Privity of Contract and its Specifications with Reference to Nepal

Abstract 

Contract is a legally binding and legally enforceable agreement concluded between the two or more than two parties and which creates legal rights and duties to the contracting parties. It is the relationship that exists between the parties to a contract. Person who is a party to a contract has enforceable rights or obligations under it. Privity of contract is a general rule or principle of contract law developed from the common law which means that a person cannot acquire rights or subject to liabilities arising under a contract to which s/he is not party. It means that contractual rights and liabilities affect only the parties to a contract and a person who is not party can neither sue or be sued on the contract. For example, if A enters into a contract with B, only A & B can enforce or sue on the contract; C who is not a party to the contract cannot do so. A contract cannot give rights or impose obligations on anyone who is not a party to the contract. In common law, the privity principle was extended, as a result of the consideration rule, to prohibit any third party from taking the benefit of a clause in a contract between two others. S/he is a stranger to the contract and cannot claim contractual right and benefit and be subject to a burden by contract to which s/he is not a contracting party. The justification of privity rule is the principle of mutuality, a contract is based on a mutual agreement so, it would be unfair to impose rights and obligations to which they are not a party of the contract and who may not have given his/her consent to be bound. Likewise, a third party to a contract will not have provided consideration to support the agreement. There are some exceptions of the doctrine of privity of contract i.e. agency, trusts, assignment, tort of negligence, collateral contracts and collateral warranties, contracts for the benefit of a spouse or child, insurance, consumer law, negotiable instruments, carriage of goods by sea etc.

Key words: Benefit, contract, enforce, law, privity, rights, third party

Introduction

A contract is an agreement giving raise to obligations which are enforced or recognized by law.  ‘Contract is a legally enforceable promise or set of promise’.[1] A contract is commonly defined as an agreement or set of promises that the law will enforce i.e. for breach of which the law will provide a remedy. According to the classical understanding, a contract is an expression of the joint will of parties engaged in a transaction. On this view, contractual obligations are voluntary assumed and sharply distinguishable from obligations imposed by the law of tort. The role of contract law, according to the classical understanding, is to facilitate the freedom of the parties to create their own private law.[2] Contract is an agreement or understanding created by the offer and acceptance of the parties which does not impose any obligations to anyone other than contracting parties. It is the law created by the contracting parties for them not by and for others. Hence, contracting parties makes law through the contract with certain terms and conditions and which is only applicable for themselves.

A contract may be defined as an agreement which is either enforced by law or recognized by law as affecting the legal rights and duties of the parties.[3] ‘In the broadest sense, a contract is an exchange of promises by two or more persons, resulting in an obligation to do and refrain from doing a particular act, which obligation is recognized and enforced by law.’[4] According to Section 504 on the Chapter of Contract of the National Civil Code 2074 (2017)., “Contract means, an agreement enforceable by law concluded between two or more parties to do or not to do something”.[5]Thus, legally binding and legally enforceable agreement concluded between the two or more than two parties and which creates legal rights and duties to the contracting parties is known as contract.

A contract is usually described as an agreement between two parties, whether corporate entities or individuals. The agreement is legally enforceable if it is based on genuine consent and involves an exchange of economic value, usually called consideration. For example, if A and B agree that A will paint B’s house and that in return B will pay A ten thousand both parties have provided consideration and the agreement will be enforced by the courts. Closely related to the requirement of consideration is the concept of privity of contract. In essence, privity rule means that only the parties to a contract – those “privy” to it have enforceable rights and obligations under that contract.[6] An individual or corporate entity who is not a party to the contract is called a ―third party.  A third party does not have enforceable rights or obligations under the contract.[7] Contractual rights and liabilities are confined only to the parties of the contract. They do not extend to a stranger. Thus, the doctrine of privity of contract emphasizes that a person who is not a party to a contract (i.e. who is a stranger to the contract) cannot bring an action on the contract.  A stranger to a contract is neither entitled to get benefits of the contract nor is he bound by contractual liabilities. Consideration of contract is the foundation of privity of contract and no any person can sue on a contract made for their benefit if they were not a party to it. Similarly, a person cannot have obligations imposed on them by a contract to which they are not a party. This doctrine is related to the issue of the creation of contractual obligations and concerned with the question of who has right and liabilities under a contract.

