Common Law Contract Enforcement Requirements: Privity
At the heart of contract law is the concept of privity of contract. One of the fundamental tests of whether a contract binds a particular person is whether a relationship of privity exists. Without privity there is no contractually binding obligation. The issue affects contract more with respect to enforcement than formation; a contract may exist but the crucial questions often overlooked are “who may sue” on the contract and “who is liable” under the contract? The question of privity is also a matter of logic. In a free society there is no obligation to enter into a contract for the most part. Hence, it is only logical, that the common law limits the scope of contractual rights and obligations to a narrow class of persons. Hence there are two parts to the rule:
*Only parties to a contract can rely upon rights created by that contract
*No other person can incur liabilities under a contract to which he/she is not a party.
In a nutshell the doctrine of privity of contract is that simple.
The House of Lords decision in the 1968 case of Beswick v Beswick [1968] AC 58 is the authority which best explains privity and which rejects the alternative notion that any beneficiary to a contract can sue on it (the finding of Lord Denning in the Court of Appeal. In that case an ageing husband, Peter Beswick, assigned his business to his nephew. One term of the agreement was the payment of a weekly annuity to Mrs. Beswick after the death of Mr. Beswick. The nephew decided, upon Peter’s death, that he was not obliged to pay the annuity as Mrs. Beswick was not a party to the contract. The court accepted this contention. However Mrs. Beswick was allowed to enforce the contract as the administratrix of the estate of Mr. Beswick where, by standing in the shoes of the deceased, she became a party to the contract and thus entered a relationship of privity with her nephew.
Acquisition of rights
It is essential to recognize that this doctrine of privities excludes third parties from gaining rights under a contract even if that party is explicitly referred to by name in the contract as the beneficiary of a provision of that contract. So, for example, if Y and X agree that Y should compensate X for a service rendered to Z, then Z is not in a position to enforce the rights that were apparently created in his favor under the contract even if Y fails to fulfill his obligations.
There are a number of circumstances worth noting where privity of contract does not affect the rights of a person to enforce under an agreement. The best example is the case of an agency arrangement. Typically an agent is regarded by law as a special case. So if a contract is entered into between a party, P, and another, A, who is secretly an agent for B, then a legal analysis of the relationship is that the contract is effectively between P and B as the agent drops out of the equation. So, in this circumstance, B could enforce against P even though B is not actually a party (privy) to the contract. The analysis is that B stands in A’s shoes and hence enjoys a relationship of privity through A. It is also worth noting that various legislative instruments may have the effect of undermining the doctrine of privity.
When does a liability arise under a contract?
Liability arises under a contract, in theory, only when a party is privy to that contract. Which makes sense as it would seem absurd for two parties to meet in a far part of the world and agree that I am liable to pay them some money. However, it is not always that simple. For example if a party acquires a property which is subject to a restrictive covenant entered into by a previous owner of a property, i.e, a party with whom the new owner has no relationship of privy, nevertheless the new owner will be liable under the covenant because under property law the obligation runs with the land rather than the owner.
An important restriction on the doctrine of privity is The Contracts (Rights of Third Parties) Act 1999 which is intended to allow a person named as a beneficiary in a contract to sue for its enforcement. The legislative intent is to undo the perceived harshness of the Beswick case. However, in many cases, the Act is explicitly excluded from application by a clause of the contract.
Filed under: Business