#7425 - The Doctrine Of Privity Of A Contract - Contract Law

Week 12

Chapter Eleven (principles book- not case book)- talks about the Doctrine of Privity of a contract.

Page 205-222

What is the doctrine of Privity of a contract?

• A party who is not a party to a contract cannot enforce the contract or incur any obligations under it.

• It has been criticised because it is subject to significant exceptions and can be circumvented in many ways and has been substantially abrogated in numerous jurisdictions.

What are the Benefits?

• It is used to prevent non-parties from enforcing contractual promises that benefit them.

• It does not prevent a contract from conferring a benefit to a third party. It simply prevents the third party from enforcing the contract.

• E.g. A and B have a contract. A has agreed to pay money to C in return for a service from B. If A does not pay C, C cannot sue. B can only sue on behalf of C. The remedies open to B may not be enough to ensure C gets paid.

• In Coulls v Bagot’s Executor and Trustee Co Ltd, for example Arthur Coulls granted a company the right to quarry stone from his property in return for royalties. Arthur and his wife signed the contract because they were joint tenants. After Arthur’s death the High Court found that the wife was not entitled to the royalties because she was a third party and the promise was not expressly made to her.

• In Trident v McNiece, McNiece was the principal contractor for a plant owned by Blue Circle. Blue Circle entered into a contract with Trident to get insurance against injury of non-employees. McNiece tried to get insurance when a non-employee was injured.

  • Mason CJ and Wilson J reasoned that the High Court had a responsibility to reform unjust rules, even if they are well entrenched. A third party should be able to enforce a contract in some cases.

  • Toohey J reasoned that the privity rule and consideration should not prevent enforcement of an insurance contract.

  • Gaudron J reasoned that not being able to prove consideration for a promise towards a third party is unfair because it unjustly enriched Trident and McNiece’s expense. The third party is entitled to enforce the obligation.

  • Deane J reasoned that McNeice should plead a trust to join Blue Circle as a party to the action to have the contract enforced.

  • Brennan and Dawson JJ dissented. They reasoned that there is no basis in policy to allow third parties to enforce contracts of insurance. There is no basis for overruling the doctrine of privity because it would create to many issues for the court to resolve.

  • Today there is the Insurance Contracts Act 1984 (Cth) to allow third parties to claim insurance.

What are the Burdens?

• The privity doctrine prevents a contract from imposing a legal burden on a third party.

• An exception to this is a restrictive covenant affecting land, which can bind subsequent owners of land. This called privity of estate rather than privity of contract. E.g. You can contract with a buyer of your land not to build on the land. You cannot impose positive covenants however like maintaining a house.

When is the privity rule not applied?

• There are two circumstance to show that a party not directly involved in the acts of contract formation is nevertheless a party to the contract.

  1. Where one of the parties who is involved acts as an agent for the non-involved party.

  • An agent is a person that has the power to enter into a contract on behalf of another person.

  • Agency relationships can be created expressly or by implication. That is by the words of the parties or implied from prior habits. A reasonable person should understand that the person has an authority to acts on the other person’s behalf.

  • It must be shown that the agent was acting on behalf of the principal and not solely for his or her own behalf unless the contract is subsequently ratified.

  • Ratification refers to the adoption or confirmation of a contract by a person who was not originally bound by it.

    2. Where one of the involved parties transfers contractual benefits to the non-involved party by way of an assignment or novation of the contract.

• Assignment is when a party contracts to transfer their rights under the contract to another person. E.g. A makes a contract with B. A assigns their rights under the contract to C. B is now obliged to perform for C. A can no longer enforce their rights.

• Novation is when if a contract is terminated, another party is substituted to perform in place of the other person. E.g. If A fails to meet their obligation to B, then C will fulfil the obligations.

What are the ways to circumvent the privity rule?

• There are several ways to avoid the privity rule if a person wants the benefit of a contract in which they are not named as a party.

• The promisor makes the contractual promise. The other party in the contract is the promisee. The third party is the beneficiary. These are the circumstances:

  1. The Promisee hold rights under the contract on trust for the beneficiary.

• The court may discern an intention on the part of B to hold trust for C the contractual right to enforce a promise.

• It creates an obligation for the promisee to enforce the promise on behalf of the beneficiary.

• The beneficiary can sue the promisor if the promisee is joined with them as a defendant.

• Courts will sometimes require a clear expression to create a trust and sometimes it is ok to imply it. This creates uncertainty around this way of addressing privity and consideration.

  1. The beneficiary may be entitled to assert an estoppel against the promisor.

• Equitable estoppel will prevent injustice arising from a party relying to his or her detriment on an expected benefit or entitlement arising from a contract to which they are not a party.

• The beneficiary must prove that they have relied upon the assumption to their detriment.

• It can also mean that a burden can be imposed on a party that is not a party to a contract.

• Estoppel by convention may be established to show who the parties in the contract are. It can be shown that the three parties shared the assumption that the beneficiary would receive a benefit under the contract.

  1. The beneficiary may be entitled to claim damages for misleading or deceptive conduct.

• The Trade Practices Act 1974 (Cth) prohibits misleading or deceptive conduct in trade or commerce.

• A person who suffers a loss as a result of such conduct is entitled to damages from the other person and other remedies.

• When there is a warranty it is not estoppel. It is inconsistent conduct and falsity of the warranty.

  1. The beneficiary may be entitled to claim damages in tort.

• If in a contract, there is a duty to take care to avoid harm to the beneficiary, then they can sue for negligence in tort and achieve an effective legal remedy which they would not have been able to do under contract law.

What are the remedies Available to the Promisee?

• Remedies the beneficiary can get by having the promisee to the contract sue on behalf of their rights.

• Damages:

  • The purpose is to compensate the plaintiff for a loss caused by breach of contract.

  • In England they allow a promisee to have damages in respect of the loss suffered by a third party.

• Specific performance:

  • Enforcement of a promise made for the benefit of the third party.

  • It will only be granted where damages are unsuitable.

What are the reasons for abolishing the privity doctrine?

• The English Law Commission wanted to reform the rule. Its arguments were:

  • The privity rule thwarts the intentions of contracting parties. It is a constraint on the freedom to contract.

  • It can cause injustice to the third party by denying them a benefit that they reasonably expect. Equitable estoppel can be used to prevent this.

  • It prevents a person who has suffered a loss through non-fulfilment of the promise from suing. It allows a person suffering no loss to sue.

  • The promisee’s willingness to sue decides if they can get damages or...