Privity of contract is the common law principle which was developed by the interpretation of the court of Britain. It is defined under the common law is: “No one may be entitled to or bound by the terms of a contract to which he is not an original party”.[8] In common law, the privity principle was extended, as a result of the consideration rule, to prohibit any third party from taking the benefit of a clause in a contract between two others.[9] In English law the privity doctrine means among other things that a non-party cannot bring an action on the contract.[10] Now ‘a basic principle of general contract law (in both civil and common law countries) is that a contract is exclusively valid between the contracting parties. Third parties do not and cannot derive rights from this contract’. [11] ‘The rule that a person who was not a party to a contract could not sue upon the contract in order to obtain the promised performance, even in the case where the contract was entered into with the object of benefitting him, was capable of producing hardship’.[12] So, we can say that, the doctrine of privity means that a contract cannot, as a general rule, confer rights or impose obligations arising under it on any person except the parties to it.

In ancient ‘Roman law also refused to acknowledge the validity of agreements in terms of which third parties were intended to acquire rights. In early Roman law privity of contract was hardly emphasized. Legal effects were not abstracted from the persons performing the formalities and could therefore not be made to originate in the person of an independent outsider’.[13] The doctrine of privity of contract is a general rule of law of contract. According to this doctrine no one but the parties to a contract are bound by it. A third person cannot be entitled to demand the performance of an obligation under a contract. The doctrine is very useful for it helps in preserving the sanctity of the contract. ‘The essence of the privity of contract is that, only those who are parties to a contract can have rights and liabilities under it. It is closely linked to the rule that, consideration must move from the promise, but can be shown to be distinct from it’.[14] For example, ‘If A had made a contract with B., its operative effect was limited to legal relations between A and B, and that it excluded or limited any liability of A to C, apart from a contractual duty, arising out of an act which as between A and B was a breach of contract’.[15] Thus, the doctrine of privity of contract says that only party to the contract can sue on it. No any third party have right to sue to obtain the benefit of a contract and those persons are not bound by the terms of a contract to which he or she is not a party of the contract.

Likewise, a contract is a two-way street and is based on a mutual agreement between two parties. Each party will have obligations under the contract and each party will have the right to sue if the other party fails to meet those obligations. An individual who is not a party to a contract is referred to as a third party. A third party will not have any of these rights described above. Only parties that are privy to the contract will be able to exercise these rights. This is referred to as the doctrine of privity of contract.[16] ‘It is clearly justifiable as a general rule that the burden of a contract should not be placed on a third party’.[17] Privity of contract has three broad effects:

1. A third party cannot receive a benefit of a contract if he is not party to that contract.
2. A third party cannot be liable under a contract if he is not a party to that contract.
3. A third party cannot enforce a contract if he is not a party to that contract.

Hence, as per the principle of privity of contract only party to a contract is affected by the rights or liability created by the contract i.e. when contracts made the liability falls only to the contract. Thus, the principle of privity of contract is an English legal concept has no right to demand performance or he is under no duty to perform but, the doctrine of privity of contract is being transformed even in Anglo U.S. laws.[18] Now privity of contract has been practiced by several legal systems and countries of the world as an important doctrine of contract law. Nepal have also accepted this concept.

Basing on the above facts, scenario and discussions this article tries to explore the concept of privity of contract, its justifications and exceptions as well as to examines the Nepalese legal provisions, notable case laws, practices of privity of contract and third party rights from the jurisprudential perspective based on the primary and secondary sources. In this study, the authors have applied multi-research methodology. The author has adopted content analysis and doctrinal research methodology according to need. The data is qualitative in nature. The study has extensively been more and more descriptive, analytical, critical as well as historical. Doctrinally, the Contract Act, 2056 (2000), provisions of Contract of the National Civil Code 2074 (2017) and other laws related to privity of contract have been used as primary sources. Other information and knowledge have been collected and utilized from secondary sources such as published research works, authorized books, articles, journals, legal research data base such as HeinOnline, jstor are retrieved from online sources and Nepal Kanoon Patrika. After collecting the data, they are descriptively analyzed and analytically explained.

