Privity of Contract – McKendrick Notes

Main Principles

General rule (common law): A third party can neither acquire rights, nor be subject of a burden to a contract to which he/she is not party (this is known as privity of contract).

The former part of the rule, stating that a third party cannot acquire rights is controversial and the courts have created a number of exceptions.

After much demand a reform act was implemented: The Contracts (rights of third parties) Act 1999. The Act provides a simple way for contracting parties to give a third party the right to enforce the terms of the contract. The contracting parties are able to define for themselves the extent to which the third party can enforce these terms (as the principle of freedom of contract is the main philosophy that underpins this act).

The issue of whether a third party should be able to enforce terms is still strongly debated.

o Should a third party, who is not a promisee and who has provided no consideration have contract rights?

The common law exceptions to the rule still stand although their significance and practicality has diminished following the 1999 Act.

A party who breaches contract and fails to confer a benefit on a third party becomes liable to the other party (not the third party). The rights of action of the other party to the contract are not affected by the 1999 Act.

The issue of whether or not a contracting party can sue on behalf of a third party is subject to debate.

The Act does not affect the general rule stating that obligations cannot be imposed on a third party. There are some exceptions to this rule (small scope) and the rule is widely accepted.

A Note on Structure of Contracts

There are many situations in which contracts involving a third party may arise. For example a company (A) may contract with a building company (B) to build a structure; the building company may then sub-contract some or all of the work to another party(s) (O). According to the general rule, if A has contracted with B and then B has contracted with O then A does not have a right to bring an action against O should O cause any damage. There are many ways which the contract or contracts could be structured to resolve this issue:

- 1) B could be liable to A and then O could be purely liable to B, so in the event of any negligence A could sue B, who could in turn take an action against O

- 2) A could create a collateral warrantee contract with O giving A the right to take an action against O in the event of negligence

- 3) The third party right of action option: A could insist that in the contract between B and O, there be a clause which states that A has a right of action against O. This would be conferring a right of enforcement on a third party (A is the third party in this case as the clause would be in the contract between B and O). A would be able to enforce the term that O work with due care and diligence against O.

Contracting parties will usually consider which option best suits them.

However, the introduction of third party rights (as set out in option 3) needs to be done with care so as to not infringe on the rights and obligations set out by the two contracting parties in the first place.

Establishment of the General Rule (Common Law)

The general rule is that third parties have no right of action

Cases: Tweddle v. Atkinson (1861) 1 B&S 393 or 121 ER 762 – Queen’s Bench

Dunlop Pneumatic Tyre Co Ltd v. Selfridge and Co ltd [1915] AC 847 – House of Lords

Before these cases the common law was unclear regarding the rights of both parties as the courts had made varied decisions. These two are credited by many as securing the doctrine of privity in English law.

Tweddle v. Atkinson (1861) 1 B&S 393 or 121 ER 762

The children of John Tweddle and William Guy were to be married. They made an agreement to each pay an amount of money to William Tweddle, who was to be married. In this contract there was a clause saying that William Tweddle had the right to sue either party if they did not fulfil their obligations. William Tweddle attempted to sue the executor of William Guy’s will (Atkinson). His claim failed.

Ratio: A third party cannot acquire contract rights from a contract to which they are not party if they haven’t provided consideration. As William Tweddle had provided no consideration the judges found it unnecessary to consider whether or not a third party could acquire rights (in the rare scenario) if they did provide consideration. This aspect of the general rule needed to be solidified by Dunlop.

Dunlop Pneumatic Tyre Co Ltd v. Selfridge and Co Ltd [1915] AC 847, House of Lords

Dunlop, a tyre manufacturer, sold some tyres to Messrs Dew, a motor accessories agent. In the contract of sale it was stated that Dew must not sell the tyres for below the list prices. However, they were allowed to offer discounts to genuine trade customers if the customer that they were selling to also agreed to sell the tyres at not lower than the list price. Dew sold tyres to Selfridge and Co Ltd. Selfridge then sold the tyres at below the list prices. Dunlop sued Selfridge for a breach of their obligation.

(jus quaestitum tertio means a third party right of action)

The House of Lords found in Favour of Selfridge: Only a person who is party to a contract can sue upon it. However, two exceptions are noted – A right may be conferred on a third party via a trust. A third party may act as an agent for one person who is party to the contract. If the promisee has contracted as an agent for another party then that other party may be able to sue. The other party, not the agent must, however, supply the consideration for the contract.

This did not occur in the Dunlop case as Dew provided the consideration, not Dunlop.

Beswick v. Beswick [1968] AC 58, House of Lords

Peter Beswick, aged 70, sold his coal delivery business to his nephew, John Beswick. Part of their agreement was that upon Peter’s death, John would pay his wife, Ruth, £5 a week until she died. Once Peter had died John paid one £5 payment then stopped fulfilling his agreement.

The Court of Appeal (well Denning) decided that Ruth was able to enforce this agreement both in her capacity as the administrator of her husband’s will and as a third party of the agreement between Peter and John (Using Section 56(1) of the LPA 1925: A person may take an immediate or other interest in land or other property, or the benefit of any condition, right of entry, covenant or agreement over or respecting land or other property, although he may not be named as a party to the conveyance or other instrument.)

