Privity of Contract and Third Party Beneficiaries 2007


I. The Doctrine of Privity of Contract

(A) The Doctrine and Third Party Beneficiaries

[7] The common law doctrine of privity means that a “contract cannot, generally, confer rights or impose obligations arising under it on any person except the parties to it.”[2] The second limb of this doctrine (under which a contract cannot impose liabilities on anyone except a party to it) is generally regarded as sensible and just as it would not be fair to subject people to contractual obligations without their consent. But the first limb (under which a contract cannot confer rights on anyone except a party to it) has been the subject of much criticism.[3] This report will focus only on the first limb of the doctrine of privity.

[8] It wasn’t until the mid-19th century, that a hard and fast rule developed that a third party could not enforce a contract to which he was not a party.[4] Prior to this, there were authorities supporting both this view and the contrary view.[5] In Tweddle v. Atkinson,[6] the Court acknowledged the existence of contrary authorities, but held that the doctrine of privity of contract meant that third party beneficiary could not enforce against the promisor the promise that the promisor had made to the promisee. The rule was affirmed in Dunlop Pneumatic Tyre Co. Ltd. v. Selfridge & Co. Ltd where it was accepted that it was a fundamental principle of law that only a party to a contract who had provided consideration could sue on it.[7] The rule has subsequently been reaffirmed in numerous cases, including Beswick v. Beswick.[8] In Beswick, a coal merchant agreed to transfer a business to his nephew in exchange for a salary and the payment of a weekly annuity to his widow on his death. On Beswick’s death, however, the nephew refused to pay the annuity. The widow brought an action in her personal capacity as the beneficiary of the contract and in her capacity as administratrix of the estate. The House of Lords held that she was not entitled to enforce the contract in her personal capacity, but as administratrix of the estate (as her deceased husband’s representative) she was able to obtain specific performance.

(B) Examples of the Problems Created by the Doctrine of Privity of Contract

[9] Three scenarios help to illustrate the problems created by the doctrine of privity of contract with respect to third party beneficiaries.[9] The first, parallels the situation in Beswick v. Beswick, supra. Where A and B enter into an agreement under which A agrees to pay a sum of money to C. Both parties intend that C should take the benefit of A’s promise, however, if A defaults, C cannot sue A because of the doctrine of privity. B has to attempt to enforce the contract for the benefit of C, even though B may not have suffered any loss.

[10] The second takes place in the construction context, where A (property developer

enters into a building contract with B (contractor). A obtains warranties from B for the benefit of C (purchasers) that any defects will be remedied within a stated period of time. If C subsequently discover a defect in their building they have no recourse against B since the purchasers are not privy to the building contract. This, despite the fact that A obtained B’s warranties for the benefit of C. (In practice a developer may withhold a portion of its payment to the contractor to ensure that B fulfils its promise to A for the benefit of C).

[11] Finally, in the insurance context where A (the employer) obtains insurance from B (insurer) for the benefit of A and C (the employee), C may have difficulty in obtaining indemnity from B, as C is not a party to the insurance contract even though the parties intend to benefit C.

(C) Arguments For and Against the Doctrine of Privity of Contract

[12] The arguments for and against the doctrine of privity of contract are well-rehearsed. They have been discussed in standard texts on contract law and nearly every law reform commission report to address the issue of privity of contract and third party beneficiaries. What follows is a summary of those arguments. For every argument against reforming the privity doctrine, a counter-argument can be made. Further, there are a number of additional arguments that can be made in favour of reforming the doctrine. As Iacobucci J. found in London Drugs, the arguments in favour of reform of the doctrine of privity are persuasive.[10]

(i) Arguments Against Reform of the Privity Doctrine

A Third Party should not be able to sue in the absence of consideration[11]

[13] Those who are in favour of the status quo point to the fact that a stranger to a contract cannot take advantage of its terms because he or she has not provided consideration.[12]

[14] The counterargument recognizes that the doctrine of privity and that of consideration are conceptually distinct. The former determines the question of who may enforce a contract, while the latter determines which promise may be enforced. There is a valid contract if consideration has been paid, albeit by the promisee rather than the third party. The fact that there has been consideration means that the third party can potentially acquire rights under the contract.[13]

A third party should not be able to obtain contractual rights in the absence of consent

[15] Some assert that a third party should not obtain any contractual rights as they have not consented to an element of the contract either by making an offer or acceptance.[14]

[16] The counterargument is that the element of consent concerns protection of personal autonomy. A third party’s personal autonomy is not undermined where the issue concerns the giving of benefits, rather than the imposing of burdens on him or her.[15] Further, when parties have agreed to benefit a third party, permitting a third party to enforce the contract, gives effect to their intention and promotes their autonomy.