Justifications for the Doctrine of Privity of Contract

As outlined above, a third party to a contract has no rights in that contract. To understand why this is the case it is important to consider two closely connected justifications. First, as a contract is based on a mutual agreement, it would be unfair to impose obligations on a party who may not have given his/her consent to be bound. Secondly, a third party to a contract will not have provided consideration to support the agreement. Even, if the intention of the parties is that a third party shall have some rights under the contract the courts will not enforce this agreement. A key requirement of enforceability, that consideration must move from the promisee, has not been satisfied.[19]

The first aspect of the rule of privity, namely the idea that a third party cannot have any burdens from the contract enforced on them, is generally accepted as good law.  It would be plainly unfair, and contrary to the idea of freedom of contract, if two parties could impose contractual obligations on a third party without the latter’s consent.[20] The doctrine is very useful for it helps in preserving the sanctity of the contract. The sanctity of the contract is preserved if the parties to a contract are held answerable to each other and not to a third person. It would be illogical and unjust to abolish the doctrine totally. If it is abolished, each and every member of society will become free to sue the contracting parties. Consequently, chaos will result and the social fabric and bond of brotherhood may be weakened. The tendency to make the contracts may also decrease because people may be afraid of doing so.

These principles were described as “fundamental” by Viscount Haldane L.C. in Dunlop Pneumatic Co Ltd vs Selfridge and Co Ltd (1915) A.C. 847: “In the law of England certain principles are fundamental. One is that only a person who is a party to a contract can sue on it. A second principle is that if a person with whom a contract not under seal has been made is to be able to enforce it consideration must have been given by him to the promisor or to some other person at the promisor’s request.” Furthermore, the general principle remains that contract can be enforced neither by nor against the third parties. Therefore, these are the reasons and justifications behind the doctrine of privity of contact.

Exceptions of the Doctrine of Privity of Contract

According to English Law there are two fundamental propositions: Consideration must move from the promisee and the promisee only. If it be furnished by any other person, the promise becomes a stranger to the consideration and, therefore, cannot enforce the promise and another is ‘A contract cannot be enforced by a person who is not a party to it even though it is made for his benefit. He/she is a stranger to the contract and can claim no rights under it’.[21] However, recent development in English Law the privity of contract rule i.e. only the parties to the contract are bound or entitled by the contract is reformed by an act “The English Contract Act 1999 (right of third party)”. The right of third party to sue provided if there is express provision i.e. he is identified in the contract by name, class or description and If the contractual term confers a benefit on him.[22] This doctrine is not absolute and cannot be applied strictly. With the passage of time, it was found that a contract between the parties did not affect only the contracting parties but, in certain circumstances, it affected third persons also. Consequently, it was felt desirable and logical that the person who is a stranger to a contract should also get contractual benefits. There are several exceptions behind the doctrine of privity of contract; the major exceptions are discussed below:

1. Agency

Agency is the relationship that exists when one person (the agent) is appointed by another person (the principle) to act as their representatives. Basically, there are three parties in the contract of agency i.e. employer is the principal, the employee is the agent and the customer is usually described as “third party”.Agency is thus a major exception to theprivity rule. An agency creates three kinds of relationships: (i) a relationship between principal and agent, (ii) a relationship between agent and third party and (iii) a relationship between principal and third party.In so far as the relationship between principal and agent is concerned, there is a privity of contract between them. This relationship supports the doctrine of privity of contract.‘For example, an employee such as a ship assistant may be an agent of their employer (the shop owner) for the purpose of selling goods, and thus any contract of sale concluded between the agent/employee and a customer will be binding on the employer. The agent/employee will not be liable on the contract of sale’.[23] The contract with which we are concerned is the contract between the agent/employee and the customer. Law believes all the works done by the agent with the customer/third party is regarded as the work done by the principal. The principal is bound to fulfil contractual liabilities undertaken by the agent. So, the principal is liable for all the prescribed works done by his/her agent. Therefore, the principal can sue and be sued on it on the matters and activities of the agency contract.