Denning argued that as long as the third party has a legitimate interest, they can sue one of the contracting parties, either as a co-plaintiff with the other party or in their own right on behalf of the contracting party. Denning: ‘Where a contract is made for the benefit of a third person who has a legitimate interest to enforce it, it can be enforced by the third person in the name of the contracting party or jointly with him or, if he refuses to join, by adding him as a defendant... It is different when a third person has no legitimate interest, as when he is seeking to enforce the maintenance of prices to the public disadvantage, as in Dunlop: or when he is seeking to rely, not on any right given to him by the contract, but on an exemption clause seeking to exempt himself from his just liability.

The House of Lords decided that Ruth had a good claim as administrator of her husband’s will, but not as the third party in the contract agreement. Denning’s above obiter statement is interesting though. The council for Ms Beswick did not ask the House of Lords to again consider whether or not she had a valid claim as a third party so this point of law is a grey one.

The scope of section 56(1) (the section used by Denning to justify validating Ruth’s claim as a third party) of the LPA 1925 is debateable. Treitel suggests that there are three limitations to this exception from the general principle of privity. Namely that it only applies to:

- Real property- Covenants running with the land- Cases where the instrument is not merely for the benefit of the third

party but purports to contain a grant to or a covenant with him. - Deeds between parties

However, despite there being evidence for these in Denning’s obiter, there is no clear support from the other judgments. Therefore, the scope and indeed existence of this exception are vague.

Stay of Proceedings – [Law dictionary definition: The putting an end to proceedings in an action by a summary order of the court]

This section deals with a contract in which a promisor has promised a promisee not to sue a third party.

Criteria for the ability to enforce a stay:

- Must be able to demonstrate that the promisor has promised not to sue the third party

- Demonstrate that the promisee had a sufficient interest in the enforcement of the promisor’s promise

Gore v. Van Der Lann [1967] 2 QB 31

Plaintiff entered into an agreement when applying for a free bus pass, which had terms stating that employees of the bus company could not be held liable for any personal injury. The plaintiff injured themselves whilst getting onto a bus and tried to sue the bus conductor (an employee of the bus company) for negligence. The bus company attempted to stay the proceedings against the conductor (who was the third party in this case) on the grounds that they had contracted with the plaintiff.

The court decided to dismiss the application for a stay because, amongst other reasons, the bus company did not have sufficient interest in the enforcement

of the promise, because it was not under an obligation to indemnify its employee against his liability to the plaintiff in negligence.

Contrast this decision with:

Snelling v. John G Snelling Ltd [1973] 1 QB 87

Three brothers are directors of a company. They are each owed considerable sums of money by the company. As relations are crumbling, they decide to make an agreement that if any one of them resigns as director, then he forfeits any monies owing to him. One of the brothers then resigned and attempted to recover the money that he was owed. The other brothers, acting as the company (which is a third party in this context) sought to rely on the agreement made between the brothers.

The court decided in favour of the company (granted the stay) and allowed it to rely upon the agreement made between the brothers. The judgment from Ormrod J comes in to conflict with that given in Gore. In this case he allows the defendants the stay despite the fact that the contracting party (the two brothers) were under no obligation to indemnify the company against any claims. Whereas, in Gore it was decided that the second criteria: of demonstrating a sufficient interest was not satisfied. Ormrod J concluded that the interest which the brothers had in running the family company was sufficient to give them an interest in obtaining a stay. This is a very broad view of the scope of the rule regarding stays.

Damages

In certain cases it is possible for one of the contracting parties to claim damages if one of the obligations of the other contracting party towards a third party has not been fulfilled. This can only occur if the contracting party has suffered a loss as a result of the breach. An example of how this might work:

A and B make a contract stating that A will pay £500 to C (a third party). B is a debtor of C and needs to £500 to be paid in order to release him from his debt. If A does not pay the money to C, B suffers because his debt is not relieved.

However, cases in which this occurs are rare.

More common are cases in which the third party suffers as a result of the breach.

Can the promisee sue to recover damages for the third parties loss?

General rule: The promisee cannot sue and recover damages for the loss that has been suffered by the third party.

The case that affirms this general rule is:

Alfred McAlpine Construction Ltd. v. Panatown ltd. [2001] 1 AC 518

Panatown contracted with McAlpine to build a project on some land owned by UIPL (the contract was not made by UIPL directly for tax reasons). McAlpine signed a separate Duty of Care Deed with UIPL. The building work was a disaster and it was alleged that repairs would cost £40 million.

Panatown tried to claim on two grounds, one for the loss of a third party (UIPL) and the second was that Panatown themselves had suffered damages although financially they were not any worse off. The House of Lords upheld McAlpline’s appeal and did not grant Panatown damages on either of the two grounds.

In Lord Millet’s dissenting judgment he explains that the concept of compensation is based upon the attempt to try and mitigate one party for their loss. Therefore, it follows that only the person who has suffered the loss is entitled to have it mitigated by compensation.

Lord Goff doubts the rule that the promisee cannot sue for a loss suffered by a third party as a result of a breach. He points out that it is absurd that, in a contract where A has contracted with B for B to build a house for C, A has no remedy in the event that B does not fulfil his contractual obligation.

