Contract: Privity and Third-Parties

Privity of Contract & Third Party Rights

Privity of Contract

The General Rule

A non-party to the contract cannot sue to enforce rights under that contract or claim damages for breach: Tweddle v Atkinson (1861) 1 B&S 393; Dunlop Pneumatic Tyre Co Ltd v Selfridge Ltd [1915] AC 847. This is known as the privity rule.

Privity of contract also prevents a third-party from relying on a defence in a contract he is not a party to: Scruttons Ltd v Midland Silicones Ltd [1962] AC 446.


The Contract (Rights of Third Parties) Act 1999

Third Party Enforcement Right (s 1)

The main exception to the privity rule is found under section 1(1) of the Contract (Rights of Third Parties) Act 1999. It applies to most contracts, save for a limited list of exceptions. This states that a third-party is entitled to enforce a contract term (or rely on an exclusion/limitation clause – s 1(6)) if:

  • The contract states that he can (s 1(1)(a)); or
  • The term purports to confer a benefit on him (s 1(1)(b)). This is so unless on ‘proper construction of the contract it appears that the parties did not intend the term to be enforceable by the third party.’ (s 1(2)).

For this exception to apply, the third party must be ‘expressly identified in the contract by name, as a member of a class or as answering a particular description but need not be in existence when the contract is entered into’ (s 1(3)).

The third party’s ability to enforce a contract term is contingent on any other relevant terms of the contract (s 1(4)). For example, if the term is conditional on the performance of another term, the third party cannot enforce it unless the other term has been performed.

Variation/Rescission (s 2)

If a third party has gained a right to enforce the contract under s 1, the parties’ ability to agree to vary or rescind the contract might be limited (s 2(1)). The parties lose the right to vary or rescind the contract without the third party’s consent if:

  • The third party ‘has communicated his assent to the term to the promisor’ by words or conduct; ss 2(1)(a), 2(2)(a)
  • The ‘promisor is aware that the third party has relied on the term’; (s 2(1)(b) or
  • The ‘promisor can reasonably be expected to have foreseen that the third party would rely on the term and the third party has in fact relied on it’: s 2(1)(c).

The postal rule does not apply to communications of assent under this provision. This means that for a communication of assent to be valid, it must actually be received by the promisor: s 2(2)(b).

The right to vary or rescind the contract will not be lost if there is an express contract term which allows non-consensual variation/rescission: s 2(3). The contract may also sets out different circumstances in which the third party’s consent is needed.

Consent is also unnecessary if the third party is mentally incapable or their whereabouts ‘cannot be reasonably ascertained’: s 2(4).

Defences & Set-Off

In defence to a claim by a third party under the Contract (Rights of Third Parties) Act 1999, the promisor may rely on any defence or set-off:

  • Which they would have against the promisee and which ‘arises from or in connection with the contract and is relevant to the term’: s 3(2). This includes exclusion and limitation clauses: s 3(6);
  • Which the contract expressly states is available to him against the third party: s 3(3); and
  • Which they would have had directly against the third party if the third party were a contract party: s 3(4).

The parties may provide by express terms that any particular defence or set-off will be unavailable to the promisor against the third party: s 3(5).

Impact on the Promisee’s Rights

Any rights granted to the third party by section 1 do not affect the promisee’s own rights to enforce the contract: s 4. This means that the promisee can sue for specific performance to force the promisor to confer the benefit on the third party.

The promisee can also sue for damages, but usually only for their own losses – they cannot sue for losses accruing only to the third party: Woodar Investment Development Ltd v Wimpey Construction UK Ltd [1980] 1 WLR 277.

There is an exception to the rule that the promisee cannot sue for the third party’s losses where the contract was entered into for the benefit of the third party, the loss was foreseeable and the third party has no right to recover substantial damages themselves: Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd [1993] UKHL 4; McAlpine Construction Ltd v Panatown Ltd [2001] 1 AC 518. Given that these cases preceded the Contract (Rights of Third Parties) Act 1999, it is likely to be a rare case where the promisee can recover for the third party’s losses. This is because the third party will normally have the right to sue personally, as explained above.

