Critical Appreciation Of Privity Of Contract

PRIVILY OF CONTRACT  :The general rule is in common law that no one but parties to a contract can be entitled to it, or bound by it, This also seems to be the import of Ss 2(a),(b),(c), and (e) of Indian contract Act which contemplates only two parties to an agreement(Kepong Prospecting Ltd v. Schmidt(1968) AC 810. The principle that only the parties are entitled to sue or be sued upon it is known as the “Privity of Contract”. It lies at the heart of the difference between rights under Contract which are in personam and proprietary rights which are in rem.

There Are two different aspects to the principle of Privity of contract which must be considered (a) acquisitions of rights by a third party, and (b) imposition of liabilities upon a third party.

As a general rule two persons entering into a contract between themselves cannot impose contractual liabilities on a third party. Thus in Gujarat Bottling vs. Coco Cola G and C agreed that G would not assign, even indirectly the rights to the contract without the consent of C. The shareholders of G transferred their shares in G which had the same effect as the assignment without the permission from C. It was held that shareholders were not party to the contract between G and C and hence not bound by it.

One exception to the above principle appears well established. A contract concerning property whether real, intellectual or personal may impose liabilities on third parties who subsequently acquire such property with notice of the contract.

English Law: In modern English Law it is well settled that consideration must move from the promisee. In Tweddle v Atkinson an agreement was entered into between the respective fathers of the husband and wife that each should pay a sum of money to the husband and that the husband should have power to sue for such sums. After the death of both the fathers, the husband sued the executors of the wife’s father for the money promised to him. It was held that action would not lie as no consideration had moved from the husband, the promisee and so the promise was as far as he was concerned, a gratuitous one. Under Indian Law section 2(d) consideration must proceed from either the promisee or any other person. This is a departure from English Law.

In Scruttons Ltd v Midland Silicones Ltd  , it was observed that the principle is that apart from special consideration of agency, trust, assignment or statute, a person not a party to a contract cannot enforce or rely for protection of its provisions. The principle was reaffirmed in Dunlop Pneumatic Tyre Co Ltd v Selfridge & Co Ltd  where it was held that as the plaintiffs were undisclosed principal, no consideration moved from them to the defendants and that the contract was unenforceable by them.

The two basic principles under the English Law as can be ascertained from the above cases are that firstly consideration should move from the promisee only and secondly that a contract cannot be enforced by a person who is not a party to the contract even if it is made for his benefit.

Reasons for the Existence of Privity of Contract:

The reasons for limiting the operation of the contract to its parties only are many and the following are the most profound:

The third party did not provide consideration for the promise, even though consideration was provided for the promise.

It is unjust to permit a person to sue on a contract when he cannot be sued upon it.

If non-contracting parties were permitted to enforce contracts made for their benefit, the rights of the contracting parties to vary or terminate such contracts would be affected.

It is unfair to call upon the promisor to be liable to two actions, from the promisee as well as the third party.

It is desirable to limit the potential liability of a contracting party from the possibility of a wide range of possible third party claimants

The Doctrine in India

There has been a divergence of opinion in India as to whether the Doctrine of Privity of Contract, which prevails in the English Courts, is applicable to the Indian Courts.

The Indian Contract Act, 1872 (hereinafter referred to as “the Act”) codifies the methods of entering into a contract, executing a contract; rules to implement provisions of a contract and effects of breach of a contract. The provisions of the Act prevail over any usage or custom or trade however the same will be valid as long as it is not inconsistent with provisions of the Act.

Section 2(d) of the Act says that ” when, at the desire of the promisor, the promisee or any other person has done or abstained from doing, or does or abstains from doing, or promises to do or to abstain from doing, something , such act or abstinence or promise is called a consideration for the promise”

It is clear from this section that the consideration for a contract can proceed from any person and not necessarily the parties to the contract. A promise is enforceable if there is some consideration for it and it is quite immaterial whether it moves from the promisee or any other person. However there is no specific provision in the Act which either for or against the Doctrine of Privity of Contact. It is through a series of case laws that the Doctrine has evolved.

In Debnarayan Dutt v Ramsadhan  it was observed that the doctrine in Tweedle v Atkinson is inapplicable in India and that “The aim of the Mofussil Courts of Justice in British India is to do complete justice according to the principles of Justice, equity and good conscience.”

The decision in Debnarayan Dutt v Ramsadhan was followed in N. Devaraja v M.Ramakrishnan .The facts of the case in brief are that A sold a house to B under a registered sale deed under the terms that a certain sum will be paid to A and the remaining to C, A’s creditor. B subsequently made part- payments to C informing that the amount was in respect of the sale and that he would pay the remaining amount, B failed to make the payment and C sued B for the same. It was held that the suit was maintainable as B promised to pay the amount to C and hence C was entitled to bring a suit against B for recovery of the amount.