The general rule still stands but it is subject to intense academic scrutiny.

Further interesting cases on this general rule:

Jackson v. Horizon Holidays Ltd. [1975] 1 WLR 1468, Court of Appeal (demonstrates difficulties with the general principle in a family context)

Julian Jackson booked a holiday for him and his family (wife and child) through Horizon holidays. The hotel that had originally been arranged for him was not

available and instead he was offered another hotel at the discounted price of £1200 along with the assurance that it would be satisfy his requirements (which he had set out in an earlier letter).

The new hotel was not satisfactory and caused Jackson and his family considerable discomfort and distress. Initial damages were set at £1,100. The point of law we are interested in is: Should Jackson be able to recover damages for the distress caused by his wife and child (as they are third parties) or only for the distress and inconvenience suffered by him.

In this case the court decides that in the case where one party has contracted for the benefit of himself and his family (Denning also gives the example of a vicar hiring a coach to take his congregation on a trip – he has made the contract for the benefit of all those travelling) he may sue for damages suffered by them as well.

Denning mentions: Lloyd’s v. Harper (1880) 16 Ch D 290, 321 – Lush LJ: ‘I consider it to be an established rule of law that where a contract is made with A for the benefit of B, A can sue for the benefit of B, and recover all that B could have recovered if the contract had been made with B himself.’

Denning argues that as it is an established principle that the third parties themselves cannot sue to recover their losses, therefore the contracting party should be able to sue on their behalf. Accordingly Denning upheld the compensatory figure of £1,100 which included damages for diminution of value and damages for Jackson and all of his family. However, James LJ was content to give the same £1,100 but only as damages for the inconvenience and distress caused by Mr Jackson and not for that suffered by his family. Orr LJ’s opinion is unclear; therefore we have a debate over whether or not this general rule is in jeopardy here.

However, Denning does say that his exception occurs in the case that the third party cannot sue themselves. Following the implementation of the Contract (Rights of Third Parties) Act 1999 this argument may have less weight as third parties can now be given rights to sue on a contract that they are not party to.

Denning’s judgment also accounts for worries expressed in previous cases. These are worries concerning the contracting party recovering losses on behalf

of the third party, but then not having an obligation to pass on the damages. Denning stated that Jackson was liable to his family by means of a personal restitutionary claim.

Woodar Investment Development Ltd. v.Wimpey Construction UK Ltd. [1980] 1 WLR 277, House of Lords (demonstrates difficulties with the general principle in a commercial context)

Wimpey agreed to buy land from Woodar for £850k and on completion of the purchase Wimpey agreed to pay £150k to Transworld Trade Ltd. Woodar claimed a repudiatory breach of the contract and tried to claim for the £150k that was due to be paid for Transworld. The House of Lords decided that there had been no repudiatory breach; however they did still consider the validity of the claim for damages on behalf of Transworld. (All of the below is therefore obiter)

Lord Wilberforce questions Denning’s use of the Lloyds v. Harper case in his judgment, claiming that the extract was taken from section discussing a situation when a contracting party is acting as an agent of a third party.

Lord Keith of Kinkel, as well as having a cracking name, agreed with Denning’s judgment, but questioned the basing of it on the Lloyds case as this case was entirely to do with agency.

At this stage, the general rule in question – that a promisee cannot sue for the loss suffered by a third party as a result of a breach – was a very murky area and judges expressed a desire to see it resolved in the future.

Established exceptions to this rule:

- A trustee can sue and recover damages for the loss of a beneficiary- An agent can recover damages for the loss of his principal

One more debateable exception: In a commercial contract concerning the transport of goods, a contracting party may sue for the loss of a third party who has gained a proprietary interest in the goods and suffered as a result of a breach. This was espoused by Lord Diplock in The Albazero [1977] AC 774, 847. The scope of this one is debateable. Originally this concept was applied solely

for the carriage of goods, but since then it has been used in other contexts (see Linden Garden trust ltd. v. Lenesta Sludge Disposals ltd. [1994] 1 AC 85 and the Panatown case). It is not clear whether this concept is confined to situations in which the transferring of proprietary interest was in the contemplation of both of the parties as a normal course of business. Diplock in The Albazero and Millet in Panatown agree that it should be so confined, however Lord Clyde in Panatown and the ratio in Darlington Borough Council v. Wiltshier Northern ltd. [1995] 1 WLR 68 state that a change of ownership was not a necessary ingredient for the exception.

As this exception that is being discussed is pretty vague, here is Diplock’s dictum to clarify:

‘In a commercial contract concerning goods where it is in the contemplation of both parties that the proprietary interests in the goods may be transferred from one owner to another after the contract has been entered into and before the breach which causes loss or damage to the goods, an original party to the contract, if such be the intention of them both, is to be treated in law as having entered into the contract for the benefit of all persons who have or may acquire an interest in the goods before they are lost or damaged. And is entitled to recover by way of damages for breach of contract the actual loss sustained by those for whose benefit the contract is entered into.’

