promisor’s obligation. Using the above example, if B had contracted with A in the capacity of trustee for C, C as beneficiary under the trust has enforceable rights. These rights arise because the law of trusts gives a beneficiary certain rights against a trustee.

In the context of privity, if C is a beneficiary under a trust, C can bring an action against B, the trustee, that has the effect of compelling B to sue A for breach of contract. In formal procedural terms C sues in an action in which B and A are joined as defendants.

The use of trust law here does not give rise, in the strict sense, to an exception to the doctrine of privity. In conceptual terms, the action against A is pursued by B, albeit at C’s insistence.

When the trust exception is pursued and B sues for damages, the measure of damages that is recovered reflect the loss to C, the beneficiary of the trust. The damages that are recovered are held by B on trust for C: Lloyd’s v Harper[3]; and Eslea Holdings Ltd v Butts [4]

(c) Estoppels
Following the decision in Waltons Stores (Interstate) Ltd v Maher[5], a third party may be able to seek relief against a promisor on the basis of promissory estoppels principles. To succeed the third party would need to establish the elements of promissory estoppels.

In Trident, Mason CJ, Wilson J, at 123-124, were of the view that it was likely that estoppels could be established on the facts of the case, but it was not necessary for them to determine the issue on the basis that they had decided the case on other grounds.

(d) Unjust Enrichment
The essence of the principle is that it requires a defendant ‘to make fair and just restitution derived at the expense of a plaintiff’: Pavey & Matthews Pty Ltd v Paul [6].

In Trident, Deane J, at 145-146, indicated that the principle could possibly be the basis for a third party to seek relief. However, it was Gaudron J, especially at 176, in Trident who based her decision in favour of Mc Niece Bros on the basis of the principle of unjust enrichment.

The action based upon unjust enrichments is not based upon the contract but independent of it. However, usually it will correspond in content and duration with the promisor’s.

4. Statutory exceptions to the doctrine of privity of contract
As per the Indian contract Act 1872, the exception to the doctrine of privity of contract are given under section

As per the Contracts (Rights of Third Parties) Act 1999 (UK)

1. - (1) Subject to the provisions of this Act, a person who is not a party to a contract (a "third party") may in his own right enforce a term of the contract if-
(a) the contract expressly provides that he may, or
(b) subject to subsection

(2), the term purports to confer a benefit on him. (2) Subsection (1)(b) does not apply 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.

This entails that a person who is named in the contract as a person authorized to enforce the contract or a person receiving a benefit from the contract may enforce the contract unless it appears that the parties intended that he may not.

As per the Contracts (Rights of Third Parties) Act 1999 court can enforce a third party to a contract only when -
(a) the contract expressly provides that he may, or
(b) subject to subsection (2), the term purports to confer a benefit on him.

4. How can a third party can be avoided in a contract?

A third party can be included in a contract only when he/she is an intended beneficiary named in the contract and must be intended to be benefited expressly in the contract. An incidental beneficiary has no rights to recover anything under the contract.

5. Case laws
· In Donoghue v. Stevenson a friend of Ms. Donoghue bought her a bottle of ginger beer, which was defective. Specifically, the ginger beer contained the partially decomposed remains of a snail. Since the contract was between her friend and the shop owner, there was no privity of contract between the manufacturer and the consumer, but it was established that the manufacturer has a duty of care owed to their consumers and she was awarded damages in tort.

· In Dunlop Pneumatic Tyre v. Selfridge and Co. Ltd. through the judgment of Lord Haldane the doctrine of privity of contract further developed.

· In Australia, it has been held that third-party beneficiaries may uphold a promise made for its benefit in a contract to which it is not a party (Trident General Insurance Co Ltd v. MacNeice Bros Pty Ltd (1988) 165 CLR 107). There were caveats however; the two parties to the contract are able to vary the terms of the contract as they see fit, unless the third-party has relied on the promise, and the promisor is subject to any defenses that it would have had, had the promise been enforced by the promisee.

· The issue any difficulties with consideration moving from the stevedores must be made out. was explored in New Zealand Shipping Co Ltd v. A M Satterthwaite & Co Ltd [1975] AC 154, where it was held that the stevedores had provided consideration for the benefit of the exclusion clause by the discharge of goods from the ship.

· New Zealand has enacted the Contracts Privity Act 1982, which enables third parties to sue if they sufficiently identified as beneficiaries by the contract, and in the contract it is expressed or implied they should be able to enforce this benefit.

· In Price v. Easton, where a contract was made for work to be done in exchange for payment to a third party. When the third party attempted to sue for the payment, he was held to be not to be in privity to the contract, and as such his claim failed.

· In the case of Winterbottom v. Wright[7], in which Winter bottom, a postal service wagon driver, was injured due to a faulty wheel, attempted to sue the manufacturer Wright for his injuries. The courts however decided that there was no privity of contract between manufacturer and consumer in order to support the Industrial Revolution.

· MacPherson v. Buick Motor Co[8]., a case analogous to Winterbottom v Wright involving a car's defective wheel. Judge Cardozo, writing for the New York Court of Appeals, decided that no privity is required when the manufacturer knows the product is probably dangerous if defective, third parties i.e. consumers will be harmed because of said defect, and there was no further testing after initial sale.

· In Provender v. Wood[9] case one father in law told another father in law that if their kids got married he will give the groom money. They got married and there was no money given to the groom. Groom sued the father in law. In this case he won because the 3rd party was so closely related to the contract.

6. Conclusion
At a point in the nineteenth century American and English common law took divergent paths on the question of whether or not a third party could take action to enforce a contract. Case law in the United States developed a doctrine based on cases ( mentioned above) whereby a third party can only enforce a contract only when he or she was named as a beneficiary even though not a party to the contract and he or she is not an incidental beneficiary, whereas in England the importance of privity in the enforcement of a contract became the major concern, although the strictness of the rule was mitigated by the use of the concept of one party to a contract holding certain rights in trust for a third party. The solution was the enactment of the
Contracts (Rights of Third Parties) Act 1999.

Regarding whether the doctrine of privity of contract should be abolished or not Iacobucci J viewed in Fraser River Pile & Dredge Ltd v Can-Dive Services Ltd:

"Privity of contract is an established doctrine of contract law, and should not be lightly discarded through the process of judicial decree. Wholesale abolition of the doctrine would result in complex repercussions that exceed the ability of the Courts to anticipate and address. It is by now a well-established principle that the Courts will not undertake judicial reform of this magnitude, recognizing instead that the legislature is better placed to appreciate and accommodate the economic and policy issues involved in introducing sweeping legal reforms. ...
That being said, the corollary principle is equally compelling, which is that in appropriate circumstances, the Courts must not abdicate their judicial duty to decide on incremental changes to the common law necessary to address emerging needs and values in society. ..[10]."
[1] Beatson (1998)" Anson's Law of Contract", 27th ed. (Oxford: OUP), p.246
[2] 1882
[3] (1880) LR 16 ChD 290
[4] (1986) 6 NSWLR 175.
[5] (1988) 164 CLR 387
[6]1987) 162 CLR 221 at 256-257
[7] (1842)
[9] (1630)
[10] [2000] 1 Lloyds Rep 199, at paragraph 43-44.

Authors contact info - articles The  author can be reached at: shuchi.lawstudent@legalserviceindia.com

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