Privity of Contract

What is Privity of Contract?

Privity is a legal term for a close, mutual, or successive relationship to the same right of prosperity or the power to enforce a promise. Privity of Contract is the relationship that exists between the parties to an agreement. According to G.H. Trietel, “The Common Law Doctrine of Privity means that a person cannot acquire rights or subject to liabilities arising under a contract to which he is not a party.”

As a general rule the contractual rights and liabilities affect only the parties to the contract and a person who is not a party can neither sue nor be sued on the contract. A contract cannot usually give rights or impose obligations on anyone who is not a party to the contract.

The Doctrine of Privity consists of two distinct rules -

• A person who is not a party to the contract cannot claim the benefit of it although the contract was entered into with the object of benefitting that third party.
• A third party cannot be subjected to a burden by contract to which he is not a party. Thus, a person cannot acquire rights under a contract to which he is not a party.

Official Definition of the Term

The Indian Contract Act of 1872 was established based on these principles of Doctrine of Privity of Contract. However, the definition of Privity of Contract and Privity of Consideration is different under Indian law. It states that consideration can shift to a third party also, which means that both a promisee and a third party can also provide consideration. Consequently, according to Indian Contract law, a person stranger to consideration can sue one of the parties.

It is defined in section 2(d) of the Indian Contract Act 1872. Consideration is considered as the foundation of every contract, and it forms the basis of it. Privity of consideration states that only a person who has provided consideration can enforce the contract and take action against it.

The law entitles only those who are parties to the contract can file suits for exercising their rights. This is known as the Privity of Contract. This law of contract creates jus in personam as distinguished from jus in rem. Therefore, a stranger to a contract cannot sue for a contract to which he was not in privity. Hence, the Indian Contract Act, 1872 does not allow a stranger to file a suit on the contract. Only a person who is a party to the contract holds the right to sue.

Essentials of Privity of Contract

• Agreement: Privity of contract requires that there is an agreement between two or more parties. This agreement must be supported by consideration, which means that each party must give something of value to the other party.
• Capacity: The parties to the contract must have the capacity to enter into a contract. This means that they must be of legal age, of sound mind, and not under any duress or undue influence.
• Identification of parties: The parties to the contract must be clearly identified. This means that there must be a clear indication of who the parties are, and what their respective roles and obligations are under the contract.
• Intention to create legal relations: There must be an intention on the part of the parties to create legal relations. This means that the parties must intend that the agreement be legally binding and enforceable.
• Privity: The principle of privity of contract requires that only parties to a contract have rights and obligations under the contract. This means that no third party can claim a right under the contract, nor can they sue for its breach.

Types of Privity of Contract

The concept of privity can be further categorized into horizontal privity and vertical privity, each describing different relationships between parties involved in contractual agreements.

Horizontal privity occurs when two parties have a mutual interest in the same subject matter, often seen in agreements where benefits are intended for a third party. For instance, if a manufacturer sells goods to a distributor, who then sells them to a retailer, horizontal privity exists between the manufacturer and distributor, as well as between the distributor and retailer. However, there is no direct privity between the manufacturer and the retailer; thus, the retailer cannot enforce any terms against the manufacturer despite receiving benefits from the contract. Consider a scenario where a manufacturer (Party A) sells products to a distributor (Party B), who subsequently sells those products to a retailer (Party C). In this case, horizontal privity exists between Party A and Party B, and between Party B and Party C. However, there is no privity directly between Party A and Party C, meaning Party C cannot hold Party A liable for any issues with the product.

On the other hand, vertical privity refers to the relationship between two parties in a contractual chain, where one party has an independent contract with another individual or corporation. This type of privity typically involves situations where property rights or benefits are transferred down a chain of ownership. Using the previous example, if Party B (the distributor) sells their business to another entity (Party D), vertical privity is established between Party A (the manufacturer) and Party D (the new distributor). Here, Party D can enforce certain rights against Party A based on their relationship through Party B.

The implications of these forms of privity are significant. Understanding horizontal and vertical privity helps clarify which parties have rights and obligations under various contractual arrangements.

