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Privity of Contract

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Privity of contract refers to the key legal concept of establishing a direct and exclusive association between individuals who have executed a lawful contract. It implies that only the individuals involved in the contractual arrangement have enforceable privileges and responsibilities under that specific contract. In simpler words, the privity of a contract dictates that people or businesses who are not parties to a contract cannot execute its provisions or be held responsible for its performance. This blog post will discuss the privity of contract, its exceptions, its importance, and more.

Importance of the Privity of Contract

While the privity of contract rule was strictly applied in the past, modern contract law has seen vital developments and exceptions to this principle. Below are several reasons why privity of contract remains an essential aspect of contract law:

• Clarity and Certainty: By limiting the enforceability of a contract to only the involved parties, the privity rule brings clarity and certainty to contractual relationships. It helps prevent confusion and disputes arising if unrelated third parties are allowed to intervene.
• Freedom of Contract: Privity of contract maintains the freedom of contracting parties to decide with whom they wish to be bound by the contract terms. It ensures that parties can negotiate and agree on provisions without fear of unintended obligations to third parties.
• Confidentiality and Privacy: Contractual agreements often contain sensitive and confidential information. The privity rule protects this information from being disclosed to unrelated parties, thereby maintaining the privacy of the contractual relationship.

Exceptions to the Rule of the Privity of Contract

The privity of contract rule is a fundamental regulation of contract law that typically defines that only individuals involved in a contract can execute its provisions or be held accountable for any violations. It shows that people or businesses not directly involved in a contract cannot file a lawsuit based on its provisions. While the privity of contract regulation has been an essential component of contract law, it is not without exceptions. These exceptions diversify the scope of parties who can execute a contract or be subject to its provisions, ensuring fairness and efficiency in contract-related issues. Below are some of the key exceptions to the privity of contract rule.

• Assignment of Rights: Another exception to the privity of contract regulation occurs when one of the parties to the contract transfers its privileges and responsibilities to a third party. This allocation of rights is known as an assignment. When a suitable assignment happens, the third party steps into the shoes of the existing individual and receives the right to execute the contract against the other contracting individual. The assignee effectively gets involved in the contract, even though they were not part of the initial contract.
• Novation: Novation is a legal concept that authorizes substituting one individual associated with the contract with a new person, with all entities' consent. Unlike an assignment, which shares only the privileges and responsibilities of one party, novation substitutes an existing individual with a new one entirely. In addition, the new person must adhere to the original contract terms and assume all rights and obligations, effectively becoming a party to the contract without any privity with the other original contracting individual.
• Tortious Liability: The privity of contract regulation can also be overlooked in specific cases concerning tort claims. While contract law predominantly deals with violations of contractual obligations between parties, tort law handles civil wrongs and breaches that cause damage to others. In some cases, an individual not involved in a contractual association might face damages due to an infringement of that arrangement. In this situation, the person facing damages may be entitled to register a lawsuit in tort against the individual who breached the contract, even if there is no direct contractual association between them.
• Statutory Exceptions: In some jurisdictions, laws have been legislated to create exceptions to the privity of contract regulation. These regulations usually give specific privileges to third parties not involved in the agreement, allowing them to implement certain conditions or seek remedies in particular circumstances. These statutory exceptions can differ greatly from one jurisdiction to another and may only apply to specific agreements or individuals.

Jeremiah C.

Challenges of the Privity of Contract

The privity of contract rule can lead to some challenges in certain situations that are as follows:

• Evolving Business Environment: The traditional privity rule was developed in simpler times when business relationships were more straightforward. However, today's interconnected global economy often involves complex and interdependent networks of relationships, necessitating a more flexible approach to contract enforcement.
• Consumer Protection: In consumer transactions, privity of contract can present challenges for consumers seeking legal remedies against manufacturers or suppliers for defective products or services. Consumer protection laws have attempted to address this issue, but gaps may still exist in certain jurisdictions.
• Assignments and Novations: Privity of contract can complicate assignments and novations, where one party transfers its rights or obligations to another party. The legal implications of these transfers may vary depending on the jurisdiction and the specific contract terms.
• International Transactions: In international business transactions , the lack of uniformity in privity rules across different jurisdictions can create complexities and uncertainties in contract enforcement, leading to potential disputes and conflicts of laws.

