Rule of Privity of Contract: Everything You Need to Know
The rule of privity of contract means that only parties to a contract may enforce the terms of said contract.3 min read
The rule of privity of contract means that only parties to a contract may enforce the terms of said contract. Common law states that an individual or group not privy (party) to a contract may not benefit from the contract nor be held liable under the contract. In other words, a person who is likely to gain something of value from the contract (also known as a third party beneficiary) has no legal right to take any contract enforcing action if they do not receive the promised benefits.
History of Privity of Contract
In the past, common law found many complications pertaining to enforcing contractual terms by a party not privy to that contract, largely due to issues associated with ancillary contract law terms requiring acceptance and consideration. At last, in 1861, the courts found a definitive answer with the Tweddle v Atkinson case. In this case, Justice Wightman stated that "no stranger to the consideration can take advantage of a contract, although made for his benefit."
Although these words are cited often, their fundamental meaning is not always assumed correctly. It's not that a third party absolutely cannot benefit from another's contract; it's that unless a party is privy to a contract, they won't legally be able to enforce it.
Damages and Specific Performance
Common law dictates that if a breach of contract has been proven, damages shall be granted to the plaintiff. However, the key issue is the amount of damages that will be recovered.
In contrast to common law damages, there's no guarantee that specific performance will be granted to a plaintiff once a breach of contract has been proven.
Exceptions to the Rule of Privity
There are a numerous exceptions to the rule of privity, a few of which are:
- If a completely warranted trust was generated in favor of a third party to a contract, they may enforce the contract.
- An "agent" is a party that enters into an agreement on behalf of another party, the "principal." The Law of Agency dictates that an agent can designate a principal acting on their behalf. The principal may sue or be sued by a third party.
- Any legal agreement entered into by a married individual that expressly offers a benefit to their spouse or child may be enforced by the spouse or child.
- Assignments and collateral warranties are particularly applicable in construction and contracting law. Collateral warranties bind third parties, such as subcontractors, architects, and engineers, to a construction project. Assignments grant sellers the option to assign their contractual benefits onto the purchaser.
- A collateral contract may exist when one party enters a contract with two other parties. The court may assume a collateral contract exists between the two other parties.
- A party may expressly state that the contractual benefit is held through them in a trust for a third party. As a result, the third party also has a right to the contractual benefit.
- Privity of Contract is not applicable to restrictive covenants, as long as they are documented in the land registrar.
- The Unfair Contract Terms Act 1977 contains the most significant limitation on exemption clauses, which are statutory.
Rule of Privity of Contract and Rules of Consideration
Under the rules of consideration, consideration must be presented from a promisee. This is somewhat similar to the rule of privity, as only the parties actually entered into the contract and who have offered consideration are able to benefit from the agreement.
The 1999 Act
The 1999 Act is intended to limit the application of the principle of contract rule, especially in certain circumstances. This made an important change to how third parties can legally enforce a contract.
One of the first applicable cases was Nisshin Shipping Co Ltd v Cleaves & Co Ltd, which raised important questions in the shipping field related to the manner in which a third party (in this case, a chartering broker) could legally enforce a promise of benefit for them in the charter parties, which contained an arbitration clause. Under s. 7 of the 1996 Arbitration Act, the ship-owner challenged the jurisdiction of the arbitrator in order to determine the chartering broker's demand for the time charters' commission due. The judge concluded that "the purpose of the clause was to confer a benefit to the extent of 1 percent commission on Cleaves alone." Thanks to the 1999 Act, the broker was able to enforce their claim against the ship-owner as a promisor, thanks to the arbitration clause.
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