The Exceptions to Privity – Main exceptions to the principle that a third party cannot sue on a contract to which they are not party in the common law (Statutory exceptions covered later)

Collateral Contracts

The courts may circumvent the rule by finding that the third party is not in fact a third party, but a contracting party. A collateral contract is a way of proving this.

Shanklin Pier Ltd. v. Detel Products Ltd. [1951] 2 KB 854

The defendants, who were paint manufacturers told the plaintiffs that their paint was suitable for painting the pier and would have a good lifespan. The plaintiffs advised their contractors to repaint the pier using this paint, relying on the advice from the defendants. The paint was unsuitable.

The defendants claimed that the warranty that was given by them was not a valid cause of action (they did also debate whether a warrantee was indeed given). McNair J stated: ‘I see no reason why there may not be an enforceable warrantee between A (the paint company) and B (the Pier company) supported by the consideration that B should cause C (contractors) to enter into a contract with A or that B should do some act for the benefit of A.’ Accordingly the court awarded Shanklin Pier ltd. damages.

This most debateable area of this exception is whether or not all of the elements of a contract (offer & acceptance etc.) are present to make a collateral contract. In some cases the courts appear more willing to stretch their definition of the elements in order to deem that a contract has been made.

In Independent Broadcasting Authority v. EMI Electronics (1980) 14 Build LR 1 the court decided that there was no intention to create a collateral contract.

In The Eurymedon [1975] AC 154, however, the courts take a very flexible approach to the formation of a contract.

If both parties are experienced in commerce and could easily have created a direct contractual relationship, but chose not to do so, the courts appear reluctant to allow the collateral contract exemption, as per Fuji Seal Europe Ltd. v. Catalytic combustion Corporation [2005] EWHC 1659.

It can be argued that this is not an exception of privity, because this exception is framed in terms of the third party as a contracting party. It is based upon the basic contract principles rather than rights of a third party. However, due to the fact that the courts are often liberal with their interpretations of the basic requirements of a contract this exception is generally considered to be an exception of privity.

Trust of a Contractual Right

A promisee may hold his right to sue the promisor on trust for the benefit of the third party. The third party then gains a property right which he can sue on if it is interfered with. As was established in Dunlop: ‘a right may be conferred by way of property, as, for example, under a trust.’ Les Affreteurs Reunis v. Walford [1919] AC 801 is an example of a case in which the courts deemed

that a contractual right had been held in trust. It might seem, at this stage as if this is an exception which can be readily used to avoid the general privity of contract rule. However, this is not the case. In latter cases the scope of this exception was narrowed. Most notably in:

Re Schebsman [1944]

John Schebsman worked for a couple of companies when his employment was terminated in 1940. The companies agreed to pay him £5,500 in consideration for the termination of his contract. They were to pay this in instalments. If he died before the instalments were paid, the money was to go to his wife and if she died to his daughter. John was declared bankrupt shortly before he died in 1942. The trustee for his bankruptcy claimed that the remaining instalments should go to his estate to satisfy his creditors as opposed to getting paid to his wife.

The widow argued that a trust had been created on behalf of the wife and the daughter and that therefore the trustee did not have a right of interception.

The Court of Appeal decided that no such trust had been created and therefore the remaining instalments were to be paid to creditors. The courts saw that there was no reason to import a trust into this situation when no such trust had been intended by the parties. There is a difference between a trust and the case where a contract has been made for the benefit of a third party. Another point that was noted was that the creation of a trust is irrevocable and deprives the contracting party of their freedom to change their minds. It is clear that a contracting party would be slow to give up this right and therefore the courts are equally slow to infer that a trust has been created.

The current situation is that this exception is not valid unless there is clear evidence that a trust has been created and usually that it was the intention of the parties to do so.

Assignment

The law allows a contracting party to assign his contractual rights to a third party. Assignment is commonly used in relation to debts. When a creditor sells on a debt to a debt collection agency, this is the assignment of the creditor’s

contractual rights against the debtor. There are 5 main points governing the law on assignments:

1. A distinction must be drawn between assigning rights and assigning liabilities. Liabilities cannot be assigned without the consent of both parties and the party to whom the liability is owed. Rights can be more freely assigned.

2. Assignments are either equitable or statutory (not much common law here). The LPA 1925 provides several criteria for assignments:

a. The assignment must be absolute and not by way of chargeb. The assignment must be unconditional and not dependent on

future uncertaintiesc. The assignment must be in writing and signed by the assignord. Express notice in writing must be given to the debtor e. The assignment must be of any debt or any legal thing in action

A statutory assignee may sue the debtor without the assistance of the assignor in court, whereas an equitable assignee must be accompanied by the assignor. An equitable assignment is more flexible and may exist if it does not comply with the terms of the statute. In a statutory assignment consideration does not have to be provided, whereas in an equitable assignment this point is more debateable.

3. Not all contractual rights are assignable. The contract itself may prohibit/limit the assignability of rights (Linden Garden trust ltd. v. Lenesta Sludge Disposals ltd. [1994] 1 AC 85). A right to sue on a contract is not an assignable right unless the assignee has a general commercial or financial interest in taking the assignment (Trendtex Trading Corporation v. Credit Suisse [1982] AC 679). The benefit of a contract is only assignable in cases where it can make no objective difference to the person on whom the obligation lies to which of the two persons he is to discharge it. I.e. no relevant special skill of contracting party or no personal relationship between original contracting parties.

