Chapter 2 - Should the privity doctrine be reformed?

 

Arguments against reforming the privity doctrine

Third party should not be able to sue in the absence of consideration

Contracts are personal transactions

Undesirable to subject promisor to two actions

Unjust that the third party can sue on the contract but cannot be sued

Limits freedom of the contracting parties to rescind or vary and exposes them to a wide range of possible third party plaintiffs

Arguments for reforming the privity doctrine

Frustrating parties' intention to benefit third parties

The privity doctrine is unduly complex, uncertain and artificial

The person who has suffered the loss cannot sue, while the person who has suffered no loss can sue

The injustice to a third party who has relied on the promise

Widespread and continuous criticism of the doctrine, and abrogation of the doctrine in other jurisdictions

Conclusion

 

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2.1           We examined in the last chapter the current law on the privity doctrine.  This chapter examines the arguments for and against reforming the doctrine, and sets out the reasons for our conclusion that the doctrine should be reformed.  In identifying the arguments for and against reform, we have been greatly assisted by the detailed examination of those arguments in the consultation paper on privity of contract published in 1991 by the Law Commission in England and Wales (the "Law Commission"), and we make extensive reference to that paper in this chapter.[1]

 

 

Arguments against reforming the privity doctrine

 

Third party should not be able to sue in the absence of consideration

 

2.2           The idea that a contract requires consideration leads naturally to the view that a stranger to a contract cannot take advantage of its terms because he has not provided consideration.  To put matters another way, since a promisee must provide consideration, it would be unreasonable to place a third party who has not provided consideration in a better position than a promisee who has not provided consideration.[2]  In commenting on the Sub-committee’s consultation paper, the Hong Kong Federation of Insurers also subscribed to this view.

 

2.3           In the Law Commission's opinion, whilst the privity doctrine determines the question of who may enforce a contract, the doctrine of consideration decides which promises may be enforced.[3]  There is a bargain (a valid contract) if consideration has been given, since the promisor's promise has been "paid for", albeit by the promisee and not the third party.  The fact that there has been consideration means that the third party can potentially acquire rights under the contract.  This contrasts with the case where the promisee has given no consideration: in that case, there is no valid contract.  We agree with the Law Commission that the "consideration" rule should not be confused with the privity doctrine.  It is thus unconvincing to seek to justify the privity doctrine on the basis of a lack of consideration moving from the third party.

 

 

Contracts are personal transactions

 

2.4           Another argument is that the ambit of a contract should extend only to those who agree on its terms and scope (ie, the contracting parties), rather than any third party beneficiary.  Contracts are seen as personal transactions affecting only the parties to them.  This is based on the notion that contracts need an element of consent which is provided by making an offer or an acceptance.  Since a third party has, by definition, made neither an offer nor an acceptance, and so has not consented, he should not obtain any contractual rights.[4]  The Hong Kong Federation of Insurers observed in response to the Sub-committee’s consultation paper that it was against the parties’ intention to allow a third party to claim on their contract, and the third party could have been joined as a party to the contract so as to be able to enforce the contract.

 

2.5           The Law Commission, however, argued that the purpose of requiring consent was to protect personal autonomy, and a third party's autonomy would not be undermined when the issue concerned the giving of benefits to (but not imposing burdens on) him.[5]  In addition, where both parties have agreed to benefit a third party, allowing the third party to enforce the agreement gives effect to their intention and, if anything, promotes the autonomy of the parties to the contract rather than the reverse.  Sir Guenter Treitel observes that the privity doctrine can scarcely be justified by saying that a contract is a personal relationship affecting only the parties to it; for this amounts to a restatement of the doctrine rather than a reason for it.[6]  We understand that contracts are personal in nature.  Nonetheless, if the parties intend to benefit a third party, their wishes as stipulated in the contract should be respected.  The law should give effect to the parties' intention.

 

 

Undesirable to subject promisor to two actions

 

2.6           If a third party can enforce the promise, the promisor will be liable to be sued by both the promisee and the third party.  It could be argued that it is undesirable for a promisor to be liable to actions from both the promisee and the third party.[7]

 

2.7           The Law Commission considered that this concern could be addressed.  Once a promisee or a third party has enforced the promise made by the promisor, the promisor's liability would disappear and the promisor would not be liable to anyone else.[8]  Experience in other jurisdictions shows that it is possible to devise a rule which protects a promisor from double liability.  So, for instance, under the Contracts (Rights of Third Parties) Act 1999 in England, where a promisee has recovered substantial damages representing the third party's loss, the third party will not be entitled to an award duplicating that sum.[9]  Chapter 4 will further explore this issue of double liability.