Approaches to Overcome Challenges in the Privity of Contract

Below are the possible solutions to the challenges faced by the privity of contract.

• Expanding Third-Party Rights: Some legal systems have introduced exceptions to the privity of contract, allowing certain third parties to enforce contract terms directly. These exceptions are often limited to specific situations, such as insurance contracts or beneficiary rights in trusts .
• Multi-Party Agreements: In complex transactions, parties can consider drafting multi-party agreements that explicitly define the rights and responsibilities of all relevant stakeholders. This approach can provide clarity and reduce potential conflicts arising from privity limitations.
• Adoption of Model Regulations: Globally acknowledged model regulations, such as the United Nations Convention on Contracts for the International Sale of Goods (CISG), offers a framework for contract enactment that assesses the challenges of privity in cross-border deals.

Key Terms for the Privity of Contract

• Incidental Beneficiary: It refers to a party who unintentionally gains some benefit from a contract but lacks the legal right to enforce its terms.
• Contractual Intention: Contractual intention refers to the requirement that for privity to exist, the parties must intend to create legal relations and be bound by the contract.
• Vicarious Performance: When one party fulfills contractual obligations on behalf of another, but privity is still maintained between the contracting parties.
• Collateral Contract: A separate contract between one of the original contracting parties and a third party, which can create privity between them.
• Quasi-Contract: A legal remedy in certain situations where a court imposes contractual obligations on parties to prevent unjust enrichment, even without a formal contract.

Final Thoughts on the Privity of Contract

A privity of contract is a fundamental doctrine in contract law that oversees the rights and responsibilities of parties in a contractual association. While it provides transparency, certainty, and privacy protection in contractual dealings, it also comes with exceptions to accommodate the legal interests of third parties. As the landscape of enterprise transactions continues to grow, the privity of contract rule may undergo further improvements to strike a balance between safeguarding the interests of the parties directly involved in an agreement and ensuring fairness for other affected parties.

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PRIVITY OF CONTRACT

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Pascal Pichonnaz

Nurgali Sakhov

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A contract is a legally binding exchange of promises or agreement between parties that the law will enforce. Contract law is based on the Latin phrase pacta sunt servanda (literally, promises must be kept) [1]. Breach of a contract is recognised by the law and remedies can be provided. Almost everyone makes contracts everyday. Sometimes written contracts are required, e.g., when buying a house [2]. However the vast majority of contracts can be and are made orally, like buying a law text book, or a coffee at a shop. Contract law can be classified, as is habitual in civil law systems, as part of a general law of obligations (along with tort, unjust enrichment or restitution).

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This Article describes a jurisprudential puzzle—what I call the puzzle of the beneficiary’s bargain—and contends that adequately resolving this puzzle will require significant revisions to some of the ways that we think about contract law. The puzzle arises when one party enters into two contracts requiring the same performance, and the promisee of the second contract is the third-party beneficiary of the first. For example, a taxi driver contracts with a woman to transport her parents from the airport next week, and then the driver separately enters a contract with the parents to transport them when the time comes. Is the second contract valid and enforceable, or does it fail for lack of consideration? This specific question—on which courts have split—implicates several important contract law doctrines. Moreover, it highlights a deep tension in our modern understanding of contractual obligation. This Article argues that adequately resolving the puzzle necessitates a general reconsideration of the relationship between rights and liability in contract law. Surprisingly, the best solution requires abandoning the foundational understanding that contract liability arises out of breach of a promisee’s right to performance. The relatively specific puzzle thus offers a lens through which to examine general concepts of modern contract law.

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Privity of contract

• Date: May 11, 2022
• By: Spencer Wright
• Estimated reading time: 5 min

Privity of contract is a legal concept which states that only parties to a contract can enforce or be bound by its terms.

This means that although performance of a contract may result in a benefit or burden to a third party to the contract, the third party cannot enforce the contract nor be subject to liabilities imposed by it.

Table of Contents

About the author.

Spencer Wright

Spencer Wright is the litigation director at Gibbs Wright Litigation Lawyers. With a strong background in business and a commanding understanding of the law, Spencer offers strategic and creative solutions to a range of commercial litigation matters throughout Queensland.

