Key Takeaways

  • Privity of contract restricts contractual rights and obligations to the parties directly involved in the agreement.
  • Courts have developed several exceptions to the privity rule, such as agency, trust, negligence, and assignment.
  • Landmark cases like Dunlop v. Selfridge, Tweddle v. Atkinson, and The Albazero illustrate key applications and exceptions in privity of contract case law.
  • The Contracts (Rights of Third Parties) Act 1999 significantly altered privity rules in the UK, allowing third parties to enforce contractual terms in some cases.
  • Privity issues often arise in complex commercial relationships, including those involving subcontracts, trusts, and public infrastructure agreements.

Popular privity of contract cases includes Alva vs. Cloninger, Vahle v. Barwick and Citizens State Bank vs. Timm, Schmidt & Co. Privity of contract is a doctrine that states that an entity that is not a party to the contract should not get benefits or be subjected to penalties arising from the contract. The privity principle intends to protect third parties from prosecution over contracts they are not parties to. 

Circumstances Under Which an Entity That Is Not in Privity to a Contract Can Be Sued

Just because an entity is not in privity to a contract does not rule out the possibility of that entity suing or being sued over matters arising from the contract. Common exceptions to the privity principle include:

  • A beneficiary of the contract who is not a party to the contract, in some instances, can sue the parties to the contract.
  • Third parties can sue contracting parties if it is proven that the contracting parties were negligent.
  • Contracts in which an agent signs on behalf of the principal. In this case, the principal can be sued.
  • When a contract is assigned to another party. The assignee can generally sue the parties to the contract.

Some popular court cases that were decided based on the interpretation of the privity principle concept are discussed below.

Common Law Exceptions to Privity of Contract

While privity of contract traditionally restricts rights and obligations to the contracting parties, several exceptions have been recognized in case law:

  • Trusts: A contract may be structured to benefit a third party, establishing the original contracting party as a trustee of the benefit.
  • Agency: An agent may contract on behalf of a principal, allowing the principal to sue or be sued even though not explicitly named.
  • Assignment: A party to a contract may assign their rights to a third party, who may then enforce those rights.
  • Negligence Claims: If a party suffers foreseeable harm due to negligence, courts may allow claims even without direct contractual privity.
  • Collateral Contracts: A collateral agreement may exist between a third party and one of the contracting parties, offering grounds for enforcement.

These exceptions aim to balance fairness with the original intent of the contracting parties, reflecting the evolving nature of privity in modern case law.

The Alva vs. Cloninger Case

In 1981, judgment was given in the Alva vs. Cloninger in the North Carolina Court of Appeals. Juan and Elsa Alva had sued Cloninger for failing to detect damage to the house they would soon mortgage. Cloninger had asked the court to dismiss the case because it was NCNB, the lender, which had commissioned the appraisal and the Alvas were not in privity to that contract. The court of appeals ruled that Cloninger was liable for the loss suffered by the Alvas because he was hired under the understanding the Alvas would be the beneficiaries of the appraisal.

The Vahle vs. Barwick Case

In 2001, Richa and Louis Vahle appealed to the Superior Court of Napa County, California, in a case in which they were attempting to file a malpractice lawsuit against their former attorney, Jill Barwick. The suit was related to a personal injury case in which Barwick had represented them against Silverado Country Club and Resort. 

The Vahles had settled the lawsuit with Silverado and signed a mutual release agreement with Silverado. The trial court had ruled that, although Barwick was not a party to the release agreement, the agreement contained language that forbids the Vahles from filing a lawsuit against Barwick. The Court of appeals overturned the trial court judgment and allowed the Vahles to sue Barwick because Barwick was not in privity to the release agreement between the Vahles and Silverado.

Citizens State Bank vs. Timm, Schmidt & Co.

In the 1983 Citizens State Bank vs. Timm, Schmidt & Co. case in the Supreme Court of Wisconsin, Timm, an accounting firm had prepared accounting reports for Clintonville Fire Apparatus Inc (CFA) in 1974-1976. CFA received loans totaling $380,000 from Citizens State Bank in 1975. The bank relied on the financial statements prepared by Timm. Later in 1976, accountants for Timm found out that CFA had misrepresented its 1974 and 1975 financial situation. The accounting firm immediately notified Citizens State Bank of these errors. Subsequently, the bank accelerated the loans resulting in the liquidation of CFA. 