Case Laws Featuring Privity of Contract

The major points of the Doctrine of Privity of Contract emerged after the Tweddle vs. Atkinson case. Here John Tweddle and William Guy agreed that both of them would pay a sum of money to Tweddle’s son, who was engaged to marry the daughter of Williams. However, before making any payment, William passed away. As William failed to fulfil his obligation, Tweddle’s son sued William’s property executor over the unfulfilled obligation which was promised before the death of William, but the court held that a third-party beneficiary cannot enforce the contract as it was made between William and Tweddle, and Tweddle’s son was not a party to the contract.

In the case of Dunlop Pneumatic Tyre Co Ltd v. Selfridge & Co Ltd (1915), the House of Lords tackled the principle of privity of contract, which dictates that only parties involved in a contract can enforce its terms. Dunlop Pneumatic Tyre Company, a manufacturer, had an agreement with its dealer, Dew & Co., stipulating that Dew would not sell Dunlop's tyres below a specified retail price. This agreement included a clause stating that if Dew's retailers (including Selfridge) sold below this price, they would owe Dunlop £5 per tyre in damages. When Selfridge sold the tyres at a lower price, Dunlop sought to sue Selfridge for breach of contract, aiming to enforce the terms of the agreement between Dew and Selfridge.

The House of Lords ruled that Dunlop could not enforce the contract against Selfridge because it was not a party to the agreement between Dew and Selfridge. The court emphasized that only parties to a contract can sue or be sued on its terms, thereby reaffirming the doctrine of privity of contract. This case established that a third party cannot enforce contractual obligations unless there is a direct contractual relationship or consideration between them and the party being sued. As a result, Dunlop's claim was dismissed, reinforcing the strict application of privity in contract law at that time.

This ruling has since been modified by subsequent legislation, such as the Contracts (Rights of Third Parties) Act 1999, which allows third parties to enforce certain contracts under specific conditions.

Difference in India and United Kingdom's Doctrine of Privity

Historically, the rigid application of privity led to numerous injustices, where third parties who were clearly intended beneficiaries of a contract were unable to enforce its terms. High-profile cases like Beswick v. Beswick highlighted these issues. In this case, an uncle arranged for his nephew to pay a certain amount to his widow upon his death, but when the nephew refused to honor this obligation, the widow could not claim her rights due to the privity rule. Such situations prompted widespread criticism from legal scholars and members of the judiciary, who argued that the doctrine was outdated and often resulted in unfair outcomes. The call for reform began as early as 1937 with the Law Revision Committee's recommendations, but it took several decades for substantial legislative action to occur. The Law Commission's reports in the 1990s further emphasized the need for change, culminating in the introduction of the Contracts (Rights of Third Parties) Bill.

Unlike the UK’s Contracts (Rights of Third Parties) Act 1999, which allows third parties to enforce contractual terms under specific conditions, India does not have similar legislation. This means that as per the Indian Contract Act, 1872, a contract cannot confer rights or impose obligations on anyone who is not a party to it. This means that third parties typically cannot enforce contractual terms unless they are directly involved in the agreement. However, Indian courts have occasionally allowed third-party claims when there is clear evidence that the parties intended to confer rights upon them but these instances are limited and depend heavily on the specific facts and wording of the contract.

Exceptions to Privity of Contract in India

A stranger or a person who is not a party to a contract can sue on a contract in the following cases. There are exceptions to the general rule, allowing rights to third parties and some impositions of obligations.

1. Trust - If a contract is made between the trustee of a trust and another party, then the beneficiary of the trust can sue by enforcing his right under the trust, even if he is a stranger to the contract. To illustrate, Arjun’s father had an illegitimate son, Ravi. Before he died, he put Arjun in possession of his estate with a condition that Arjun would pay Ravi an amount of Rs 500,000 and transfer half of the estate in Ravi’s name, once he becomes 21 years old.