The rule against double recovery applies, meaning that the promisor cannot be sued twice for the same loss. As a result, the court has the power to reduce any award to the third party to take into account sums paid to the promisee with respect to the third party’s loss or ‘the expense to the promisee of making good to the third party the default of the promisor’: s 5. The reduction is the amount the court thinks is appropriate.


Other Exceptions to Privity of Contract

Collateral Contracts

If the third party has a separate contract with one of the parties obliging them to make sure the original contract is enforced to their benefit, then they can indirectly enforce the original contract by suing for breach of this collateral contract: Shanklin Pier Ltd v Detel Products Ltd [1951] 2 KB 854.

However, in many cases it will be difficult to show that a collateral contract exists. This is because usually because the third party has not provided any consideration.

Trust of a Promise

The privity doctrine does not apply to property rights. This means that if a third party has property rights in the contract’s subject matter, they can sue for any interference with their rights.

Prior to the enactment of the Contract (Rights of Third Parties) Act 1999, the courts tried to get around the privity rule using the notion of a ‘trust of a promise’: Les Affréteurs Réunis Société Anonyme v Leopold Walford (London) [1919] AC 801. A trust is a proprietary arrangement in which one person (‘the trustee’) holds the legal title to a piece of property for the benefit of another person (‘the beneficiary’). The beneficiary holds part or all of the equitable title to the property. The beneficiary can sue the trustee if they breach their obligations.

The problem is that not everything is capable of being ‘property’ subject to a trust. It was historically controversial whether a contractual obligation could be ‘property’. In addition, the creation of a trust now has strict requirements. In particular, the parties must actually intend to create a trust in the third party’s favour. This is likely to be rare.

As a result, in modern times it will be a very rare and unusual case where a ‘trust of a promise’ is relevant: Re Schebsman [1944] Ch 83; Rolls Royce Power Engineering plc v Ricardo Consulting Engineers Ltd [2003] EWHC 2871.

Assignment

A contract party is normally free to assign their contract rights and obligations under the contract. If this is done, the third party takes the original party’s place in the contract. They can then enforce those rights and/or are subject to those obligations.

Agency

Agency is a legal device which allows a person (‘the agent’) to contract on behalf of another (‘the principal’). If the person negotiating the contract is an agent, in reality they will never become a party to the contract. The real second party is the principal. However, to be an agent, the negotiator must have the principal’s authority to enter into the transaction.


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Contract Rights of Third Parties Quiz

Test yourself on the principles governing when a third party can sue under a contract they are not privy to.

1 / 9

If a third party has gained the right to rely on a contract's terms under the Contract (Rights of Third Parties) Act 1999, when do the original parties require their consent to vary or terminate the contract?

2 / 9

In what circumstances will the original parties no longer need to acquire the consent of the third party who has a right to sue under the Contract (Rights of Third Parties) Act 1999 to vary or terminate the contract?

3 / 9

At common law, can a third-party who did not provide consideration for a contract rely on the terms of that contract?

4 / 9

Kefka and Lenne enter into a business contract for the benefit of Celes, expressly granting her rights to sue for breach under the Contract (Rights of Third Parties) Act 1999. The contract also provides that both Kefka and Lenne can rely on a particular exclusion clause if they are sued for negligence by Celes. Lenne breaches the contract in a way which triggers this exclusion clause. Can Celes succeed in a claim against Lenne?

 

5 / 9

Where a third party has a claim under the Contract (Rights of Third Parties) Act 1999, can a party to the contract sue for damages incurred by the third party?

6 / 9

The postal rule applies to any communications of assent to a contract by third parties under the Contract (Rights of Third Parties) Act 1999. True or false?

 

7 / 9

Where a claim is made by a third party under the Contract (Rights of Third Parties) Act 1999, which three defences can the defendant rely on?

8 / 9

Under the Contract (Rights of Third Parties) Act 1999, in what two scenarios can a third-party to a contract enforce the terms of that contract?

9 / 9

For the purposes of the Contract (Rights of Third Parties) Act 1999, when is a contract term 'for the benefit' of a third party? (Two answers)

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