Undesirable for a Promisor to be subject to double recovery or a flood of litigation brought about by third party beneficiaries

[17] A consequence of allowing a promisee and a third party to enforce a contract is that the promisor may face double liability for the same loss. That is, there is a concern that separate suits would be brought against the promisor by the promisee and the third party.[16]

[18] In answer to this argument is that fact one promise can only give rise to a single cause of action. Once extinguished, the promisor will not be further held liable.[17] Further, this concern can be addressed through procedural provisions. For example, Rule 38 of the Alberta Rules of Court provides for the joinder of necessary parties and Rule 229 provides for the consolidation of actions.[18] Other jurisdictions have addressed this issue directly through detailed legislative provisions concerning third party beneficiaries.[19]

[19] Similarly, circumscribing the definition of who is a third party beneficiary would limit the range of potential plaintiffs and reduce the possibility of a flood of litigation.[20]

Unjust that a third party beneficiary can sue on the contract but cannot be sued

[20] Another argument in favour of the status quo is that it would be unjust for a third party to be able to sue on a contract when they could not be sued.[21]

[21] The counter-argument is that unilateral contracts are enforceable under contract law. In addition, the promisor, although unable to take reciprocal action against the third party, can take action against the promisee. In addition, by intending to benefit a third party, the parties to a contract would be alerted to the fact that identifying a third party beneficiary would mean that the third party cannot be sued, but could sue on the contract.[22]

The Potential for Infringement of the contracting parties ability to rescind or vary the contract

[22] The argument is that if third parties could enforce contracts made for their benefit, the rights of contracting parties to vary or rescind such contracts would be unduly hampered.

[23] This issue has been addressed differently in different jurisdictions. Many have sought to strike a balance between the contracting parties’ right to rescind and the interests of the third party in maintaining enforceable rights. The Supreme Court of Canada held in Fraser River that variance of a contract was possible up until the point “the contract crystallized into an actual benefit” for the third party.[23]

[24] In the UK, article 2 of the Contracts (Right of Third Parties) Act 1999 provides that the contracting parties may vary or rescind the contract until the third party has communicated his assent to the promise or the promisor is aware that the third party has relied on it.

(ii) Arguments in Favour of Reform of the Privity Doctrine

The Law Concerning Privity of Contract is Unduly Complex, Uncertain and Artificial

[25] As will be discussed further, a key criticism of the doctrine of privity of contract is that the numerous exceptions that have been created both by both statutes and the courts to mitigate the harshness of the doctrine have resulted in law which is overly complex.[24] It is not always clear whether a third party in a particular case can enforce a right under a contract or not. Further, it is difficult, if not impossible, to reconcile the various exceptions that have developed.[25]

The Doctrine Frustrates the Enforcement of Sensible Commercial and Personal Arrangements Made on a Daily Basis

[26] Many criticize the doctrine of privity of contract for its failure to give effect to the expressed intention of the parties to benefit a third party. In such circumstances, it is asserted that the failure of the law to afford a remedy to third parties frustrates the parties’ intentions.[26]

The Person who has Suffered the Loss Cannot Sue, while the person who has suffered no loss can sue

[27] As a result of the doctrine of privity, the person who suffered the loss (i.e. the third party) cannot sue, whereas the person who has suffered no loss (i.e. the promisee) can sue, but may only be able to obtain nominal damages.[27] For example, where the breach of a contract consists of a failure to perform in favour of a third party, unless the promisee also suffers some loss as a result of the breach, the damages awarded would generally only be nominal. Where a contract is made for the benefit of a third party, the promisee has normally no claim to the money or other performance properly due to the third party. In some cases, the courts have awarded the promisee with specific performance,[28] but such a remedy will not be available in every case. Further, even in those cases where substantial damages or specific performance may be available, the promisee, may not be able to, or wish to, sue the promisor.[29]

An Injustice to a Third Party Who has Relied on the Promise

[28] A third party may act in reliance on a promise made in a contract, particularly where it is clearly contemplated in the contract that the third party will acquire enforceable rights. Under the doctrine of privity, the third party would have no recourse, where the promise is not fulfilled.[30]

Widespread Criticism and the Reform of the Doctrine in Other Jurisdictions

[29] As will be discussed, the doctrine of privity of contract has been the subject of widespread academic and judicial criticism in both Canada and other common law jurisdictions.

[30] The Supreme Court of Canada, in London Drugs, acknowledged the academic and judicial criticisms of the restrictions imposed by the doctrine of privity. The Court, however, held that “major reforms to the rule denying third parties the right to enforce contractual provisions made for their benefit must come from the legislature.”[31] It introduced a “principled exception” to the doctrine, but stopped short of abolishing it.

[31] As well, several law reform commissions in Canada have criticized the doctrine and called for legislative reforms.[32] Their calls, however, have been largely unheeded by their respective provincial legislatures. New Brunswick is the only common law jurisdiction in Canada to have introduced a general legislative provision for the benefit of third party beneficiaries.

[32] In contrast, many other common law jurisdictions, including the U.S., the U.K., Australia (Western Australia and Queensland), New Zealand and Singapore have introduced legislation to abrogate or reform the doctrine. Further, law reform commissions in Hong Kong and Ireland have also recently recommended reforms in this area.

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