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Hong Kong Law Reform Commission |
1.1 In this chapter, we further explain the doctrine of privity and
illustrate its effect with some real-life examples. We then examine common law
and statutory principles which have the effect of circumventing the doctrine, ie
allowing a third party to enforce a jus quaesitum (a right conferred on
him by the contractual parties). The last part of the chapter looks at judicial
developments in other common law jurisdictions and discusses how those
developments have been received by the Hong Kong courts.
1.2 As
explained in the Preface, the doctrine of privity has two aspects. The first
aspect, which is the crux of our present discussion, is that, as a general rule,
a person cannot acquire and enforce rights under a contract to which he is not a
party. The doctrine of privity at common law is generally considered to have
been established in Tweddle v
Atkinson.[4] The court in
that case held that, in the words of Wightman J, "no stranger to the
consideration could take advantage of a contract though made for his
benefit." [5]
That is to say, a third party to a contract, not having provided
consideration himself, cannot enforce the contract even if it has been
entered into for his benefit. The rule was affirmed in Dunlop Pneumatic Tyre
Co Ltd v Selfridge & Co Ltd
[6] when the House of Lords
accepted that it was a fundamental principle of law that only a party to a
contract who had provided consideration could sue on
it.[7] This "consideration" rule is
related to the doctrine of privity and is regarded as a possible explanation for
the doctrine.[8]
1.3 When
considering the effect of the privity doctrine, account needs to be taken of the
remedy rule: the need to prove loss in an action for breach of contract. When a
plaintiff sues for breach of contract, he must prove that he has suffered actual
loss as a result of the alleged breach. Otherwise, he will only be entitled to
nominal damages. This, when combined with the privity doctrine, could lead to
unjust results in some circumstances. For example, suppose a contract is
entered into between a parent company and a contractor for the benefit of a
subsidiary company. If the subsidiary company subsequently suffers loss as a
result of the contractor's breach, the subsidiary company cannot sue the
contractor because it is not a party to the contract. The parent company, even
though it is a party to the contract, will only recover nominal damages because
it has suffered no actual loss. Hence it is not a viable option for a promisee
(the parent company) to sue the promisor (the contractor). The decision of
Alfred McAlpine Construction Ltd v
Panatown[9] is a good example of
the rule that a person can only recover nominal damages unless he has suffered
actual loss.
1.4 The effect of the first aspect of the doctrine of
privity on everyday life can best be illustrated by some real-life
examples.
1.5 A and B enter into an agreement under which A agrees to pay a sum
of money to C. Both parties fully intend that C should take the benefit of A's
promise. If A defaults, C cannot sue A because of the doctrine of privity. It
does not help for B to sue A for damages since B would be unlikely to have
suffered any damage himself. Sometimes, the Court may be able to prevent an
injustice to C if B is prepared to sue A for specific performance and the Court
is prepared to make an order compelling A to perform his promise.
1.6 A property developer enters into a building contract with a
contractor under which the contractor promises to use good workmanship and sound
materials. The contractor warrants that he would make good any defects in the
building within a stated period of, say, twelve months. Shortly before
completion of the building, the developer sells individual units to purchasers.
If a purchaser of a unit discovers a defect in his flat, he has no direct
recourse against the building contractor. This is still the case even though
the developer may have obtained the building contractor's warranties
specifically for the benefit of purchasers, since purchasers are not "privy" to
the building contract. In practice, a developer may withhold part of the
payment to the building contractor to ensure that the building contractor
honours its promise. The developer may also contract with the purchaser that it
would exercise its best endeavours to enforce all defects and maintenance
obligations under all contracts relating to the construction of the
development.[10] Nevertheless, a
purchaser may find himself in a poor bargaining position because his only direct
recourse, if any, is against the developer. Even that would depend upon the
terms of his contract with the developer and on whether the developer is still
around to honour its promise. In certain
circumstances[11], the contract
between a developer and the purchasers may provide that where the developer is
wound up, all warranties and guarantees under all contracts relating to the
construction of the development would be assigned by the developer to the
owners' corporation incorporated under the Building Management Ordinance (Cap
344) or if no such corporation exists to the manager of the development for the
time being to be held in trust for purchasers of the units in the development.
This recourse against the contractor is indirect, and an individual purchaser
may, however, encounter difficulties in compelling the owners’ corporation
or the manager of the development to sue the contractor.
