This article is written by Swetalika Das from Amity University, Kolkata. This is an exhaustive article that talks about the need for reform in the privity rule of contract law. 

Introduction

The doctrine of privity rule in Contract Law is an English Law principle that prevents any third party or a stranger from being bound by any obligations or terms and conditions of a contract. Here, a third party or a stranger means any party other than the original parties of the contract. 

What is the actual purpose behind this principle? Are there any exceptions to it? Does this principle need reform? These are exactly the questions that are going to be answered in this article focusing mainly on the required reforms in the doctrine of privity rule of contract law.

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The privity rule of Contract Law: meaning and purpose 

Meaning:

As already stated, the doctrine of privity rule of contract law allows only the original parties to be entitled to the terms and conditions of the contract. 

Let’s take an example to understand it:

Abhishek accepts an offer from a company in consideration of receiving fees every month with some other facilities provided by the company. If in this case, the breach of contract occurs then no other person is entitled to the terms and conditions of the contract because the contract is between Abhishek and the company.

Purpose:

The only purpose behind this rule is to protect the third parties from getting involved in any sort of lawsuit initiated from the contract.

Comparison between English Law and Indian Law 

English Law

In English law, both the doctrine of privity rule and the doctrine of consideration was established in the 19th century. The provision of the privity rule of contract law was first introduced in the case Tweddle v. Atkinson (1861). In this case, Tweddle’s father-in-law came into a contract with Atkinson to contribute an amount of $200 and $100 each to Tweddle and his wife. Tweddle’s father-in-law contributed his part but Atkinson died before contributing the money as a result of which Tweddle filed a suit against Atkinson’s estate. However, the court rejected his claim due to the absence of consideration from Tweddle’s father-in-law to Atkinson. Also, Tweddle himself was not a part of the contract. As Tweddle was a third party to both contract and the consideration, his claim was not accepted by the court even if it was for his benefit.

Further, the doctrine of privity was modified in the case Dunlop Pneumatic Tyre Co Ltd v. Self ridge & Co (1915) where the court rejected the claim of the plaintiff because he was not part of the contract.

Indian Law

The rule came into notice after a judgment of the privy council in the case of Jamna das v. Ram Autar (1911) where the privy council held that there is no contract between the plaintiff and the other party which makes the plaintiff a stranger to the contract and hence, the plaintiff cannot claim for any damages arising out of the contract. But it doesn’t mean that the above case will always be the same as in the famous case Donoghue v. Stevenson (1932) Ms. Donoghue’s friend brought a defective ginger beer that contained a partially decomposed snail due to which Ms. Donoghue filed a suit seeking damages. In this case, the contract was between her friend and the owner of the shop but it was observed that the manufacturer should have some sense of commitment and a duty of care towards his customers, consequently she was awarded the damages. 

Comparison

If we compare both the laws then we can say that there are many similarities between the English law and the Indian law that only the original parties of a contract can file the suit. However, the scope of privity rules is much wider in Indian law than in English Law. It’s because the definition and importance of consideration in Indian law are much wider than in English law (Babu ram Budhu mal and Ors. v. Dhan Singh Bishan Singh 1956). In India, a stranger or a third party can sue if the contract involves consideration but the same cannot happen in England. 

Consideration in privity rule of Contract Law:

As the above comparison suggests, the only difference between English law and Indian law is that a person can sue even if he is a stranger to the consideration. Therefore, it’s important to understand the concept of consideration in Indian contract law. In simple terms, consideration can be defined as an exchange of value between the parties because in a contract both the parties must benefit from each other. 

Before moving into the legal definition of consideration we need to first know the meaning of contract and agreement under the Indian contract law:

  • Contract: Section 2(h) of the Indian Contract Act,1872 (ICA, hereinafter) explains a contract as a valid agreement between two parties that is enforceable by law.
  • Agreement: Section 2(e) of the ICA,1872 states that every promise and set of promises made by the parties that form a consideration between the parties is known as an agreement.
  • Consideration: Section 2(d) of the ICA, 1872 states that an act of consideration can be formed as per the desire of the promisor, promisee, or any other person.

It is important to note that the term “any other person” mentioned in Section 2(d) is third-party of consideration. This denotes that if there is a presence of consideration in the contract then it does not matter who provided the consideration. 

Example:

Rajesh promises Dinesh to give a pair of shoes in consideration of Rs. 2000 but the consideration is provided to Rajesh by Rahul instead of Dinesh. This shows that the presence of consideration matters even if it’s provided by a third party to the contract.