 

 

Unjust that the third party can sue on the contract but cannot be sued

 

2.8           One argument in favour of the privity doctrine is that it avoids the unjust result that a person could be treated as a party to a contract for the purpose of suing upon it when he could not be sued.[10]

 

2.9           However, the fact that the third party can sue, but not be sued, should not be seen as an impediment to enforceability of a contract since unilateral contracts[11] in which only one person is obliged to perform are enforceable under the law of contract.[12]  Moreover, although the third party is immune from reciprocal action by the promisor, the promisor may protect his interests by taking action against the promisee.[13]  We must also emphasise that it is up to the parties to decide whether to confer a benefit on a third party, and what benefit is to be conferred.  If their intention is to benefit a third party when they are fully aware that the third party cannot be sued, they should have the freedom to do so.

 

 

Limits freedom of the contracting parties to rescind or vary and exposes them to a wide range of possible third party plaintiffs

 

2.10                Clearly, if third parties are able to enforce contracts made for their benefit, the freedom of the contracting parties to rescind or vary such contracts is affected, and promisors may be subject to a wide range of possible third party plaintiffs.[14]  However, experience in other jurisdictions suggests that it is possible to strike an appropriate balance between the interests of contracting parties in maintaining freedom to rescind or vary their contract and the interests of third parties in maintaining enforceable rights.  For instance, under the Contracts (Rights of Third Parties) Act 1999 in England, the contracting parties may vary or cancel the contract until the third party has communicated his assent to the promise, or has relied on it.[15]

 

2.11                Similarly, a sufficiently circumscribed test of who is a third party beneficiary could narrow the range of third party plaintiffs and avoid a flood of litigation.[16]  We understand that these issues must be addressed, but they should not preclude reform.  Chapter 4 will explore them in greater detail.

 

 

Arguments for reforming the privity doctrine

 

2.12                Apart from setting out the arguments against reforming the privity doctrine, the Law Commission also comprehensively presented the case for reforming the doctrine in its 1996 report.  In the following paragraphs, we will discuss those arguments with examples to better illustrate the anomalies of the doctrine before concluding that the doctrine should be reformed.

 

 

Frustrating parties' intention to benefit third parties

 

2.13                The foremost criticism of the privity doctrine is its failure to give effect to the expressed intention of the parties. The privity doctrine prevents effect from being given to the contracting parties' intention to benefit a third party.  The failure of the law to afford a remedy to third parties in such cases frustrates the parties' intentions.[17]  We find it difficult to justify why, in situations where a contract is expressly made for the benefit of a third party, the third party should not be able to enforce that benefit. 

 

2.14               The facts of the case of Tweddle v Atkinson[18] well illustrate how the privity doctrine can impede the contracting parties' intention.  In that case, the plaintiff's father and his would-be father-in-law agreed to pay the plaintiff £100 and £200 in contemplation of his intended marriage.  The marriage took place, but the father-in-law failed to pay the £200 as agreed and subsequently died.  The plaintiff sued the executor of his father-in-law's estate.  It was held that the plaintiff could not succeed, as he had not provided consideration for the agreement between his father and father-in-law.    The agreement in question was made by the contracting parties with the intention of benefiting the plaintiff, but the manifest intention of the contract was frustrated by the privity doctrine.

 

 

The privity doctrine is unduly complex, uncertain and artificial

 

2.15                One of the main criticisms of the doctrine is that the law relating to it is unduly complex.  Over time, the courts have circumvented the privity doctrine to mitigate its harshness.  The effect has been to increase the law's complexity and artificiality, and to raise doubts as to whether a third party in a particular case can circumvent the doctrine.  We fully endorse the view that the existing law is complex, uncertain and artificial.  The need to circumvent the doctrine demonstrates that the doctrine causes injustice in particular cases.  It also casts doubt on the coherency of the doctrine.  It is clear from the extensive litigation that the problems associated with the privity doctrine have not yet been resolved.[19]

 

2.16                The Priviy Council's approach to the case of New Zealand Shipping Co Ltd v A M Satterthwaite & Co Ltd (The Eurymedon)[20] demonstrates the unnecessary complexities which can arise in seeking to circumvent the doctrine and give effect to the contracting parties' intention. 