4. The assignee cannot recover more damages against the other contracting party that the assignor could have done had the assignment not taken place.

5. The liability of a contract cannot be assigned without the consent of the other party (the one not involved in the assignment). The process of

transferring the liability with consent is called novation. The main case relation to novation is The Tychy (No 2) [2001] 1 Lloyd’s Rep 10, 24. This case states that novation is the creating of a new contract with one party being replaced by another. The consent of the other party must be clearly given either directly or implied by conduct.

Agency

In Dunlop it was stated that in order for the rules of agency to apply, consideration must have been given either by the principal or by the promisee who was acting as his agent. An agent must be person who has been given the authority to act on behalf of his principal in a way that alters the principal’s legal relations with third parties.

Once an agent, acting within the authority given to him by the principal (the principle may limit the agent’s rights – e.g. do not pay more than £100 for this service), has entered into a contract with another party, the agent becomes removed from the situation and the contract is now seen as being between the principal and the other party. The agent can no longer sue or be sued on the contract as per Wakefield v. Duckworth [1915] 1 KB 218)

Problems arise when the agent acts in excess of the authority that was granted to him by his principal (when the principal’s identity is disclosed). When deciding the extent of the agent’s power the courts will look at applied, apparent and usual authority. This is a complex area of law. The third party (with whom the agent is making a contract with) is not bound by the limitations set forth by the principal, unless the other party is aware of these limitations.

Agency as regards an undisclosed principal: The rules here have a few key differences – The agent of an undisclosed principal may sue or be sued on the contract, any defence which the other party may have against the agent is also available against the principal and the terms of the contract may limit/deny the principal’s right to sue or be sued on the contract. In some cases with an undisclosed principal it may be the case that the agent is the main party to the contract and the principal is not contractually involved. These points, whilst seeming to contradict the principles of privity, these principles find their grounding on commercial convenience.

The undisclosed principle rules have come under a lot of scrutiny as it does not seem right that a third party can find himself in a contractual agreement with a party whose existence he was not aware of and may object to (contrast with the principles of privity: a third party may not have rights conferred on them or be granted rights even with the consent of both of the contracting parties). The common law has imposed some limits on the undisclosed principal’s right to intervene, but the scope of these is uncertain.

Negotiable Instruments

A negotiable instrument may be transferred to a purchaser and grant them the rights ‘free from defect’ that were held by the contracting party. This is better than an assignment because an assignment takes place subject to equities as opposed to free from defect. The main example of a negotiable instrument is a cheque. A cheque is a contract made between the drawer and his bank, to deliver a certain sum of money to a third party. The third party has the right to present the cheque and demand payment of the sum from the bank.

Tort

When a third party suffers as a result of the negligence of one of the contracting parties then the third party may have a claim in tort. There is less debate when this principle becomes involved in personal injury and damage to property claims and more when we look at claims for economic loss.

Personal injury:

Donoghue v. Stevenson [1932] AC 562

Claimant (the third party in this case) claimed that she became ill after drinking a bottle of ginger beer (with a decomposed snail in it) that was purchased from a cafe by a friend. She made a claim in tort against the manufacturer of ginger beer. The manufacturer argued that their duty was to the party that they had contracted with and that they owed nothing to a third party.

The House of Lords decided that the manufacturer had a duty of reasonable care to all consumers and the claimant’s tort claim was upheld.

Economic Loss:

Junior Books ltd. v. Veitchi Co Ltd. [1983] 1 AC 520

The claimants entered into a contract with some main contractors for the construction of a factory. The main contractors sub-contracted some of the work to the defendants. The claimants alleged that the defendants had laid a floor poorly. Instead of suing the main contractors, who could in turn sue the defendants, the claimants made a claim in tort against the defendants. The courts decided that the defendants had assumed a responsibility towards the claimants and therefore they were liable to them.

This case seems to create a handy shortcut. However, it has come under criticism as surely it is the case that the sub-contracted party assumes responsibility to the party that they have contracted with as opposed to a third party. The principle espoused in this case has not been seen elsewhere in relation to economic loss claims.

A tort claim does have the potential to circumvent privity of contract; however, it must be proved that the defendant was negligent.

Statutory Exceptions

This area of the common law ceased to exist after the enactment of the 1999 Act. There were a number of statutory provisions, which granted third parties contract rights. An example of an attempted use of a statutory exception is Denning’s use of the LPA 1925 Section 56(1) in Beswick. Four examples of statutes that provided exceptions to privity are The Married Women’s Property Act 1882, Section 11; The Marine Insurance Act 1906, Section 14(2); The Road Traffic Act 1988, Section 148(7); The Carriage of Goods by Sea Act 1992, Section 2.

Third Parties, Exclusion Clauses, and Exclusive Jurisdiction Clauses

This section concerns debates surrounding whether a third party may take the benefit of an exclusion or limitation clause in a contract to which it is not a party and whether a claimant can be bound by a limitation clause in a contract to which he is not party. Most of this is now covered by the 1999 Act and the common law is complex so I will leave this section (McKendrick pp 1006-1022).

