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PRIVITY OF CONTRACTS

Updated: Feb 20, 2022

Written by: Navya Mallela


INTRODUCTION:


Legal Definition and Analysis-


"The common law doctrine of privity of contract means that a contract cannot (as a general rule), confer rights or impose obligations arising under it on any person except the parties to it." The rule observed in common law is that the contract confers advantages and imposes obligations only between the contracting parties. As a result, a third party will be unable to obtain a right and will not be liable under the contract. Thus, the concept of privity of contract proposes and establishes itself as the most important rule in contractual relationships. The doctrine has long been ridiculed as artificial and opposing to the parties’ intention to benefit a third party.[1]As a result, courts have frequently used devices like agency or trust to enable a third party to enforce a benefit conferred on it.Legislation has also made incremental encroachments into the doctrine by providing for certain explicit exceptions.


THE PRIVITY OF CONTRACT UNDER INDIAN LAW


The term "contract" implies that it is a type of legal agreement between two people in which both parties are bound by the terms of the contract to which they are parties. But then a reasonable question comes to mind that what if the contract gives some value to the third party? Is it justified not to allow to third party to sue in case of denial of benefit conferred expressly under a contract? Is it reasonable to deny a third party the right to sue in case of denial of benefit conferred expressly under a contract? In light of this, it is crucial to address the Doctrine of Privity.

This doctrine ensures that a stranger to a contract can neither sue nor be sued by the parties to the contract. However, over time, it became clear that the doctrine is too rigid to deal with the current social context, because a contract impacts not only the persons involved, but also society as a whole. As a result, both the legislative and the courts developed and applied certain limitations (or exceptions) to the doctrine.

Privity of Contracts has three broad effects[2]:

1) A third party cannot receive a benefit if he is not party to that contract.

2) A third party cannot be liable under a contract if he is not a party to that contract.

3) A third party cannot enforce a contract if he is not a party to that contract.


Exceptions to Rule of Privity:


Trust:

Where a person acts as a trustee and enters into a contract the beneficiary of the contract can sue if the promise has not been performed. It was held in M. C. Chacko v. State Bank of Travancore[3] that a trust does not exist simply because a contracting party agrees to provide a benefit to a stranger. For this exemption to apply, it must be demonstrated that there was a purpose to engage into the contract as a trustee, as evidenced by the use of express words such as 'trust or trustee.'

The beneficiary has the right to sue if there is a duty in equity that amounts to a trust arising out of the contract.In Narayani Devi v Tagore Commercial Corporation Ltd[4],A bargain between the plaintiff's husband and the defendants, in which the plaintiff's husband's shares were sold to the defendant and the share money remained charge for payment of monthly sums both to the husband and after his lifetime to the wife, could be enforced by the wife because the obligation was in the nature of Trust.


Tort of Negligence:

The misdeed of carelessness can be seen as a special case for the outsider principle where the carelessness being referred to comprises the penetrate of a contract to which the offended party isn't a gathering.For example, in Donoghue v Stevenson,[5] it was established that if A provides items to B under a contract with B, A may owe a liability to C in the event of personal injury or property damage caused by absconds in those items. However, the right of not being damaged or having one's property harmed as a result of another's negligence exists independently of any contractual exertion by A.It is just in an exceptionally wide sense, hence, that standard instances of the misdeed of carelessness establish exemptions for the outsider principle.


Covenants concerning land:

The law allows some agreements (whether positive or negative) to run with land in order to benefit (or weigh) those other than the original contracting parties. The crucial contract may refer to either freehold or leasehold property. The Landlord and Tenant (Covenants) Act 1995 has recently strengthened the law on agreements relating to leasehold land.


Agency:

A contract made by an agent on behalf and for the benefit of his principle may, of course, be ratified and enforced by the principal. The promisee is regarded as the agent, though in form the principle.[6]


Collateral Contracts:

A collateral contract is one that is signed in addition to the main contract between two parties. It's one that involves both of them as well as a third party. This contract may allow the first contract to be enforced by a third party. Shanklin Pier Ltd. v. Detel Products Ltd[7]is a famous example of this, which occurred in England in 1953. Shanklin Pier (plaintiff) hired contractors to paint a pier. After that, the contractors asked Detel Products to provide them with paint. The plaintiffs were given this instruction based on the defendants' assertion that the paint would endure for seven years.When the paint work failed after three months, the plaintiff sued and was granted permission by the courts to proceed with the lawsuit against the defendant because, while the main contract was between the contractor and the defendant, there was a collateral contract between the plaintiff and the defendant that guaranteed seven years of protection.