 

2.17                In that case, a drilling machine was shipped from Liverpool to New Zealand.  The bill of lading contained a clause exempting the carrier from liability after one year.  Another clause extended this immunity to the carrier's servants, agents and independent contractors.  Stevedores negligently damaged the machine.  The consignee sued the stevedores more than a year later.  The stevedores sought to rely on the exclusion clause in the bill of lading.  For the stevedores to be able to claim the protection of the exclusion clause, four conditions laid down by Lord Reid in the earlier case of Scruttons Ltd v Midland Silicones Ltd had to be satisfied.

 

2.18                The first three of the four conditions were satisfied.  The main problem lay in finding the consideration by the stevedores for the exclusion clause in a contract to which they were not a party.  The Privy Council found in favour of the stevedores by proceeding in the following way:

 

"… the bill of lading brought into existence a bargain initially unilateral but capable of becoming mutual, between the shipper and the appellant [ie the stevedores], made through the carrier as agent.  This became a full contract when the appellant performed services by discharging the goods.  The performance of these services for the benefit of the shipper was the consideration for the agreement by the shipper that the appellant should have the benefit of the exemptions and limitations contained in the bill of lading." [21]

 

2.19                The Eurymedon demonstrates that, with considerable ingenuity and inconvenience, it is possible in some circumstances to get round the privity doctrine.  That result, however, was only achieved at the end of protracted and expensive litigation.  The solution used in The Eurymedon was criticised as too technical by Lord Goff of Chieveley in Re The Mahkutai:

 

"Though these solutions are now perceived to be generally effective for their purpose, their technical nature is all too apparent; and the time may well come when, in an appropriate case, … the courts should… recognise… 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." [22]

 

 

The person who has suffered the loss cannot sue, while the person who has suffered no loss can sue

 

2.20                As pointed out by the Law Commission, the doctrine produces the perverse and unjust result that the person who has suffered the loss of the intended benefit (ie the third party) cannot sue, while the person who has suffered no loss (ie the promisee) can sue.[23]  The absurdity of the doctrine's effect is illustrated by the case of Beswick v Beswick.[24]  In that case, an uncle transferred his business to his nephew in return for a promise from the nephew to pay a weekly sum to the uncle's widow after the uncle's death.  The House of Lords held that the widow could not maintain a successful action in her personal capacity, as she had not been a party to the promise between the uncle and his nephew.  She was, however, held to be able to sue for the loss to her husband's estate in her capacity as administratrix.  Nevertheless, she could only recover nominal damages because the uncle (and hence his estate) had suffered no loss from the nephew's breach of promise.  The widow, in her personal capacity, who had suffered actual loss of the intended benefit of the promise, could not sue, while the estate, which had suffered no loss, had that right to sue.  Their Lordships took the view that it would be unjust to award nominal damages in the present situation and therefore ordered specific performance of the nephew's promise.

 

2.21                In commenting on the Sub-committee’s consultation paper, the Hong Kong Federation of Insurers observed that apart from damages based on loss, there could be other remedies, such as specific performance or other equitable remedies, which did not require the proof of loss.  In the context of an insurance contract, a policyholder who has not suffered any loss may seek specific performance to enforce the insurer’s promise to benefit beneficiaries.  We must, however, point out that equitable remedies are at the courts’ discretion.  The House of Lords was able to achieve fairness by ordering specific performance in Beswick v Beswick.  Such a remedy may not be available in every case, however.  It could not be used, for instance, where the contract is not supported by valuable consideration or is one for personal service.  Moreover, the widow as administratrix in the Beswick case of course had no problem with bringing an action against the promisor for her own good.  In other cases, even if specific performance or substantial damages could be obtained, the promisee may not be able, or wish, to sue for one reason or another, such as the stress and strain of litigation and its cost, sickness or being overseas.[25]  The Hong Kong Federation of Insurers also observed that in a typical life insurance contract, a trust was usually expressly created in favour of the beneficiary who could then enforce his equitable interest against the policyholder.  Thus, the combined effect of the remedy rule and the privity doctrine will not necessarily create unjust results.  While this may be true for life insurance contracts, the present reform concerns contracts in general.  We believe that in many situations, third parties may be left without a remedy.