1.7 B is a sub-contractor of A. B takes out an insurance policy to
cover his and A's liability to employees' compensation with an insurer (C),
without joining A as a party. An employee of B is injured in the course of
employment because of the negligence of A's employee. A pays the required
compensation to B's employee. A, however, will have difficulties in seeking
indemnity from C, since A is not a party to the insurance contract even though
the parties intend to benefit him.
1.8 As illustrated in the above examples, strict adherence to the
privity doctrine can prove artificial and contrary to the parties' intention,
and can lead to injustice and inconvenience. There are, however, circumstances
in which the doctrine does not apply, either because of supervening principles
of common law or because of specific statutory provisions which allow a third
party to enforce a right conferred on him by the contracting parties. The
following paragraphs will first explain the principles at common law, followed
by those in statutes. The merits and limits of employing these common law and
statutory principles as options for reforming the privity doctrine are discussed
under "Option 1" and "Option 2" respectively in Chapter 3 where other possible
options for reform are also considered.
1.9 Covenants in a lease can benefit third parties who later acquire
an interest in the property. Hence a person may be able to enforce a covenant
affecting land made by his predecessor in title even though he was not a party
to the covenant, and a covenant may be enforced against someone acquiring land
with notice that it is burdened with a
covenant.[12]
1.10 A trust is an equitable obligation to hold property on
behalf of a beneficiary. A chose in action may be the subject matter of a
trust. For example, if A makes a promise to B to pay a sum of money to C, a
trust of that promise can be construed as created by B in equity in favour of C.
In such case, B would be the trustee while C would be the beneficiary under the
trust. If this agreement is construed by the court as a properly constituted
trust, C can, in his capacity as beneficiary, sue A to enforce the promise.
Though C is not a party to the promise made by A to B, C could nonetheless
enforce the promise in equity.
1.11 However, the use of this trust
device to circumvent the doctrine of privity has its restrictions. A promisee
(ie B in the example quoted above) is not a trustee for a third party unless he
manifests an intention to create a
trust.[13] Where the word "trust"
or "trustee" is not used, there may be difficulties in determining whether or
not there is the requisite intention to create a trust. Moreover, there must be
an intention to benefit the third party. If the promisee intends the promise to
be for his own benefit, there will not be any trust created in favour of the
third party.[14] The main
difficulty of using the trust device is that the court has confined its usage
within narrow limits. The trust device has so far been applied only to promises
to pay money or to transfer
property.[15] According to Sir
Guenter Treitel, the trust device has therefore been treated as an exception to
the doctrine of privity but is of limited and uncertain
scope.[16]
1.12 A contract between A and B may, in addition to creating
contractual obligations between the parties, impose on B a duty of care towards
a third party, C, under the law of tort. Breach of a duty of care on the part
of B may render him liable to C for
negligence.[17]
1.13 A contract between two parties may be accompanied by a
collateral contract between one of them and a third party. For instance, A may
enter into a contract of repair with B which specifies the use of the paint
manufactured by C because of its special quality. If the paint supplied does not
have that quality, A cannot sue C on the contract of sale of the paint to B
because A is not privy to the
contract.[18] The Court may,
however, resort to the device of a collateral contract between A and C under
which C would be held to have warranted to A the quality of the paint in
consideration A's agreement with B to buy the paint.
1.14 A person who is entitled to the benefit of a contract may
transfer the benefit to another person who is not a party to the contract. This
process is known as assignment, and the consent of the party liable under the
contract is not needed. An assignment may be seen as a circumvention of the
privity doctrine because the person bearing the burden of the contract becomes
liable to a person with whom he had no contractual relationship and whom he may
not have intended to benefit.
1.15 Agency is the relationship between two persons, by agreement or
otherwise, where one (the agent) may act on behalf of the other (the principal).
One consequence is that the principal acquires rights and incurs liabilities
under the contract made by the agent on his behalf with third parties, even
though the principal is not a party to the contract. Agency is sometimes looked
upon as only an apparent exception to the doctrine of privity because in an
agency the agent is only the instrument of the principal, who is the real
contracting party.[19] This view
may be true if the agent acts within his actual authority, but where, for
example, the principal's identity is not disclosed, an established agency is a
clear exception to the doctrine of
privity.[20]
1.16 Section 41 of Cap 219 provides that a covenant is
enforceable not only by the parties but also by the convenantee's successors in
title, assigns, lessees and mortgagees. Section 26 of Cap 219 provides:
"[a] person may take an immediate or other interest granted to him in land or the benefit of any condition, right of entry, covenant or agreement granted to him over or in respect of land, although he may not be named as a party to the instrument."