The Case for Reform of The Doctrine of Privity

The Law commission made a report on the state of privity prior to the 1999 Act, which in turn formed the basis for the act. The report makes some useful criticism.

Arguments in favour of reform from the report:

1. The main principle of privity – that two consenting contracting parties cannot convey a benefit on a third party – runs contrary to our general principles of contract law that seek to realise the will and intentions of the contracting parties. This is unjust towards the contracting parties.

2. The current doctrine is unjust towards third parties. When a third party has been given reasonable expectation to be able to legally enforce a contract the doctrine prevents this. This is especially harsh when the third party has relied on the contract or its benefits have become an unmoveable aspect of their affairs. The report raised the issue of whether the contracting parties should be able to change their minds despite the third party having relied on the contract. They decide that if the third party has suffered a strong injustice by the varying or discharging of a contract to which they are not party this overrides the altered intentions of the contracting parties.

3. It is wrong that a contracting party who has suffered no loss can sue, whereas a third party who has suffered loss cannot sue. See Beswick v. Beswick.

4. Under the current doctrine the promisee may not wish to sue on behalf of the third party leaving the third party, who has suffered a loss, no remedy.

5. There are currently (before the act) many statutory and common law exceptions to privity. The existence of so many exceptions shows that the doctrine is an unjust one. These exceptions continue to arise and evolve, demonstrating that the current ones have not resolved all of the issues. The exceptions are also uncertain and subject to much litigation. Both of these factors strongly suggest that a reform is necessary.

6. As the current doctrine and its exceptions are so complex, artificial and uncertain it would be far more expedient to create an Act. The technical exceptions create uncertainty, which is never desirable in commercial

situations. The law has become so convoluted and containing many ‘grey areas’ (see many earlier references to law being uncertain/grey) that reform is necessary.

7. The doctrine of privity has come under criticism throughout the common law world (academics, other governments etc.) and some areas have already implemented reform. This is a sure sign of the need for change.

8. The legal systems of most of the member states of the EU (France, Germany, Italy, Spain etc.) allow contracting parties to confer contractual benefits to a third party (Only UK, and Ireland do not). There is growing pressure from the EU for harmonisation of commercial law and the pressure on the UK to bring its contract law in line with the other states will keep growing. Especially given the current work by the EU’s commission on European Contract Law.

9. The third party rule causes constant practical difficulties in current commercial practice.

Conclusion of the report: ‘For the reasons articulated above, we believe that a reform of the third party rule is necessary. Contracting parties may not, under the present law, create provisions in their contracts which are enforceable directly by a third party unless they can take advantage of one of the exceptions to the third party rule. Our basic philosophy for reform is that it should be straightforwardly possible for contracting parties to confer on third parties the right to enforce the contract.’

Opposition to The Law Commission’s Report and to Reform

Whilst many academics have supported the arguments put forward in the report, it has come under some criticism, most notably from Professor R Stevens ((2004) 120 LQR 292).

1. The lack of a third party right of action does not mean that the intention of the contracting parties is thwarted. It just means that one of the contracting parties has altered their intentions. His suggested reform would be a greater right of action for the promisee (contrast with argument that contracting party may not always wish to sue on behalf of a third party, therefore this is an injustice to third parties). He suggests

that giving a right of action to the third party denies the contracting parties of their right to alter the contract as intentions change.

2. The third party does not have a right to rely on a promise made to someone else; therefore there is no injustice to the third party.

3. Already covered4. If the promisee decides not to sue on behalf of a third party then it is his

right to do so and this does not mean that the right should be given to a third party.

5. Some of the current exceptions to the doctrine are not true exceptions, and the existence of the true exceptions does not justify the creation of a new exception.

6. There are still uncertainties in the Act as there are with the common law. 7. Widespread criticism does not mean that they are right and we are

wrong.8. As regards the argument for the UK to come in line with other EU

member states: Roman law does not recognise third party contract rights. Some aspects of law which are dealt with contract law in EU states are dealt with by tort law in the UK. EU states and the UK recognise third party rights in different circumstances and it is not as simple as saying that there is a European consensus with which the UK is currently not conforming to.

9. The Act does not provide any real aid to current commercial transactions and is not more expedient than the common law.

Analysis: The crux of the debate is whether or not to allow third parties a right of action. Two main arguments in favour of the old doctrine: The third party is not a promisee and the third party has provided no consideration for the promise. Only the promisee, which has provided consideration, should be enabled to enforce the contract.

Contracts (Rights of Third Parties) Act 1999

This act is now the main source of law relating to the rights of third parties. The Act’s main objective was to set out a simple legal mechanism which would allow two contracting parties to confer a right of action on a third party.

Rights of a third party to enforce a contractual term (Section 1)

As per section one of the act, the mechanism may give a third party a right of action if:

i. the contract expressly states that it doesii. or if there is a benefit to the third party expressed in a term of the

contract. However, the third party does not have a right of action if it appears that the contracting parties did not intend him to do so.

The third party must be expressly identified (need not be named, just identified – sons of X or subsequent owners of the property will suffice) in the contract, but need not be in existence when the contract is constructed.