ISSUES/CHALLENGES:


The doctrine of privity has come under serious attack for its refusal to recognise the right of a third party beneficiary to enforce contractual provisions made for his/her benefit. Law reforms, commentators and judges have pointed the gaps that sometimes exist between contract theory on the one hand, and commercial reality and justice on the other. The availability of the above-mentioned exceptions doesn't always correspond with their need.

It is no surprise that law reform bodies in various common law jurisdictions have critically examined the doctrine and recommended its reform.

The following are the issues of doctrine of privity:

1) It causes injustice to the third party who may have relied on the contract to regulate his affairs, and thus upsets the reasonable expectations of the third party to get benefit under contract.

2) It frustrates the intentions of parties to the contract when they intended to confer some benefit to the third party.

3) In case, third party suffers any damage then he has no option to claim compensation due to this privity rule.

4) Such a third party who suffers a loss cannot sue, however the promisee who has suffered no loss can.

5) This doctrine is undue complex and uncertain. During the passage of time, judiciary has made chinks into this doctrine to lessen its rigidity and it has been reduced into a vulnerable and weak principle.


CONTRACTS (RIGHT OF THIRD PARTIES) ACT 1999[8]


This is one of the major reforms that took shape when the rule of privity or, specifically, thirdparty-beneficiaries is considered.The Law Commission stated its perspective and unquestionably, the opinion of a significant body of judicial and intellectual options after the publication of its interim proposals (five years) was in favour of changing the privity theory in English Law (of contracts).In its fundamental recommendation, the Commission proposed that the third parties (subject to being explicitly identified) should have the right to enforce contractual provisions were either

The contracting parties aim to confer: such a right upon the third party aim to confera benefit on the third party”

On the condition that the contractual parties do not propose that the third-party beneficiary be denied the ability to enforce the contract in any way. As a result, the report signalled a considerable departure from the prevalent attitude of the privity doctrine, which was acknowledged by Lord Haldane LC as one of the fundamental foundations of English contract law in the earlier part of the century.

The Law Reform Commission (LRC) recognised and indicated in its concluding Report that a third party should be entitled to defend its contract rights in three scenarios, as considered and expected in a draught law named "Contract Law (Privity of Contract and Third-Party Rights) Bill, 2008." The LRC recognises that the extent to which and when a contract can be enforced by a third party must be limited.

The legal system of the United States recognises the ability of a third party to sue on a contract for its own benefit, and it was established by legislation in other Commonwealth nations. The Contract (Rights of Third Parties) Act of 1999 allows third parties to enforce contractual terms. The Indian Law Commission should establish a body to protect the rights of third parties.”


CONCLUSION:


This inquiry has formed the basis of the Doctrine of Privity with the help of crucial legislative acts and judgments in numerous nations, particularly those of England and India. The current unaffected needs of modern contract law, as well as the non-conventional approach of the judiciary proportionate to the Doctrine of Privity, have provided a path for redress to legitimately affected persons who may have been deprived of rights per se as a result of the strict elucidation of the Doctrine of Privity. If the breach is proven, a stranger might be awarded damages under the present legal system.The stranger, on the other hand, should be included until the “proposed beneficiary” has reciprocal responsibilities. Accordingly, it was desirable and rational that the person who is a stranger to a contract should be imposed with contractual liabilities and also get contractual benefits.The court later recognised several exceptions to the privity rule in order to aid such people. In reality, these exceptions make it tolerable, but the question remains whether it is better to further amend the concept or to completely eliminate it. With the doctrine's growing unpopularity, the courts developed a number of ways to get around it. These were often both complex and artificial, and they made use of agency and trust law, as well as other concepts and areas such as collateral contracts. However, the scope of these exclusions has been restricted.

[1]Avatar Singh, Law of Contract and Specific Relief Acts, Eastern Book Company, Lucknow (9th edition. Report 2006). [2] Ryan Murray, Contract Law the Fundamentals, Sweet & Maxwell, London (1stedn 2008), p. 75 [3] AIR 1970 SC 504 [4] AIR 1973 Cal 401 [5] [1911] 39 IA; 21 MLJ 1158 [6] Lilienthal, Jesse W. “Privity of Contract.” Harvard Law Review, Vol.1, no. 5, 1886, pp. 226-232. JSTOR, www.jstor.org/stable/1321337. [7][1951] 2 A11 ER 471 [8] Contracts (Rights of Third Parties) Act 1999

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