Case law

In Venkata Chinnaya Rau v. Venkataramaya Garu and others (1882) case the Hon’ble Madras High Court stated that the consideration does not always move from the promisee, it can also move from any other person who is not involved in the contract. 

Additionally, some other cases that explain the concept of consideration are such as Dunlop Pneumatic Tyre Co Ltd v Selfridge & Co Ltd (1915), Tweddle v Atkinson (1861),  Dutton v Poole (1678)

Exceptions to the privity rule of Contract Law

  • Building in the trust:

 In this exception of the privity rule of Contract Law, the third party is entitled to sue the other party if there is a presence of trust. It is also important to note that there must be a certain benefit to the third party. According to this exception, in case of any breach of trust, the third party can sue the other party even if he is not a part of the contract. (Lloyds v. Harper 1880, M.C. Chacko v. State bank of Travancore 1970)

For instance, person “A” gives the possession of his company’s share to person “B” with a condition that person “B” would give 50% of his shares to Person “C”. But after the death of person “A”, person “B” refused to give any of his share to person “C”. As a result of this, person “C” sued person “B”. In this case, person “C” has trusted “B” for receiving the shares but person “B” didn’t fulfill the conditions. Here, person “C” can sue the other party even if he is not part of the contract.

  • Contract with the third party through an agent:

 According to the Indian Contract Act, an agent is a person who acts and represents on the behalf of a  principal and deals with the other parties who are not a part of the contract. If the agent establishes a contract with a third party, then it’s the responsibility of the agent to fulfill all the terms and conditions of the contract. For instance, if A is an agent of B, then A will build a contract with C and deal with him on behalf of B.

  • Acknowledgment, estoppel, or admission: 

According to this exception, a third party can sue the other party if they acknowledge an act, then they are obliged to do that act. In case of failure, they would be liable as per the law of estoppel. (Waltons stores Ltd v Maher 1988)

For instance, Jack asks Mary to give Rs. 5000 to Patrick on his behalf. If in this case, Mary acknowledges it then she is bound to pay the amount to Patrick. If she doesn’t pay the amount then Patrick can sue her irrespective of the fact that he is the third party.

  • Family Arrangements or marriage expenses: 

The family arrangements or marriage settlements are mentioned in the Specific Relief Act,1963. If a contract is made according to the family arrangements or marriage settlements to provide benefit to the third party or stranger to the contract then the third party can sue for the benefits of the contract. (Sundara Raja v Lakshmiammal 1914)

For instance, Ankita belongs to a joint family, and her family made some arrangements to pay the expenses for her marriage. However, the family parted ways due to which the provision for marriage expenses of Ankita was not fulfilled. Later, Ankita sued for her benefits even if she is not part of the contract. 

The need for reform in privity rule of Contract Law 

History of reform in privity rule

In 1937, the British Courts observed the need for reforms in the doctrine of privity rule and proposed the Sixth Interim Report that states the benefits for the third parties in a contract. The cases like Beswick v Beswick (1968), increased the significance of the call for reform where Lord Reid referred to the 1937 report and stated about the necessity to deal with the matters related to the privity rule. Similarly, in cases such as White v Jones (1995) and Woodar investment development ltd v Wimpey constructions (UK) Ltd (1980), the Judges criticized the inflexible nature of contract law while dealing with third party rights. 

In 1996, the Law Commission of the UK agreed to carry out the reforms in the doctrine of privity without making any difference in the doctrine of consideration. Later, the law commission concluded that:

  1. The doctrine of privity need to get a legislative reform
  2. The main aim of the legislative reform is that the third party should be able to enforce according to the terms and conditions of the contract. 
  3. The other parties of the contract must agree that the third party should receive the benefits from the contract and intend to form legal obligations upon the third party.

Contract (Rights of Third Parties) Act, 1999

Introduction

After a brief discussion, the English Parliament enacted the Contract (Rights of third parties) Act,1999 to change the old rule of “only the party of a contract could enforce the contract terms”. The Act made the changes by making the third parties eligible to enforce the terms according to their wish. 

Applicability

It applies to almost all the contracts except some contracts such as carriage of goods contracts, negotiable instruments, and articles of association of a company. Further, the Act states that the third parties cannot enforce terms in employee contracts against the employer of a company. 

When the third party rights arise

  • If the contract expressly provides the right to a third party
  • If the contract confers about providing the benefit to a third party.