1.17 Under Cap 273, a third party may in specified circumstances step
into the shoes of the insured and enforce his rights under the policy by suing
the insurance company directly. According to section 2, where a person who is
insured against liabilities to third parties under a contract of insurance
becomes bankrupt, makes a composition or an arrangement with his creditors, or
is wound up, his rights under the contract of insurance are transferred to the
third party to whom the liability was incurred. In other words, the third party
has a direct cause of action against the insurer.
1.18 A person with a limited interest in property may insure and
recover its full value, holding any amount above his own interest on account for
others similarly interested. Section 14(2) of Cap 329 provides
that:
"A mortgagee, consignee or other person having an interest in the subject-matter insured may insure on behalf and for the benefit of other persons interested as well as for his own benefit."
1.19 A bill of exchange is defined in section 3(1) of Cap 19
as:
"an unconditional order in writing, addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand or at a fixed or determinable future time a sum certain in money to, or to the order of, a specified person or to bearer."
Under
section 38(a), a holder of a bill of exchange may sue on the bill in his own
name. A holder of a bill of exchange means a payee or an indorsee of a bill who
is in possession of the bill, or a bearer of the bill (section 2).
1.20 Where goods sold are to be delivered by sea, the seller will
enter into a contract of carriage with the carrier, which is evidenced by a bill
of lading. The goods are then consigned to the buyer, to whom the bill of
lading is endorsed. At common law, a buyer of goods carried by sea cannot sue
the carrier on the contract of carriage because there is no privity between
them. However, under section 4(1) of Cap 440 a lawful holder of a bill of
lading has "all rights of suit under the contract of carriage as if he had
been a party to that contract". In other words, the buyer can sue
the carrier direct, notwithstanding that he was not a party to the contract of
carriage.[21]
1.21 There have been recent judicial developments in Canada and
Australia relaxing the strict doctrine of privity. Although these overseas
judicial developments are not binding on courts in Hong Kong, the fact that they
represent the judicial opinion of the superior courts in other major common law
jurisdictions may have some impact on local judicial thinking. In the following
paragraphs, we first explain these overseas judicial developments, and then
discuss how the Hong Kong courts have received them.
1.22 Two recent judgments of the Supreme Court of Canada have
modified the law relating to privity: London Drugs Ltd v Kuehne & Nagel
International Ltd [22] and
Fraser River Pile & Dredge Ltd v Can-Dive Services Ltd
[23]. In the "Fraser
River" case, a third party beneficiary sought to rely on a contractual
provision so as to defend against an action brought by one of the contractual
parties (the insurer). The court held that the third party beneficiary was
entitled to rely on the waiver of subrogation clause whereby the insurer
expressly waived any right of subrogation against the third party beneficiary.
Iacobucci J emphasised that in appropriate circumstances the courts should not
abdicate their judicial duty to decide on incremental changes to the common law
which were necessary to address emerging needs and values in
society.[24] In the "London
Drugs Ltd" case, employees of a warehouseman sought to rely on the
limitation of liability clause in the contract between their employer and the
client (the bailor) when the employees were sued by the bailor. The Supreme
Court held that the privity rule could be relaxed where the parties to the
contract had, expressly or by implication, intended the relevant provision to
confer a benefit on the third parties (the employees), and the action taken out
by the third parties came within the scope of the agreement between the initial
parties. The employees fulfilled these two conditions, and thus could benefit
from the limitation clause, despite the privity doctrine. The court recognised
a limited exception to the doctrine in the circumstances of the case so as to
conform to "commercial reality and
justice".[25]
1.23 The decision of the High Court of Australia in Trident
General Insurance Co Ltd v McNiece Bros
Propretary[26] has
relaxed the strictness of the doctrine. The importance of this case is its
implications for the privity doctrine in Australia
generally.[27]In this case, the
respondent (McNiece) was the principal contractor for construction work being
carried out at the limestone crushing plant of a company which took out a public
liability insurance policy with the appellants (Trident) covering itself and all
contractors and sub-contractors. A person injured at the construction site
recovered damages from McNiece, which in turn brought an action against Trident
to seek indemnity for the amount of damages paid. The High Court of Australia
held that McNiece was entitled to seek indemnity form Trident even though
McNiece was not a party to the insurance contract.