 

 

The injustice to a third party who has relied on the promise

 

2.22                The Law Commission highlighted the injustice to a third party who had, in relying on the promisor's promise, regulated his affairs in the expectation that he would benefit from the promise.[26]  That injustice would be particularly acute where a third party regulates his affairs to his own detriment.

 

Illustration

 

A and B agree that A is to pay a sum of money to C.  C gives his car to D, in the expectation of using the money from A to buy himself a new one.  If A does not keep his promise, C may be left with no remedies even though he has relied on the promise to his own detriment.

 

 

Widespread and continuous criticism of the doctrine, and abrogation of the doctrine in other jurisdictions

 

2.23                The privity doctrine has been the subject of considerable judicial criticism over the years.  Professor Jack Beatson has stated that no other doctrine of English contract law has been subjected to more criticism by the senior judiciary than the privity doctrine.[27]  Steyn LJ pointed out that:

 

"there [was] no doctrinal, logical, or policy reason why the law should deny effectiveness to a contract for the benefit of a third party where that [was] the expressed intention of the parties."[28] 

 

The House of Lords has also made repeated demands for reform of the doctrine.  For example, Lord Scarman hoped that the House of Lords would reconsider Tweddle v Atkinson and other cases which stood guard over the unjust rule.[29]  Professor Andrew Burrows has also observed,

 

"Lord Denning in various cases tried unsuccessfully to bring about reform judicially.  And Lords Reid, Scarman, Diplock and, more recently, Lord Goff and Lord Steyn have all in their judgments criticized the privity doctrine and called for its reform."[30]

 

2.24                Sir Roy Goode has said that a strong case can be made out for relaxing, if not entirely abandoning, the privity rule.[31]  In addition, various law reform bodies in the common law world have critically examined the privity doctrine and recommended its reform.[32]  In Australia (the Northern Territory, Western Australia and Queensland), England, New Zealand and Singapore the doctrine has eventually been abrogated by legislation.[33]  In Europe, the legal systems of many non-common law jurisdictions also recognise and enforce third parties' rights, including Austria, Belgium, France, Germany, Greece, Italy, Luxembourg, the Netherlands, Portugal, and Spain.[34]  The extent of the criticism, and the fact that reform has been adopted in so many jurisdictions, clearly indicate that the privity doctrine is fundamentally flawed.

 

 

Conclusion

 

2.25                After careful deliberations, we have decided that there is a need to reform the privity doctrine.  We note that one member of the Sub-committee was not convinced that a case for reform has been made out.  (He made clear, however, that if the privity doctrine were to be reformed, the recommendations made in this report should be the way forward.)

 

2.26                In that member's opinion, the doctrine is a cornerstone of the common law and has worked well for over one hundred and fifty years.  Although there have been calls from various quarters for the doctrine to be changed by statute, many jurisdictions remain unconvinced.  For instance, while some states in Australia have reformed the doctrine, most states (including New South Wales, Victoria and the Australian Capital Territory) have not.  Furthermore, there is no evidence that the abolition of the doctrine will benefit consumers.  The effects of change should be ascertained in those jurisdictions where the doctrine has been reformed.

 

2.27                The dissenting member also highlights the specific problem in the construction industry.  Generally speaking, a number of different contractors are involved in any building project, and the purchaser of a flat may not be able to tell which of those contractors should be held responsible for a particular defect.  This would compound the cost and complexity of any legal action brought by the purchaser.  Reform of the privity doctrine may also bring injustice to a contractor if an unscrupulous developer winds up its shelf company to avoid liabilities and does not pay its contractors for their work.  In this case, a contractor is not only unpaid for his work, but may also become involved in a legal action concerning work which may or may not be found to be defective.  If the abolition of the privity doctrine is designed to shift the risk of buying a flat from the purchaser to the contractor, the contractor is not the best party to take the risk and would become a victim in such circumstances.  Furthermore, the type of claim which can be made by a purchaser may be different from the type which can be made by a developer, thus further increasing a contractor's risk.  This does not seem fair.

