Key Takeaways

  • Privity of contract prevents third parties from suing or being sued on contract terms they are not party to.
  • Several important exceptions to privity exist, including agency, trusts, collateral contracts, and negligence.
  • Modern courts increasingly allow third parties to benefit from or be held liable under contracts in specific contexts.
  • Third-party rights statutes and consumer protection laws often override traditional privity limitations.
  • Assignments and statutory rights are additional exceptions that expand the scope of enforceable obligations.
  • UpCounsel can connect you with qualified attorneys for help interpreting and enforcing contractual rights.

Privity of contract is a concept stating that contracts should not give rights or obligations to entities other than those who are parties to the contract. The principle helps to protect third parties to a contract from lawsuits arising from that contract. There are some exceptions to the privity principle and these include contracts involving trusts, insurance companies, agent-principal contracts, and cases involving negligence.

The Privity Principle

Privity is sometimes used as a defense in business litigation. The principle has its roots in England and was developed to reduce individuals and entities being caught up in lawsuits. The principle can help protect innocent third parties from contracts that they may not even know about. Consider, for example, a new tenant who settles into a house after making a lease agreement with the landlord. 

The tenant finds out that, contrary to the contract she signed with the landlord, the house's air conditioning system is faulty. The new tenant raises the issue with the landlord who tells him that the AC fault is the responsibility of the previous tenant. The new tenant cannot sue the previous tenant because the previous tenant was not a party to the new tenant's lease agreement with the landlord. 

If the new tenant wants to take legal action, it has to be against the landlord. The privity principle also applies when a tenant subleases a property he is renting. The landlord may not be able to sue the tenant to whom the property was subleased.

In contract law, privity and consideration are closely related and any contract that does not follow both principles is not enforceable. Any contract with privity, but without consideration, is not valid. For example, a contract made between two friends Andrew and John. Andrew promises to pay John a monthly fee because John is such a nice person.

In such a contract there is no consideration, there is nothing John is giving back in return for the payments from Andrew.  If Andrew defaults on his payments and John sues him for breach of contract, courts would likely not enforce the contract. This is because, although the contract is in line with the privity concept, there is no consideration in the contract.

Types of Privity 

  • Horizontal Privity - can be brought up if benefits in a contract are given to another party that is not a party to the contract.
  • Vertical Privity - this may be raised when another contract is made arising from one of the parties to another contract.

Exceptions to the Privity Principle

In modern times, situations have arisen that have necessitated the relaxing of the privity principle.

  • Collateral Contracts and the Sale of Defective Goods
    A third party may sue the seller over defective goods if the third party is affected by the flaws in the goods.
  • When an Agent Is Involved
    An agent may enter a contract with another party on behalf of a principal. In this case, the principal may not be able to be released on grounds of the privity principle because he was represented in the contract.
  • Trusts
    In some circumstances, an agreement between a trustee and another party may affect the owner.
  • Restrictive Agreements
    In some cases, a restrictive agreement may be enforceable against a third party. This may be the case when owners of a house sell to another person with the understanding that the buyer would not change the design of the house. If the buyer sells the house to a third party and some requirements are met, the third party may be obligated to follow the original owners' conditions.
  • Negligence
    In the case of personal injury resulting from negligence, the negligent party may generally be sued by third parties who are not parties to any contract with the negligent party.
  • Assignment of the Contract
     In some cases, benefits from a contract may be assigned to another party.
  • Insurance Companies
    A third party involved in an automobile accident with an insured vehicle may, in some cases, sue the insurance company when he gets a favorable court ruling against the vehicle owner.

Another legal principle similar to privity is issue preclusion. Issue preclusion, also known as collateral estoppel or res judicata, prohibits an entity from litigating an issue more than once.

Third-Party Beneficiary Rights

One major exception to the privity principle occurs when a third party is an intended beneficiary of a contract. Under the third-party beneficiary doctrine, a person who was not a party to a contract but is intended to benefit from it may have the right to enforce it. Courts typically distinguish between:

  • Intended beneficiaries – those explicitly meant to benefit from the agreement (e.g., a life insurance policy naming a beneficiary).
  • Incidental beneficiaries – those who benefit indirectly and cannot enforce the contract.

If it can be shown that the contracting parties intended to confer a benefit upon the third party, that third party may gain the right to sue for enforcement of the contract.

Statutory Exceptions to Privity

In many jurisdictions, statutory frameworks have evolved to override the privity rule in specific areas. For example:

  • Consumer protection laws often grant rights to consumers even if they were not direct parties to the sales contract.
  • Employment law may allow employees to sue third-party insurers or benefit providers based on legislation, despite a lack of direct contractual relationship.
  • Contract (Rights of Third Parties) Act 1999 (UK) – this legislation allows a third party to enforce a contract if the contract expressly allows it, or if the contract purports to confer a benefit on them.

Such statutes significantly expand the number of circumstances in which privity is bypassed.

Promissory Estoppel and Reliance

Promissory estoppel can act as an exception to privity when a third party has reasonably relied on a promise, and it would be unjust not to enforce the promise. For example, if Party A promises Party B that Party C will receive a benefit, and Party C takes actions in reliance on that promise, courts may find that enforcing the promise is necessary to avoid injustice. This doctrine is particularly useful in commercial and real estate contexts.

Novation Agreements

Novation involves replacing an original party in a contract with a new one, with the consent of all parties involved. When novation occurs:

  • The original contract is extinguished.
  • A new contract is formed.
  • The incoming party assumes all obligations and rights.

Since all involved parties agree to the substitution, the new party is not barred by the privity rule. This allows third parties to step into existing contracts without violating contractual doctrines.

Subrogation in Insurance and Finance

Subrogation allows a third party—typically an insurer—to step into the shoes of a contractual party to enforce a right or claim. For instance, after an insurance company pays out a claim to the insured, it may pursue the at-fault third party who caused the loss. Even though the insurer wasn't an original party to the contract between the insured and the third party, it gains legal standing through subrogation.

Real Property and Covenants Running with the Land

In real estate, privity does not always apply strictly, especially with covenants that “run with the land.” These are agreements tied to the land itself, not just the contracting parties. When land is sold, these covenants may bind future owners or allow them to enforce terms of the original agreement, depending on statutory or common law principles in that jurisdiction.

Public Contracts and Government Immunity

Contracts involving government entities sometimes create enforceable rights for third parties, such as citizens or service beneficiaries. In these cases:

  • Courts may allow individuals to sue under certain public contracts if they are the intended beneficiaries.
  • However, sovereign immunity or legislative limitations may still apply, requiring careful legal analysis.

This area is nuanced and varies significantly by jurisdiction.

Frequently Asked Questions

  1. What is the privity of contract rule in simple terms?
    A1: It's a legal principle stating that only parties to a contract can enforce or be bound by its terms.
  2. Can a third party sue under a contract?
    A2: Yes, in certain exceptions like third-party beneficiary rights, statutory rights, or when subrogation applies.
  3. What is an example of a third-party beneficiary?
    A3: A life insurance policyholder names a beneficiary who can claim benefits even though they weren't a party to the contract.
  4. How does assignment affect privity of contract?
    A4: Assignment transfers rights under a contract to another party, who may then enforce those rights despite not being an original party.
  5. When should I consult a lawyer about privity issues?
    A5: When dealing with contracts involving multiple parties, government contracts, or insurance disputes—legal interpretation is crucial. You can find an experienced attorney through UpCounsel.

If you need help with the privity principle, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.