1.24 In the High
Court of Australia, three of the Justices criticised the doctrine of privity.
Mason CJ and Wilson J (who delivered their judgment jointly) were of the view
that there was "much substance" in the criticisms directed at the
doctrine of privity.[28] Toohey J
considered that:
"the law which precludes him [ie a non-party assured] from doing so [ie suing the insurer] is based on shaky foundations and, in its widest form, lacks support both in logic or in jurisprudence".[29]
1.25 Mason
CJ, Toohey and Wilson JJ decided the case on the basis of a specific abrogation
of the privity rule in relation to insurance contracts. Mason CJ and Wilson J
put forward their arguments as follows:
"In the ultimate analysis the limited question we have to decide is whether the old rules [of privity] apply to a policy of insurance. The injustice which would flow from such a result arises not only from its failure to give effect to the expressed intention of he person who takes out the insurance but also from the common intention of the parties and the circumstances that others, aware of the existence of the policy, will order their affairs accordingly ... In the nature of things the likelihood of some degree of reliance on the part of the third party in the case of a benefit to be provided for him under an insurance policy is so tangible that the common law should be shaped with that likelihood in mind."[30]
1.26 The "Trident" case was considered in B + B
Construction Ltd v Sun Alliance and London Insurance
Plc,[31] the facts of
which were similar to those of the "Trident" case. Pak Kee, a
sub-contractor, took out an insurance policy with an insurer (the defendant),
and the "insured" was described in the contract as "Pak Kee and his
contractors". An employee of Pak Kee was injured because of the negligence of
an employee of the principal contractor (the plaintiff), which was then held
liable to pay damages for negligence and to reimburse Pak Kee for employee's
compensation. The plaintiff brought an action against the defendant as the
insurer for an indemnity. Since the defendant did not take the point that the
plaintiff was not a party to the insurance contract, the Hong Kong Court of
Appeal proceeded on the footing that the plaintiff's claim, if otherwise good,
was enforceable in the usual way. Hence, at issue was whether the scope of the
indemnity extended to the
plaintiff.[32] Godfrey VP
(with whom Ribeiro JA agreed) nonetheless stated incidentally:
"[the court is] aware of the judicial abrogation of the rule effected in Australia by the decision of the High Court (split 4 to 3) in [the "Trident" case], a case the facts of which bear many similarities to our own. ...But here, in Hong Kong, the law remains as magisterially stated by Viscount Haldane LC in Dunlop Pneumatic Tyre Co Ltd v Selfridge & Co Ltd [1915] AC 847 at 853: '... only a person who is a party a contract can sue on it. Our law knows nothing of a jus quaesitum tertio...' ".[33]
1.27 No
Hong Kong case can be found in which the "Fraser River" case has been
considered. The Privy Council in Re the
Mahkutai[34] mentioned both the
"Trident" case and the "London Drugs Ltd" case. Lord Goff
of Chievely of the Privy Council stated in an obiter
dictum:
"the time may well come when, in an appropriate case, it will fall to be considered whether the courts should take what may legitimately be perceived to be the final, and perhaps inevitable, step in this development, and recognize in these cases a fully-fledged exception to the doctrine of privity of contract, thus escaping from all the technicalities with which courts are now faced in English law. It is not far from their Lordships' minds that, if the English courts were minded to take that step, they would be following in the footsteps of the Supreme Court of Canada (see [the "London Drugs Ltd" case]) and, in a different context, the High Court of Australia (see [the "Trident" case]). Their Lordships have given consideration to the question whether they should face up to this question in the present appeal. However, they have come to the conclusion that it would not be appropriate for them to do so, first, because they have not heard argument specifically directed towards this fundamental question, and second because, as will become clear in due course, they are satisfied that the appeal must in any event be dismissed."
The
Privy Council here raised the possibility of "a fully-fledged exception" to the
privity doctrine. Nevertheless, as Godrey VP reiterated in the "B + B"
case, the privity doctrine is still part of the Hong Kong law.
[4] (1861) 1 B & S 393.