 

2.28                We do not share this Sub-committee member's concerns.  Whether the developer remains in existence or not should not affect the contractor's duty to consumers to make good any defects due to its poor workmanship.  By paying the purchase price, a consumer pays the contractor indirectly (through the developer) for the construction work up to a specified standard.  It would seem unfair to the consumer if the main contractor were not to assume any responsibility for defects or sub-standard materials used in the development.  There is no valid reason why the consumer should not be given the benefits of any warranty given by the contractor to the developer.  All in all, we do not accept the arguments against reform which have already been dealt with one by one in the preceding paragraphs.  Although certain issues require careful thought, this should not stand in the way of what is in our opinion a convincing case for reform.  None of the issues raised are insurmountable and Chapter 4 will consider ways to address these concerns.

 

2.29                While acknowledging the anomalies of the privity doctrine, the Commissioner of Insurance highlighted a social policy issue in his response to the Sub-committee’s consultation paper.  If a sub-contractor takes out an insurance policy to cover his and the main contractor’s liability for employees’ compensation, the main contractor would have little incentive to improve risk management, as he would be able to seek indemnity from the sub-contractor’s insurer for damage caused by his own employees.  Instead, the pressure would be on the sub-contractor to minimise such risks, but he would have no control over the main contractor’s employees.  In response to the Commissioner’s concern, we would point out that main contractors have a statutory obligation to take out insurance cover for employees’ compensation.[35]

 

2.30                The British Chamber of Commerce, the Consumer Council, Clement Shum of Lingnan University, the Housing, Planning and Lands Bureau, the Law Society of Hong Kong and Stephenson, Harwood & Lo shared the view that the privity doctrine was anomalous.  They supported the relaxation of the privity doctrine to the extent that third parties should be able to enforce contracts which conferred benefits on them.  The Hong Kong Society of Accountants also shared their concern that strict adherence to the privity doctrine would frustrate the contracting parties’ intention to benefit third parties.  The Hong Kong Association of Banks believed that our proposal would enhance the flexibility of the law of contract, even though they would not want third parties to acquire rights to sue banks.  Some consultees were of the view that the privity doctrine was so anomalous that it should be abolished in its entirety.  We emphasise that the spirit of the present reform is to respect the contracting parties’ freedom of contract.  In some cases, contracting parties may wish to confer a benefit on a third party, without enabling him to enforce that benefit.  We think that the total abolition of the doctrine would deprive contracting parties of this choice.

 

2.31                In contrast, the Hong Kong Federation of Women Lawyers and the Chinese General Chamber of Commerce expressed reservations at relaxing the privity doctrine.  The Hong Kong Federation of Insurers was of the opinion that there was no need to reform the privity doctrine, since contracting parties were free to assign contractual rights to third parties under the existing law so as to benefit third parties.  For example, under a standard life insurance contract, an assignee of the contractual benefit can enforce his rights in court.  We think, however, that our proposed reform would avoid the need for a promisee and the third party to sign a separate contract of assignment.  Furthermore, the promisor’s assent is not essential for an assignment.  From the promisor’s point of view, our proposed reform would enable a promisor to ascertain the third party’s identity before deciding whether to confer a benefit on the third party.  Finally, the Law Commission observed that there was a thin divide between (i) making a contract for the benefit of a third party; and (ii) making a contract for the benefit of a third party and, immediately thereafter, assigning that benefit to the third party.  If an immediate assignment is valid, there can hardly be fundamental objections to allowing the third party to sue without an assignment.[36]

 

2.32                The Federation of Insurers also believed that there were no anomalies in the privity doctrine.  The doctrine worked well in Hong Kong and its reform was not to anyone’s benefit.  Abrogation of the doctrine in other jurisdictions was not an acceptable reason for Hong Kong to change such a fundamental rule in the law of contract.    

 

2.33                We have carefully considered the responses made to the consultation paper.  Despite the reservations expressed in some quarters, we find the arguments in favour of reform compelling, and consider that there should be a simple and clear mechanism whereby a third party can generally enforce a benefit intended to be conferred on him.  In other words, if the parties to a contract wish to confer a benefit on a third party, they should have the freedom to do so, and their wishes should be respected and given legal effect.  The fact that the privity doctrine prevents effect from being given to the contracting parties' intention runs counter to the underlying theory of contract, and presents a range of practical difficulties which we have described in this chapter and Chapter 1.  Sir Guenter Treitel has pointed out that none of the reasons for the privity doctrine take account of "the inconvenience that can result from its practical operation".[37]  We would emphasise, however, that we favour reform of the doctrine, rather than its outright abolition.  Our intention is to provide a fair mechanism for the enforcement of third party rights.