However in Jamna Das v Ram Autar [ the Privy Council extended the doctrine to India and held that the person not party to the agreement cannot recover the amount due from one party. This decision has been followed in few cases later like Babu Ram Budhu Mal v Dhan Singh Bhishan Singh [5]  where the mortgagee was not allowed to recover the money retained by the second mortgagee under an agreement between the owner and the second mortgagee.

Subbu Chetti v Arunachalam considers in detail the development of the Doctrine of Privity of Contract with reference to the decisions of the English Court. The court considering the decision in various English cases held that “where all that appears is that a person transfers property to another and stipulates for the payment of money to a third person a suit to enforce that stipulation by the third party will not lie.”

The Supreme Court has by its decision in M.C. Chacko v State of Travancore (1970 SC 504)expressed itself in favour of the rule in Tweedle v Atkinson thus clearing the ambiguities in the application of the doctrine of Privity of Contract.

There are two aspects of this doctrine. Firstly, no one but the parties to the contract are entitled under it. Rights or benefits may be conferred upon a third party but such a third party can neither sue under the contract nor rely on defenses based on the contract. The second aspect is that the parties to a contract cannot impose liabilities on a third part

The Exceptions to the Rule

1.Beneficiaries under a trust or charge-Any beneficiary under a trust or when an obligation under a contract is undertaken for the benefit of a third party, coupled with a charge on immovable property; the third property beneficiary can enforce it.

2. Covenants running with the land – It is an accepted principle of the law of transfer of property that anyone who takes property will be entitled to all the benefits running with the land. Any covenant imposing an obligation on a party can be enforced by any stranger who gets that property.

3.Family Arrangements Marriage Settlement, partition or other  Family arrangements between male members and female members of a family, benefiting female members in the family, such as provisions for maintenance and marriage expenses, are enforceable by the beneficiaries, i.e., the female members.

4.Acknowledgement or Estoppel-Where the promisor has by his conduct, whether by acknowledgement or part payment or estoppels created a Privity between himself and the stranger he cannot be permitted to plead that action will not lie at the instance of a stranger. So A having received money from B for payment over C Admits to C receipt of the money, A is deemed to constitute himself as agent of C and C is entitled to recover the amount from A.

5. Assignment: It’s a process whereby right to enforce a contract is vested in someone other than original creditor without the consent of the original debtor. By its very nature where the assignment is validly made, the assignee may bring an action to enforce his rights under the contract, even though he was not originally a party to it.

6. Statutory exceptions: Sometimes the statutes cast a duty for the benefit of a third party to the contract. He can get the advantage though he is a a stranger to the contract e.g the insurance company has to bear the third party risk in accidents involving  a motor vehicle -New India Assurance company Ltd vs. Rula(2000) 3 SCC 195, 199, AIR 2000 SC 1082. Statutory exceptions to the Privity rule have been similarly carved out for third parties in the context of a holder of a promissory note, bill of exchange or cheque, a consignee of goods under a bill of lading or a subsequent endorsee and an undisclosed principal(Section 231 of Indian contract Act 1872Contracts (Rights of Third  Parties) Act 1999provides some reform for this area of law which has been criticised by judges such as Lord Denning and academics as unfair in places. The act states:

1. – (1) Subject to the provisions of this Act, a person who is not a party to a contract (a “third party”) may in his own right enforce a term of the contract if-
(a) the contract expressly provides that he may, or
(b) subject to subsection (2), the term purports to confer a benefit on him.
(2) Subsection (1)(b) does not apply if on a proper construction of the contract it appears that the parties did not intend the term to be enforceable by the third party.

This means that a person who is named in the contract as a person authorised to enforce the contract or a person receiving a benefit from the contract may enforce the contract unless it appears that the parties intended that he may not.

The Act enables the aim of the parties to be fully adhered to. Taking the situation in Beswick v Beswick whereby the only reason why Mr Beswick and his nephew contracted was for the benefit of Mrs Beswick. Under the Act Mrs Beswick would be able to enforce the performance of the contract in her own right. Therefore, the Act realises the intentions of the parties.

The law has been welcomed by many as a relief from the strictness of the doctrine, however it may still prove ineffective in professionally drafted documents, as the provisions of this statute may be expressly excluded by the draftsmen.