2. Trusts

A third party can enforce a contract if a completely constituted trust was created in their favor by the contract. A trust is a serious undertaking with different consequences to a contract.  The parties cannot rescind or vary the agreement without the consent of the third party beneficiary and a trustee may owe various special duties to the third party beneficiary. Third party can enforce the contract if the intention of the contracting parties is that he should benefit from performance of the contract.”[24] Therefore, trust is also one exception of privity of contract which can ensure rights to the third parties in certain circumstances.

3. Assignment

Suppose X and Y enter into a contract whereby X agrees to confer a benefit on Y, Y may be able to assign (transfer) the benefit of the contract to a third party (T). T is then entitled to sue X on the contract and Y loss the right to enforce or very the contract. The transfer of contractual benefits is called assignment; Y is called the assignor; T is called the assignee; and X is called the debtor. X’s consent is not necessary for the assignment of contractual benefit from Y to T.[25] The assignee can then sue the debtor in their own name, without joining the assignor as a party to the action. So, assignment is an important means of avoiding the effects of the privity rule, and the assignment of contractual rights is common in business transaction.

4. Tort of Negligence

If a person suffers a loss as a result of another person’s negligence, that person may be able to sue in the tort of negligence. Third parties who are prevented by the privity rule from suing in contract may attempt to rely on the tort of negligence. For example, in Donoghue vs. Stevensona woman who sick after drinking a bottle of ginger beer which contained a dead snail was unable was unable to bring an action in contract against the manufacturer of the beer, because she had no contract with the manufacturer. However, she was able to bring an action in the tort of negligence as she could show that the manufacturer had breached his duty of care to her.[26] It includes pure economic loss, professional negligence etc.

5. Collateral Contracts and Collateral Warranties

A collateral contract or –as it is often called-a collateral warranty is “a contractual promise from one party to a contract to a third party which relates in some way to the terms of the original contract.” In this situation the third party is strictly speaking only a “third party” in relation to the main contract; they are a contracting party as regards the collateral contract. The legal consideration for a collateral warranty is often the making of the principal contract, or a promise to nominate a party as a sub-contractor or supplier.[27]

6. Contracts for the benefits of a spouse or child

Contract entered into by a person that confers a benefit on their spouse and/or their children can be enforced by the spouse and/or the children[28] under the fulfillment or non-fulfillment of certain conditions.

7. Insurance

Insurance contract are often made by the insurer (insurance Company) and insured (purchaser of insurance policy) for the benefit of a third party. A person can purchase an insurance policy for another’s benefit. For example, if a husband takes a life insurance policy for the benefit of his wife and children, the wife and children can claim or sue the life insurance company, although they are strangers/third party to the insurance contract as well as to the consideration. The insurance company is liable to pay the amount assured by the insurance policy. Since the wife and children are not the parties of the insurance contract even though the parties intend to benefit him/her. Thus, insurance contract is also one of the exception of privity of contract.

8. Consumer Law

A number of important exceptions to the privity rule exist in relation to consumer contracts. For example, when a consumer enters into a hire purchaser arrangement, the consumer’s contract is with the hire purchase company and not the seller of goods. If the privity rule applied the consumer could not sue the seller of goods for any breach of contract or misrepresentation.[29] Hence, consumer law safeguard the rights of the consumer.

9. Negotiable Instruments

Cheques, bills of exchange and promissory notes etc. are example of negotiable instruments. Cheques and bills of exchange order the payment of money, whereas promissory notes contain a promise to pay certain amount of money in specified time. Ownership of the rights contained in the instrument can be transferred to and enforced by a third party, referred to as the “holder in due course” [30] or the bearer of that instrument.

10. Carriage of Goods by Sea

When goods are carried by sea, the person who wishes to send the goods (the shipper) enters into a contract with a carrier, and this contract is evidenced in transport document called a bill of lading. The shipper then sends the bill of lading to the person who is to collect the foods (the consignee). The consignee must present the bill of leading to the carrier to have the goods released to them. The contract of carriage, as evidenced in the bill of lading, is entered into by the shipper and the carrier of the goods, and the consignee is not a party to this contract.[31] The consignee as a third party can sue the carrier of the goods in contract if the goods are lost or damaged.