Application of privity of contract

The doctrine of privity of contract was first explored in Australia in Coulls v Bagot’s Executor and Trustee Co Ltd (1967) 119 CLR 460.

Mr Coulls granted a company the right to quarry stone from his property in exchange for payment of royalties. The agreement was headed “Agreement between Arthur Leopold Coulls and O’Neil Construction Proprietary Limited” but was signed by Mr Coulls and his wife Doris (as well as a company representative) and provided that the company pay the royalties to them as “joint tenants”.

When Mr Coulls died, his executor sought direction from the court about whether the royalties had to be paid to Mrs Coulls.

The High Court held that Mrs Coulls was not entitled to receive royalties because she was a third party and the promise was not made expressly to her.

Insurance exception

A third party’s ability to enforce a contract was considered in Trident General Insurance Co Ltd v McNiece Bros Pty Ltd (1988) 165 CLR 107.

McNiece was the principal contractor for construction work at Blue Circle cement plant. Under Blue Circle’s insurance with Trident, the insurer agreed to indemnify “the assured” against liability for injury to non-employees.

The contract defined “the assured” as Blue Circle, all related companies, and all contractors and suppliers.

A worker who was contracted to McNiece by another company was injured on site and sued McNiece for damages.

McNiece sought indemnity from Trident under its insurance contract with Blue Circle. Trident argued McNeice had no right to sue because he was not a party to the contract.

The High Court ruled that although McNiece was a third party, the contract intended to cover any contractor working for Blue Circle.

This ruling effectively created an exception to the doctrine of privity for insurance contracts.

Mason CJ and Wilson J stated the privity rule had been eroded by statute and had the potential to cause injustice, saying: “…we consider it is the responsibility of this court to reconsider in appropriate cases common law rules which operate unsatisfactorily and unjustly.” [1]

They said in the case of insurance contracts, the privity rule would cause injustice because of the likelihood of reliance on such contracts by third parties, who organise their actions in the knowledge that another person has insured against a particular risk. [2]

Statutory exception

The Insurance Contracts Act 1984 (Cth) was passed after the Trident case, and allows a person covered by a general insurance policy to make a claim from the insurer even though the person is not a party to the contract.

There are other statutory exceptions to the privity rule, including section 55(1) of the Property Law Act 1974 (Qld), which largely abolished the privity rule:

“A promisor who, for a valuable consideration moving from the promisee, promises to do or to refrain from doing an act or acts for the beneficiary shall, upon acceptance by the beneficiary, be subject to a duty enforceable by the beneficiary to perform that promise.”

The privity rule does not apply when a party entered a contract via an agent (a person who holds the power to enter a contract on behalf of another person).

It must be shown that the party expressly or impliedly consented to the agent acting on their behalf.

Assignment and novation

The privity rule does not apply when a party transfers contractual rights and/or obligations to a third party.

In some circumstances, a party may transfer their contractual rights to a third party, via “assignment”.

Whether a right may be assigned depends on the construction of the contract. Contractual obligations cannot be transferred but a third party may be substituted for an original contracting party, via “novation”.

Novation means privity of contract is then established between the original party and the substituted party.

Circumventing the privity rule

There are several ways the privity rule may be circumvented, including when:

• rights are held on trust for a third party; or
• assert an estoppel against a party (when the third party has, to their detriment, relied on a promise made by a contracted party);
• claim damages in tort (when a contracted party has a duty to take care to avoid harm to a third party); and/or
• claim damages for misleading and deceptive conduct (when a contracted party engages in misleading and deceptive conduct and a third party suffers loss as a result).

Remedies to privity of contract

To mitigate the negative effects of privity of contract, the courts have ordered both equitable and discretionary remedies. These include damages, and when damages are inadequate, specific performance.

How Gibbs Wright Litigation Lawyers can help

The doctrine of privity of contract is technical and highly complex area of law. You can discuss your contract privity matters with one of our contract lawyers today in a no-obligation, confidential consultation.

• Trident General Insurance Co Ltd v McNiece Bros Pty Ltd (1988) 165 CLR 107, 123. ↩︎
• Trident General Insurance Co Ltd v McNiece Bros Pty Ltd (1988) 165 CLR 107, 123-4. ↩︎

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Privity of contract, harvard law review - united states, doi 10.2307/1321337.

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