1. Family Settlement -If a contract is made under a family arrangement to benefit a stranger (person not a party to the contract), then the stranger can sue in his own right as a beneficiary of the contract.
2. Assignment of a Contract- If a contract is made for the benefit of a person, then he can sue upon the contract even though he is not a party to the agreement. It is important to note here that nominees of a life insurance policy do not have this right.
3. Acknowledgement or Estoppel- If a contract requires that a party pays a certain amount to a third-party and he/she acknowledges it, then it becomes a binding obligation for the party to pay the third-party. The acknowledgment can also be implied.
4. Contract through an agent- If a person enters into a contract through an agent, where the agent acts within the scope of his authority and in the name of the person (principal).

Indian Case Laws featuring Privity of Contract

The landmark case with reference to privity of contract in India is the case of Jamna Das v. Ram Autar Pande, decided on January 24, 1916. The Privy Council addressed the doctrine of privity of contract within the context of a mortgage transaction. The plaintiff, Jamna Das, had previously entered into a mortgage agreement with Musammat Lakhpati Kunwar, who later sold the mortgaged property to the defendant, Ram Autar Pande, while leaving a significant amount of money intended for settling Jamna Das's debt in Pande's hands. After failing to recover his dues through appropriate legal channels against the original mortgagors, Jamna Das sought to hold Pande accountable, claiming he was a trustee for the amount left with him. The Privy Council ruled that there was no trust created in favor of Jamna Das since he was not a party to the transaction between Lakhpati and Pande. The court emphasized that the doctrine of privity meant that only parties to a contract could enforce its terms. Consequently, Jamna Das's claim was dismissed as he could not sue Pande for the debt because he was not privy to the contract between Pande and Lakhpati. This case reinforced the strict application of the privity doctrine in India, highlighting that third parties cannot enforce contractual rights unless they are directly involved in the agreement.

The issue of third-party rights was initially taken up in the case of Lakshmi Ammal v. Sundararaja Iyengar (1914) wherein a promise was made by Lakshmi Ammal's father to cover her marriage expenses, which he later failed to fulfill. Lakshmi Ammal sought to enforce this promise against Sundararaja Iyengar, despite not being a direct party to the contract. The court ruled that Lakshmi Ammal could enforce her father's promise, emphasizing that third parties intended to benefit from a contract have the right to do so. This decision established a precedent in recognizing the rights of intended beneficiaries in family agreements. This case underscores the importance of family arrangements in contract law and affirms that intended beneficiaries can claim rights under contracts made for their benefit.

The case of M.C. Chacko v. State Bank of Travancore (1969) is another key decision in Indian contract law on similar lines, concerning the doctrine of privity of contract and third-party rights. M.C. Chacko was the manager of High Land Bank, which had an overdraft account with Kottayam Bank. To secure repayment, his father, K.C. Chacko executed letters of guarantee and later transferred properties to family members via a deed of gift, stating that any liabilities would be met by M.C. Chacko or the gifted properties. After K.C. Chacko's death, the State Bank of Travancore sought to recover debts from M.C. Chacko, claiming a charge on the properties.

The Supreme Court ruled that no charge had been created in favor of the State Bank under the deed, as it did not intend to convert personal obligations into secured debts for the bank. The court emphasized that since the bank was not a party to the deed, it could not enforce any rights from it, reaffirming that third parties cannot enforce contracts unless they are intended beneficiaries or have legal standing. Additionally, the court noted that M.C. Chacko could not be held liable because the limitation period for enforcing the guarantee had expired. This case highlights the significance of privity in contract law and the limitations on third-party claims.

Way Forward

Over the years, Indian courts have increasingly recognized the limitations of the privity of contract doctrine, acknowledging how its strict application can create challenges for third-party beneficiaries. Cases like Jamna Das v. Ram Autar Pande have underscored these concerns, leading to ongoing discussions about potential reforms that would enable third parties to enforce rights under certain contracts. Despite these discussions, the fundamental principles of privity remain largely unchanged, reflecting a careful balance between upholding contractual freedom and safeguarding the interests of those not directly involved in agreements. As commercial practices continue to evolve, there is a growing consensus that further adjustments to this doctrine may be necessary to better serve contemporary needs and ensure fairness in contractual dealings.