Kepong Prospecting Ltd v Schmidt [1968] AC 810, a decision of the Privy
Council on appeal from Malaysia, seems to support the view that the doctrine of
privity is distinct from the rule that consideration must move from the
promisee. G Treitel, The Law of Contract, Sweet and Maxwell,
11th Edition, 2003, at
587.
[5] (1861) 1 B & S 393,
at 397.
[6] [1915] AC 847.
[7] The existence of the doctrine of privity was, however, later doubted by Denning LJ in Smith and Snipes Hall Farm Ltd v River Douglas Catchment Board [1949] 2 KB 500 in 1949 and Drive Yourself Hire Co (London) Ltd v Strutt [1954] 1 QB 250 in 1954. See also G Treitel, The Law of Contract (cited above), at 588. However, the House of Lords (with Lord Denning dissenting) once again affirmed the existence of the doctrine of privity in 1961 in Sruttons Ltd v Midland Silicones Ltd [1962] AC 446.
[8] G Treitel, The Law of
Contract (cited above), at pages 588. Chapter 2 will discuss whether the
rationale is valid, and will also critically discuss other possible reasons for
supporting the privity
doctrine.
[9] [2001] 1 AC 518.
[10] R5C(2)-(5) of the Solicitors’ Practice Rules (Cap 159); Circular No 04-53 (PA) of the Law Society of Hong Kong and Circular Memorandum No.40A of the Legal Advisory and Conveyancing Office <http://www.info.gov.hk/landsd/download/html/40a.html> (last visit on 7 April 2004).
[11] R5C(2)-(5) of the Solicitors’ Practice Rules (Cap 159); Circular no 04-53 (PA) of the Law Society of Hong Kong and Circular Memorandum No.40A of the Legal Advisory and Conveyancing Office <http://www.info.gov.hk/landsd/download/html/40a.html> (last visit on 7 April 2004)..
[12] Tulk v Moxhay (1848)
2 Ph 774.
[13] Swain v Law
Society [1983] 1 AC 598, at 620.
[14] G Treitel: The Law of Contract (cited above), at 648.
[15] G Treitel: The Law of Contract, (cited above), at 650.
[16] G Treitel: The Law of Contract (cited above), at 650
[17] Dononghue v Stevenson [1932] AC 562.
[18] Shanklin Pier Ltd v
Detel Products Ltd [1951] 2 KB
854.
[19] G Treitel, The Law
of Contract, (cited above), at 645.
[20] According to Sir Guenter Treitel, other scenarios are where an agent acts without actual but within his "usual" authority and in certain cases of agency of necessity. G Treitel, The Law of Contract, (cited above), at 646.
[21] At common law, where a
carrier delivers the goods to a buyer, an implied contract may arise from the
carrier's attornment to the buyer and the buyer's acceptance of the goods, to
the effect that the goods were delivered in the same apparent good order and
condition as when received by the carrier. This device enables a third party to
sue the carrier on an implied contract having similar (but not necessarily
identical) terms to those in the bill of lading. See Brandt v.
Liverpool [1924] 1 KB
275.
[22] (1992) 97 DLR
(4th) 261
[23] [2000]
1 Lloyds Rep 199
[24] [2000] 1 Lloyds Rep 199, at
208 (para 44). "[T]he Courts may... ,bound by both common sense and
commercial reality, ... determine whether the doctrine of privity... should be
relaxed in the given circumstances" (See The Canadian Encyclopedic
Digest: Ontario, 3rd Edition, at Title 32 Contracts, para
58.1).
[25] S Waddams, The
Law of Contracts, 4th Edition, 1999, Canada Law Book Inc, at
202.
[26] [1987-1988] 165 CLR
107
[27] Carter and Harland,
Contract Law in Australia, 4th Edition, 2002, Butterworths, at
352.
[28] [1987-1988] 165 CLR
107, 118.
[29] [1987-1988] 165
CLR 107, 168.
[30] [1987-1988]
165 CLR 107, 123-4.
[31] [2000]
2 HKC 295.
[32] [2000] 2 HKC 295, at 301 I
to 302 D. The plaintiff lost and appealed to the Court of Final Appeal ([2001]
3 HKC 127) which also decided on the scope of the indemnity, without even
mentioning the privity
doctrine.
[33] [2000] 2 HKC 295,
at 301B to 301F.
[34] [1996] 2
HKC 1.