Citizens State Bank later filed a lawsuit against Timm and its malpractice insurance company to recover the money the bank lost to CFA. Although the supreme court ruled that accountants are liable for negligence to third parties who are beneficiaries of the accountant's reports, the court ruled against Citizens State Bank because there was no evidence that Timm knew that the bank would be a beneficiary of CFA's 1974 and 1975 financial statements.

Logan-Baldwin vs. L.S.M. Gen. Contr., Inc.

In this 2011 case in New York in the Munroe County Supreme Court, the Logan-Baldwin family sued its contractors and subcontractor seeking damages of $250,000. The family had hired a construction company, LSM, under the understanding that the company would get skilled subcontractors to perform some of the work. The company hired subcontractors to do some of the work. The family was not satisfied with the subcontractors' work, so they filed a lawsuit for breach of contract and fraudulent misrepresentation.

The subcontractor asked the court to dismiss the case because the family was not in privity to their contract with LSM. The court sided with the subcontractors.

The Albazero Principle and Commercial Contracts

A major development in privity of contract case law came from The Albazero case (1977), where the House of Lords recognized that, in certain commercial arrangements, a contracting party could recover damages on behalf of third parties. In this case, a shipper sought damages for lost cargo even though ownership had passed to a third party by the time the loss occurred.

The ruling introduced what’s now called the Albazero exception, which permits claims by contracting parties in situations where:

  • The contract was intended to benefit a third party; and
  • It was understood that the contracting party would be responsible for enforcing the rights.

This principle often applies in shipping, insurance, and complex commercial agreements involving chain contracts.

Landmark Cases Illustrating Privity of Contract Principles

Several historical cases have shaped the understanding of privity of contract:

  • Dunlop Pneumatic Tyre Co. Ltd. v. Selfridge & Co. Ltd. (1915): Reinforced that only a party to a contract can sue on it. Dunlop, despite having a resale price agreement, could not enforce it against Selfridge due to lack of privity.
  • Tweddle v. Atkinson (1861): A foundational case where a son could not enforce a contract made between his father and his father-in-law, despite being its intended beneficiary.
  • Beswick v. Beswick (1968): The House of Lords held that a widow, although not a party to a contract, could enforce it as administratrix of her late husband's estate.

These decisions affirm the privity doctrine while also exposing its limitations and prompting reforms.

Modern Legislative Reform – Contracts (Rights of Third Parties) Act 1999

In the UK, the Contracts (Rights of Third Parties) Act 1999 significantly reformed the privity doctrine. The Act allows third parties to enforce contractual terms if:

  • The contract expressly provides that they may do so, or
  • The term purports to confer a benefit on them.

This legislation has broadened the scope of enforceable rights for third parties, especially in commercial agreements where external beneficiaries are common.

Key provisions of the Act include:

  • A third party must be expressly identified in the contract, either by name or as a member of a class.
  • The parties to the contract can expressly exclude the application of the Act.
  • A third party who gains enforcement rights under the Act has the same remedies as a contractual party.

This reform is essential for practitioners and clients dealing with contracts where third-party beneficiaries are involved.

Frequently Asked Questions

  1. Can a third party sue for breach of contract under privity rules?
    Generally, no—unless an exception applies or the contract falls under statutes like the Contracts (Rights of Third Parties) Act 1999.
  2. What are some common exceptions to the privity of contract doctrine?
    Exceptions include trust, agency, assignment, negligence, and collateral contracts.
  3. What does the Albazero Principle allow?
    It allows a contracting party to recover damages on behalf of third parties under specific commercial circumstances.
  4. How has UK law changed the privity rule?
    The Contracts (Rights of Third Parties) Act 1999 allows third parties to enforce contract terms in certain conditions.
  5. Why does privity of contract still matter in modern law?
    It preserves contractual certainty by ensuring only intended parties are legally bound, while exceptions and statutes balance fairness for third parties.

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