April 2009

01 Apr 2009

Stop! Or My Friend Will Sue

Technology (and other) contracts are often entered into by one company in a related group of companies on the basis that the whole group will be permitted to use the relevant IT system or services. If there is a failure in the IT system or services, the wider group (not just the company that has the contract with the provider) may suffer loss or damage or want to enforce the contract against the provider. The common law doctrine of privity of contract creates a general rule that only a party to a contract can enforce the contract. But, the doctrine has a number of exceptions, both common law and statute based. This article examines the privity doctrine and the circumstances where a contract can be enforced by someone who is not a party to that contract.

What is the Doctrine of Privity?

The doctrine of privity arises from a strict theory of contract law. It states that only a party to a contract can enforce it; also that a contract cannot impose enforceable obligations on persons that are not parties to a contract. Whilst this may seem reasonable and simple enough, it can give rise to some unsatisfactory results in practice. For instance, where a contract is entered into by a party as agent for another person, or on behalf of the contracting party. As a consequence, a number of exceptions to the doctrine have been developed. 

In the above example, the principal of the agent would be able to enforce the contract. Another example is where a contract is entered into by a trustee - the beneficiary may be able to enforce the contract even if the beneficiary is not a party to the contract. There are also exceptions that can apply in relation to contracts relating to land and sometimes even other property.

There are also a number of statutory exceptions to the doctrine such as the Consumer Guarantees Act 1993, which gives consumers enforceable rights against the manufacturers or suppliers of goods or services even though there is no contract between the producer or supplier and the consumer. 

Contracts (Privity) Act 1982

In addition to the specific exceptions to the doctrine of privity developed through case law and specific statutory provisions, the Contracts (Privity) Act 1982 (Act) applies generally to all contracts. It allows a person who is not a party to a contract, but who was intended to benefit from the contract (third party beneficiary), to enforce it as if that person was a contracting party. 

In order for a third party beneficiary to enforce a contract made between two other parties directly, on the basis of the Act, the third party beneficiary must establish: 

1. the contract makes a promise that confers a benefit on the third party beneficiary; and
2. the third party beneficiary must be sufficiently identified in the contract (this element is known as designation). 

The promise of a benefit may be implied, but there must be an intention to confer a benefit. The identification of the third party beneficiary can be by name, by description or by reference to a class in the contract.

An important proviso is that the Contracts (Privity) Act will not apply to a promise which is not intended to create an obligation that is enforceable by a non contracting party. For this reason often contracts will contain a standard term that states that nothing in the contract is intended to confer any benefit enforceable by a third party. It is important to look out for these clauses where you intend third parties to be able to rely on and enforce the contract.

A third party beneficiary satisfying the requirements in the Act can enforce a promise contained in the relevant contract as if he or she was a party to that contract. This person or entity could also receive relief by way of damages, specific performance or an injunction where it is appropriate.

Variations

The Act also addresses the issue of variations of contracts conferring a benefit on a non-contracting party. The parties to a contract that contains an enforceable benefit to a third party beneficiary may amend or terminate the contract at any time with the consent of that third party beneficiary. The contract may also be amended or terminated without the consent of the third party beneficiary, until:

1. the position of the third party beneficiary has been materially altered by his own or another's reliance on the promise;
2. the third party beneficiary has obtained judgment upon the promise; or
3. the third party beneficiary has obtained the award of an arbitrator upon a submission relating to the promise. 

Naturally, it will depend on the individual circumstances of the case as to what amounts to a "material alteration of the position of the non-contracting party".

When a third party beneficiary has acted in reliance of a promise contained in a contract, and it is not possible to vary the contract in the manner described above, the contracting parties can apply to a Court to authorise a variation or discharge. When doing so, a Court also has the power to order the promisor to pay to the third party any sum as it thinks just.

Things to Consider

While the Act has significantly limited the application of the doctrine of privity, in that it establishes a general right for a non-contracting party to enforce a contract if certain elements are established, the doctrine can still apply where those elements are not established and other exceptions to the doctrine do not apply. Accordingly, when negotiating a contract, parties must turn their minds to who is intended to benefit from the contract and what rights should any third party beneficiaries have in relation to enforcement of the contract. When contracts are intended to be enforceable by third parties, the simplest way to do this is to include clear and unambiguous provisions stating that the contract confers a benefit on a named third party and that the benefit is enforceable by that third party.

Author

Karen Ngan

Partner - Corporate & Commercial

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