Analysis of Nepalese Legislations and Case Laws on Privity of Contract

As formerly stated, there was no specific legal provision of privity of contract in Nepalese legislations before the enactment of Contract Act 2056 (2000) but there were some case laws in which the Supreme Court speaks about the privity of contract and paves the way out as well as creates the roadmap regarding this concept. Case laws were in favor of privity of contract regarding persons having no beneficiary rights and locus standi. Previously, in Contract Act 2056 (2000) there was provision concerning privity of contract in Section 78 which states that, “only a person who is a party to a contract may demand the execution of that contract from other party”.[32]

The National Civil Code,2074 (2017) is the present legislation which provisioned the concept of privity of contract in Part 5- “Provisions Relating to Contracts and Other Liabilities” under Section 529 and 530. ‘Only the person who is a party to a contract can demand the performance of the contract by the other party. However, if a contract is concluded for the benefit of any person, such a person can demand the performance of that contract even if he or she is not a party to such a contract’.[33] If two or more persons jointly enter into contract to do or not to do any act, all such a persons can jointly demand the performance of that contract, except as otherwise provided for in the contract.[34] These legal provision clearly specify the rights of parties of the contract solely or jointly to demand performance of the contract. Additionally, it prescribes the exceptional clause for right of the third party to demand performance of the contract if it is related to the benefit of the third party.

The Supreme Court of Nepal have also interpreted, recognized and applied the doctrine of privity of contract in several cases. In the case of Pradip Raj Pandey vs. Karma Laxmi Kayansakar[35], the things stated in the contract can only be fulfilled by the parties of the contract. Persons beyond the contracting parties i.e. third party cannot be obliged to fulfill the obligations of contract it is the theme of privity of contract. In this case the issue of privity of contract is raised by the parties of the case but the court held that the fact in issue of the case is not related to the doctrine of privity of contract. In the case of Damodar Ropeways and Construction Company vs. Government of Nepal, Ministry of Finance[36] the Supreme Court of Nepal defined contract and the court held that, contract means a lawful agreement concluded by concerned parties with free consent and which is enforceable to them. Thus, the terms and conditions of contract are binding to the concerned parties and to follow those conditions became the legal obligations for contracting parties. Contract law is the law relating to obligation applicable to the concerned parties of the contract. If one party does not fulfill the obligations as per the contract, another party gets exception to fulfill their obligation. Parties who is not able to fulfil the obligations cannot compel another party to fulfill their obligations.

Conclusion

Contract means an agreement between two parties, whether corporate entities or individuals. The agreement is legally enforceable, if it is based on genuine consent and involves an exchange of economic value usually called consideration. The concept of privity of contract as a rule of contract has developed form the common law. Generally, in contract, there is connection or relationship existing between the agreed parties. Privity of contract means, only parties to a contract has a rights or liability under it, a non-party cannot acquire rights or liabilities hence, a third person cannot demand performance or obliged to perform in the contract in which he/she is not a party. Though the concept of privity of contract is the result of English law now this concept has widened in the contract law of various jurisdictions. While talking about the Nepalese context, there is separate provision of privity of contract in the National Civil Code 2074. In practice the Supreme Court of Nepal has also applied the doctrine of privity of contract in several cases. Thus, the general thought of privity of contract has not been completely abolished in both civil and common law countries and this principle is still viewed as the foundation of contract law in Nepal as well.

With these above provision, third parties of contract can claim for performance, but Nepalese legislation cannot fully capture those holistic problems of third party’s rights. Obviously, it cannot give answer the questions regarding to this issues. For example, whether it can amend or not, if those contract which have included third party rights without the consent of such party? Whether alter or encroach the right of third parties, without consent of his available rights in contract or not? Whether third patty shall claim mediation or not? Whether third party shall claim compensation or even, specific performance or not, if his available rights will breach? Whether the parties of contract can sue against the third parties or not? Nepalese laws, in this regard remains silences in these various issues. So, it needs to be ample improvement in these seeing lacunas with effective amendments and improvements. All these provisions are not enough for the protection of third parties right. Nepalese Legal system still remains silences, regarding the holistic issues and rights of third party. Therefore, it needs to be immense improvement in Nepalese legislations on these areas and these lacunas must be erased for ensuring rights of the parties of the contract and third party rights.