Third-party beneficiaries

In Australia, it has been held that third-party beneficiaries may uphold a promise made for its benefit in a contract of insurance to which it is not a party (Trident General Insurance Co Ltd v. McNiece Bros Pty Ltd (1988) 165 CLR 107)Austlii. It is important to note that the decision in Trident had no clear ratio, and did not create a general exemption to the doctrine of privity in Australia.

Queensland, the Northern Territory and Western Australia have all enacted statutory provisions to enable third party beneficiaries to enforce contracts, and limited the ability of contracting parties to vary the contract after the third party has relied on it. In addition, section 48 of the Insurance Contracts Act 1984 (Cth) allows third-party beneficiaries to enforce contracts of insurance.

Although damages are the usual remedy for the breach of a contract for the benefit of a third party, if damages are inadequate, specific performance may be granted (Beswick v. Beswick [1968] AC 59).

The issue of third-party beneficiaries has appeared in cases where a stevedore has claimed it is covered under the exclusion clauses in a bill of lading. In order for this to succeed, three factors must be made out:

  • The bill of lading must clearly intend to benefit the third party.
  • It is clear that when the carrier contracts with the consignor, it also contracts as an agent of the stevedore. That is, either the carrier must have had authority by the stevedore to act on its behalf, or the stevedore must later ratify (endorse) the actions of the carrier.
  • Any difficulties with consideration moving from the stevedores must be made out.

The last issue was explored in New Zealand Shipping Co Ltd v. A M Satterthwaite & Co Ltd [1975] AC 154, where it was held that the stevedores had provided consideration for the benefit of the exclusion clause by the discharge of goods from the ship.

New Zealand has enacted the Contracts Privity Act 1982, which enables third parties to sue if they are sufficiently identified as beneficiaries by the contract, and in the contract it is expressed or implied they should be able to enforce this benefit.Consumer protectionPrivity of estatePrivity English law

  • In US: DeCicco v. Schweizer, 117 N.E. 807 (1917) Cardozo J held a daughter was entitled to enforce a promise by her father to her husband to pay her instalments of money, because she had knowledge of the promise. There was sufficient “consideration”.

Even inIndia, The Law Commission of India has recognized that rigid adherence to the rule of Privity of contract causes hardship and much before the corresponding legislative changes in the UK incorporation of a separate section in the Indian Contract Act to the following effect in order to address the issue:

Law Commission of India,  in its 13 th Report (1958) at para 16 recommended adding a new section 37 A to the Act: Benefits conferred on third parties: (1) Where a contract expressly confers a benefit directly on a third party, then unless the contract otherwise provides, it shall be enforceable by the third party in his own name, subject to any defences that would have been valid between the contracting parties.

(2) where a contract expressly conferring a benefit directly upon a third party has been adopted expressly or impliedly, by a third party, the parties to the contract or rescind or alter it so as to effect the rights of a third party.

The preponderating view, however, is that the English rule of privity of contract applies to India, notwithstanding section 2(d). The privy council in Jamnadas vs Ram autar 34 All 63(pc)applied the rule. In krishnalal vs promila, Rankin CJ, struck a decisive blow to the argument based on the langiage of section 2 (d). While conceding that the clause might be construed as implying a departure from the corresponding English rule, he observed that the definitions of the promisor and promise in section 2, rigidly excluded the notion that a stranger to the contract can sue thereon.

Conclusion

The Act does not specifically provide for the doctrine of Privity of Contract; however through a series of case laws the doctrine as laid down in Tweddle v Atkinson is now applicable in India along with various exceptions.

I’d also advise the Indian Parliament to enact a law adding Section 37 A to the Indian Contract act as recommended above by the Law Commission of India in its 13 the report in 1958 to mitigate the hardship caused to strangers due to rigid application of this doctrine and the it’d augur well for the judiciary to reduce the hardship caused to strangers for whose benefit a contract has been formed to eschew acting within the narrow confines of the doctrine  while keeping in view the principles of justice, equity and good conscience and relax the rule of Privity of contract in its strict sense in appropriate cases.,. Liberal interpretation of this doctrine should be the rule rather than exception.

With reference to consideration of a contract the position in India and England are somewhat different. Under the English law only a party to the contract alone can pay the consideration. If he doesn’t pay the consideration he becomes a stranger to the contract. Under the Indian Law, it is not necessary that consideration should be moved from the promisee alone.Even a Stranger can enforce am contract if the contact was made avowedly for his benefit albeit not a party to the original contract.

References: 1) Indian Contact Act By Mulla 13 th Edition

2)”Critical Study of Privity of Contract” courtesy http://www.lawteacher.net

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