Third parties may enforce the terms (limitation clauses, exclusion clauses) of a contract if the mechanism is enforceable.

Under 1(5) the third party has the right to enforce the contract as if he were a contracting party and may be ordered specific performance or an injunction.

Academic commentary: Point (i) is generally accepted. Point (ii) is criticised by some as making the act too uncertain and that it would have been better to only allow third parties a right of action when it is expressly stated.

Section 1 in general, encourages contracting parties to make it clear whether or not they wish to confer a right on third parties. An express statement can be made either way, in favour of conferring rights or not.

However, Burrows (in The Contracts (Rights of Third parties ) Act and its Implications for Commercial Contracts [2000] LMCLQ 540, 542-546) points out that many of the intentions of the parties in a contract are not set out in express terms, but implied, therefore it would be wrong to only rely on an express term. Also, this Act would not help in many past cases if point (ii) were not present: Beswick, Woodar v. Wimpey, Jackson v. Horizon Holidays and Trident General Insurance Co ltd. v. McNiece Bros. Finally, the express statement of the mechanism is only likely to appear in well drafted contracts between corporations that can afford good legal advice and would not cover the consumer sphere.

Point (ii) is only to apply where the third party will receive a benefit directly from the promisor, not as a consequence of the contract.

To summarise: The contracting parties are free to chose whether they wish third parties to be given a right of action by including a simple term in the contract that states either that such a right is to be conferred or that the parties do not wish third parties to be conferred any rights under the Act. However, if the contract makes no statement either way this can have the effect that the contracting parties are left with unintended liabilities, which goes against the principles of contract law. Burrows concludes that although there is a slight risk of the promisor being burdened with unintended liabilities, this will always be a risk, given our objective outlook on contract law. McKendrick notes that the phrase ‘purports to confer a benefit’ has been a relatively easy test to prove in the case law following the implementation of the act: Prudential Assurance Co ltd v. Ayres [2007] EWHC 775 (Ch); Nisshin Shipping Co ltd v. Cleaves & Co ltd. [2003] EWHC 2602 (Comm); The Laemthong Glory (No.2) [2005] EWCA Civ 519. In such cases it has been noted that it is not necessary for the benefit to the third party to be the predominant aim of the term. The subsection is also applicable even if a benefit is conferred on someone other than a third party as well.

Section 1(2): Silence is not enough evidence to prove that the contracting parties did not intend to confer a right of action on third parties. When there is no clause expressly stating that the parties did not intend to confer rights on third parties under the act, there have been two unsuccessful attempts to persuade the courts that there was an implicit intention not to confer rights:

1. The contracting parties have argued that since the third party already has a right of action under the common law (obviously only available in some circumstances, e.g. when a trust has been created etc.) it is unnecessary to confer another right on them under the act. In Nisshin Shipping Co ltd v. Cleaves & Co ltd. [2003] EWHC 2602 it was argued that the parties intended to create a trust of promise in favour of the third party, therefore the Act should not apply. This failed.

2. There have been attempts to state that the structure of the contract shows that there was not an intent to confer rights on third parties as was tried in The Laemthong Glory case. This also failed as the courts decided that the sequence of contracts does not prevent a third party from being given rights of action.

The initial response to the Act from the commercial world was to include clauses that negate the Act, but as the commercial world has begun to realise the merits of the Act its use may become more widespread.

Section one implies that a third party has the right to enforce a term without having provided any consideration.

The section is unclear on whether or not a deed serves as a contract for the purposes of the act. In Prudential Assurance Co ltd v. Ayres [2007] EWHC 775 (Ch) there was no challenge to the proposition that it was, however, the lack of challenge means that this point is still unresolved.

Variation and Rescission of Contract (Section 2)

This section dictates that generally that the contracting parties cannot alter or rescind the contract without the permission of the third party in a number of circumstances – if the third party has communicated his assents to the promisor, if the promisor is aware that the third party has relied on the term etc.

Benefits for contracting parties: Again they have the right to include in the contract a term which allows them the right to rescind or vary the contract without the consent of the third party. This preserves freedom of contract.

Benefits for the third party: If he communicates his assent to the promisor his right trumps that of the contracting parties to rescind/vary the contract. If the promisor should reasonably have expected that the third party would have relied upon the contract and the third party does then the contract cannot be rescinded/varied. However, the precise meaning of ‘relied upon’ and ‘reasonably expected the third party to rely upon’ are likely to cause controversy.

However, the promisor may terminate the contract as a result of a repudiatory breach by the promisee without the consent of the third party.

Can an irrevocable third party right be created upon formation of the contract? Law commission view: The contracting parties cannot give the third party a right that cannot be altered or terminated from the moment that the contract is formed as this would run contrary to freedom of contract. The third

party must first communicate his assent to the promisor or rely upon the promise before his rights become irrevocable.

Burrows view: The contracting parties can give the third party security regardless of their adherence to section 2(1) due to the wording of 2(3)(b) – ‘The consent of the third party is required in circumstances specified in the contract instead of those set out in (1)(a) to )(c).’