Limitations of the Contract (Right of third parties) Act, 1999

  • The Act does not provide any exception that the third parties should not be the subject of a burden in the contract to which they are not the original party.
  • The provision of enforceability in Section 1 of the Act must be satisfied for the third parties to enforce their rights. 
  • According to the Act, the parties of a contract can draft an “opt-out” clause that states about denial of the rights of third parties but the provision does not provide any right to the third parties to seek remedies.
  • The Act doesn’t say anything about the rights of the promisee to obtain remedies for the benefits of third parties.

Why is reform needed in the privity rule of Contract Law

The privity rule of contract law raises a lot of issues and demands for reform. First of all, the rule that denies the rights of a third party to sue and that only the other party is eligible for recovering their losses would lead to injustice towards the third party. Also, the rule opens a room of uncertainties or complexities due to a large number of common law exceptions and statutory exceptions. Hence, the need for reform is high.

The privity rule of contract law has created several problems that can be addressed through the help of some contexts, such as:

Construction contract

In the context of constructions, the case D & F Estates Ltd v Church Commissioners for England (1989) held that the claim of the purchaser cannot be accepted and the builder was not liable in tort concerning the quality of the building. Due to such cases, the third party in construction cases such as tenants, purchasers, and property financiers seek protection. 

For instance, a property developer enters into a contract with the contractor. The property developer undertakes a warranty from the contractor for the benefit of the purchaser (third party), that in the case of any defects the contractor will provide the remedies to the purchaser. However, if the contractor doesn’t provide the remedies then the third party cannot sue the contractor due to the privity rule.

Insurance contract

In this case, if the employer receives insurance from the insurer for the sake of his employee then in case of breach of contract by the insurer, the employee cannot file a suit against the insurer because he is not part of the contract. 

Contract to pay the third parties

The “A and B came into a contract to pay money to C” is what we commonly see in the topic of privity rule. Similarly, in the famous case Beswick v. Beswick (1968) where the nephew promised his uncle to pay a certain amount of money every week to his aunt because of which the uncle sold the business to his nephew. However, after the death of his uncle, the nephew stopped paying his aunt as a result of which the aunt filed a suit against the nephew and claimed damages. However, the court refused to allow the aunt to claim for damages as she was not part of the contract. Therefore, it shows that the rule of privity can lead to injustice towards the third parties.

What are the possible reforms in the privity rule of Contract Law

The possible reforms in the privity rule have been mentioned in the 13th report of the Law Reform Commission of India where they recommended the following reforms:

  • The original parties of the contract can identify the name of the third party in the contract before the enforcement of the contract. 
  • The third-party must be allowed to enforce a term in the contract irrespective of the presence of consideration.
  • The original parties should not be allowed to cancel the contract on their own, affecting the rights of third parties. They must take the consent of the third party before canceling the contract. 
  • If a contract benefits more than one third-party then each party must approve the contract to avoid any sort of confusion.
  • There should be a provision made in the legislation when the original parties of the contract mention the enforcement of rights of the third party. This term would help the contracting parties to protect the rights of the third parties.
  • The legislation should also be applicable in the case where the third party is a customer. So that the third party can sue the promisor.
  • The legislation should not apply to Section 25 of the Companies Act 1956.
  • The legislation should not provide any rights to the third parties to sue their employees.

Amendment for benefits of the third parties

The rigorous use of the privity rule has undoubtedly caused injustice to the third parties. The proposed legislation and reforms suggested by the 13th report of the Law  Commission are truly an escape from injustice for the third parties. Therefore, the Law Commission of India recommended that a new provision of Section 37A which is similar to the Contracts (Rights of Third Parties) Act, 1999 should be enacted in the Contract Act that states the benefits to third parties. The following benefits are:

  1. If a contract directly mentions the third party then it must be enforceable in the name of the third party and allow the third party for defenses that would have been valid between the original parties.
  2. If a contract expresses regarding the benefits upon a third party then the contracting parties cannot terminate it, form a new contract or alter the terms of the contract as it can affect the rights of the third parties. 

Conclusion

Undoubtedly, the aim behind the introduction of these rules is to protect the third party from lawsuits but the rule lacks behind while protecting the rights of the third parties. Also, the number of exceptions creates a lot of uncertainties and complexities in the implication, and the provisions for the doctrine of privity rule don’t confer anything about the benefits for the third parties which shows the significance of reform in the doctrine of privity rule.

References

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