[1] JOHN D. DONNELL et. al., LAW FOR BUSINESS, IRWIN Homewood, Illinois, U.S.A, at 73, (1983).

[2] JEANNIE PATERSON et. al., PRINCIPLE OF CONTRACT LAW, (2^nd ed.), Law Book Co., Sydney, at 3, (2005).

[3]G.H. TREITEL, AN OUTLINE OF THE LAW OF CONTRACT, (5^th ed.), Butterworths, London, at 1, (1995).

[4] M.C. SHUKLA, MERCANTILE LAW, (1^st ed.), S. Chand & Company Ltd., New Delhi, at 5, (1999).

[5] National Civil Code 2074 (2017) Section 504.

[6] REPORT ON PRIVITY OF CONTRACT AND THIRD PARTY RIGHTS, Law Reform Commission, (1^st ed.), at 1, (February 2008), available at https://www.lawreform.ie/_fileupload/Reports/Report%20Privity.pdf, (accessed on 6 August 2020).

[7]Ibid, at 5.

[8]  Price vs. Easton, 4 B. & Ad. 433.(1833).

[9] Anka L.H. Ernes, Third Party Rights & Contractual Groupings vs Privity of Contract in Commercial Contract Law, EUROPEAN JOURNAL OF COMMERCIAL CONTRACT LAW, Vol.4, No.2-3, at 16, (November 2012), available at HeinOnline, (accessed on 2 August 2020).

[10] Hein Kotz, The doctrine of Privity of Contract in the context of contracts protecting the interests of third parties, Tel Aviv University Studies in Law, at 195, (1990), available at HeinOnline, (accessed on 1 August 2020).

[11] ERNES, Supra note 9, at 15.

[12] EWAN MCKENDRICK, CONTRACT LAW, (7^th ed.), Palga Macmillan, New York, at 138, (2008).

[13] ERNES, Supra note 9, at 15.

[14] Prof. RICHARD STONE, CONTRACT LAW, (1^st ed.), Cavendish Publishing Limited, London, at 73, (1994).

[15] Charles P. Taft, Negligence in relation to Privity of Contract, THE YALE LAW JOURNAL, Vol.30, No.6, The Yale Law Journal Company, at 609-610, (April 1921), available at https://www.jstor.org/stable/789231, (accessed on 5 April 2020).

[16] RYAN MURRAY, CONTRACT LAW (THE FUNDAMENTALS), (1^sted.) Sweet & Maxwell, London, at 75, (2008).

[17]STONE, Supra Note 14, at 73.

[18]YADAV KUMAR K.C., CONTRACT LAW, A COMPARATIVE STUDY, (1^st ed.), Pairavi Prakashan, Kathmandu, at 81, (2016).

[19] STONE, Supra Note 14.

[20] Supra note 6, at 5.

[21] AVTAR SINGH, CONTRACT AND SPECIFIC RELIEF, (12^th ed.), Eastern Book Company, India, at 113, (2017).

[22]EWAN MCKENDRICK, CONTRACT LAW (TEXT, CASES AND MATERIALS), (3^rd ed.), Oxford University Press, New York, at 968, (2008).

[23] Supra note 6, at 6-7.

[24] Supra note 6, at 8.

[25] Ibid, at 9.

[26] Ibid, at 13.

[27] Ibid, at 18.

[28] Ibid, at 16.

[29] Ibid, at 17.

[30] Ibid at 19.

[31] Ibid.

[32] Contract Act, Section 78, 2056 (2000).

[33] National Civil Code, Section 530(1), 2074 (2017).

[34] National Civil Code, Section 530(2), 2074 (2017).

[35] Nepal Kanoon Patrika, Vol.3, D.N. 9368, at 510, (2072).

[36]  Nepal Kanoon Patrika, Vol.5, D.N. 9591, at 815, (2073).

Authors

*Bimal Prasad Lamichhane is Assistant Professor at Gandaki University, Pokhara (Nepal).

** Saroj Bhandari is Judicial Officer at High Court Patan.