Case law has not yet defined which view is correct, so the safe option is for the third party to fulfil 2(1) or for the contracting parties to create a trust of the contractual right.

Defences available to the Promisor (Section 3)

This section is applicable when a third party brings an action which is founded on section 1. The promisor has any defence available against a third party claim, which he would have available against the promisee. However section 3(2) states that the promisor is not able to bring a counterclaim for any matter arising in the contract. Section 3(4) does allow for counterclaims against the third party if the claim arises outside of the contract, but counterclaims may not arise in any other context.

Freedom of contract is again preserved as the contracting parties can contract out of this by putting express terms in the contract.

Enforcement of Contract by Promisee (Section 4)

Section 4 merely states that ‘section 1 does not affect any right of the promisee to enforce any term of the contract.’

Therefore, the act does not affect the rights of the promisee. The next section deals with the possibility that the promisor may be left liable to the third party and the promisee.

Protection of Promisor from dual liability (Section 5)

This states that if a third party makes a claim after the promisee has already recovered damages for the loss of the third party, then the third party’s award shall be reduced accordingly. If the promisee makes a claim after the third

party has already claimed then the award is likely to be nominal as now the promisee can only claim for their own loss, not that of the third party.

Exceptions (Section 6)

As suggested this section provides a list of cases in which the act does not apply. Some of the subsections are there to ensure that the act does not conflict with contracts in which a statutory third party right of action is already available - for example for the carriage of goods. Other’s give specific examples of contracts in which the acts shall not apply, for example between employers and employees. Check this section to see that the contract at hand is applicable with the act.

Supplementary Provisions Relating to Third party (Section 7)

Subsection one of this section states that the existing exceptions to the doctrine of privity are not affected by the act and still apply. This therefore means that the law is still as complex, although the common law exceptions may become less relevant following the act. The commission stated that it is open to the judiciary to further develop the common law exceptions to the doctrine of privity and they did not want the act to hamper this. Section 7(2) puts the third party in a worse position than the promisee by not allowing them to invoke the Unfair Contract Terms Act 1977 (except in cases of personal injury or death), whereas a promisee can use this Act.

Arbitration Provisions (Section 8)

If there is an arbitration clause in the contract then the third party must first go through arbitration proceedings before litigation. This section was referred to in the Nisshin Shipping case and it was decided the case should be referred to arbitrators who have the right to determine them. The arbitration clause can only be invoked if, on its construction it was intended by the parties that any issue regarding third party rights or liabilities should be referred to arbitration.

Northern Ireland (Section 9)

This section lists the exceptions for the application of the Act in Northern Ireland.

Short Title, Commencement and Extent (Section 10)

The Act cannot be enforced in any contracts concluded before 11 May 2000. When my issue of McKendrick was written there had not been any litigation under the Act, however it is in force. Check for more recent cases.

END OF SECTION ON THE ACT

The Imposition of Liabilities on Third Parties

The 1999 Act does not affect this area of privity. The general rule, of course, is that liabilities or burdens cannot be placed on a third party. There are three main exceptions to this rule:

1. A and B have formed a contract. C is a third party. It is a tort for C to induce B to enter into a contract with him, which would cause B to breach his contract with A. In this sense the third party must respect the sanctity of the original contract. Authority:

Lumley v. Gye (1853) 2 El & Bl 216

The plaintiff had contract with Miss Wagner to sing at his theatre for a period of time. The defendant induced Miss Wagner to break her contract with the plaintiff and instead some and sing at his theatre for a higher price. The court decided that this was indeed a tort. Some have argued that the plaintiff should have brought his case against Miss Wagner as she was the one who breached the contract, however it is now law that inducing a party to breach a contract is a tort.

2. If the owner of goods is involved in a bailment then he may be bound if certain conditions are satisfied (discussed previously).

3. MOST IMPORTANT AND CONTROVERSIAL EXCEPTION: This exception relates to whether or not the purchaser of land is affected by any contracts made between the previous owner and other parties. There is some debate over the issue, but the general doctrine now seems to dictate that such contracts are enforceable against the seller only if he is aware of them upon purchase/gift of the land and only if the party enforcing the agreement can prove that the covenant was imposed for the benefit of neighbouring land owned by him. The only rememdy available is an injunction to prevent the new purchaser from breaching

the old contract . A specific performance order is not available. Authority: Swiss Bank Corporation v. Lloyds Bank Ltd [1979] Ch 548.

Final Comments

Lawyers seem reluctant to use the 1999 Act at the moment, however this is likely to change given that it provides a simple mechanism for conferring contractual rights on third parties. The Act is underpinned by the intention of preserving freedom of contract and as such invited contracting parties to make their intentions clear at the formation of the contract. The common-law exceptions to the doctrine of privity are preserved by the act, however their significance may diminish over time.

In cases where the intentions of the parties are not made clear, then first look at section 1(1)(b) of the Act and see if the case complies with this. If not then turn to common law exceptions from the doctrine of privity. It remains to be seen whether or not judges will be more reluctant to enforce the exceptions after the formation of the Act or not. The Act is now the first port of call when dealing with privity despite the continued existence of the common-law exceptions.

Shit that took a while, where did the last 5 weeks go!? Privity better come up in the exam...