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Hong Kong Law Reform Commission |
Legal principles which have the effect of allowing third parties to enforce rights |
How the |
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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 and 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
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.[1]
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." [2]
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 [3] 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.[4] This "consideration" rule is
related to the doctrine of privity and is regarded as a possible explanation
for the doctrine.[5]
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[6]
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 the developer would exercise its best endeavours to enforce all
defects and maintenance obligations under all contracts relating to the
construction of the development.[7] 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[8], 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, however, and an individual purchaser may 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.[9]
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 that
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.[10] 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.[11] 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.[12] 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.[13]
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.[14]
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.[15] 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 of 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.[16] 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.[17]
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.[18]
1.21 There
have been recent judicial developments in
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 [19]
and Fraser River Pile & Dredge Ltd v
Can-Dive Services Ltd [20]. In the
1.23 The
decision of the High Court of Australia in Trident
General Insurance Co Ltd v McNiece
Bros Propretary[23] has relaxed the strictness of the
doctrine. The importance of this
case is its implications for the privity doctrine in
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.[25] 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".[26]
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 the 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."[27]
1.26 The
Trident case was considered in B + B Construction Ltd v Sun
Alliance and London Insurance Plc,[28]
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.[29] 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
1.27 No
"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 Godfrey VP reiterated in the B + B case, the privity doctrine is still part of the Hong Kon
[1] (1861)
1 B & S 393. Kepong Prospecting Ltd v Schmidt [1968] AC
810, a decision of the Privy Council on appeal from
[2] (1861) 1 B
& S 393, at 397.
[3] [1915]
AC 847.
[4] 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.
[5] 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.
[6] [2001] 1 AC
518.
[7] 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 27 June 2005).
[8] 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 27 June 2005).
[9] Tulk v Moxhay (1848) 2 Ph 774.
[10] Swain v Law Society [1983] 1 AC 598, at
620.
[11] G
Treitel: The Law of Contract (cited
above), at 648.
[12] G
Treitel: The Law of Contract, (cited
above), at 650.
[13] G
Treitel: The Law of Contract (cited
above), at 650
[14] Dononghue v Stevenson [1932] AC 562.
[15] Shanklin Pier Ltd v Detel Products Ltd
[1951] 2 KB 854.
[16] G Treitel, The Law of Contract, (cited above), at
645.
[17] 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.
[18] 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.
[19] (1992) 97 DLR (4th)
261
[20] [2000] 1 Lloyds
Rep 199
[21] [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).
[22]
[23] [1987-1988] 165 CLR 107
[24] Carter and
Harland, Contract Law in
[25] [1987-1988] 165 CLR 107, 118.
[26] [1987-1988] 165 CLR 107, 168.
[27] [1987-1988] 165 CLR 107, 123-4.
[28] [2000] 2 HKC 295.
[29] [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.
[30] [2000] 2 HKC 295,
at 301B to 301F.
[31] [1996] 2 HKC 1.