LAW EXTENSION COMMITTEE

WINTER COURSE 2005

CONTRACTS

LECTURE NOTES

WEEK FIVE

PRIVITY OF CONTRACT

1. The Privity of Contract Doctrine

The privity of contract doctrine dictates that only persons who are parties to a contract
are entitled to take action to enforce it. A person who stands to gain a benefit from the
contract (a third party beneficiary) is not entitled to take any enforcement action if he
or she is denied the promised benefit.

Example:

A promises B, for consideration moving from B, to pay C $ 100.

Here A and B are parties to the contract – privy to the contract – and can sue each
other if there is a breach by the other. C is not a party to the contract and cannot sue A
is A fails to pay C the sum of $ 100.

A classic authority for the doctrine is Dunlop Pneumatic Tyre Co Ltd v Selfridge &
Co [1915] AC 847, where at 853, Viscount Haldane said:

My Lords, in the law of England certain principles are fundamental. One

is that only a person who was party to a contract can sue on it. Our law
knows nothing of a jus quaesitum tertio [third party right of action] arising
by way of contract.

See also Coulls v Bagot’s Executor & Trustee Co Ltd (1967) 119 CLR 460, at 478,
per Barwick CJ.

2. Privity and its Relationship to the Doctrine of Consideration

When looking at the doctrine of consideration we observed the rule that consideration
must move from a promisee, or, in other words, that only a person who has provided
consideration can enforce a promise. In the above example one could have argued that
C could not sue on the basis that C had not provided any consideration for A’s
promise to pay C the sum of $ 100.
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This raises the question of whether there is a distinction between the privity and
consideration rules. This question has generated considerable discussion in academic
circles and there is a division of opinion between those who say the rules are in fact
one rule differently expressed and those who argue that the two rules are distinct.

In the cases, the relatively scant references to the question tend to support the two
separate rules approach.

See Coulls v Bagot’s Executor, at 478, Barwick CJ and, at 494, per Windeyer J;
Trident General Insurance Co Ltd v McNiece Bros Pty Ltd (1988) 165 CLR 107, at
115-116, Mason CJ, Wilson J and at 164, per Toohey J.

3. Remedies Against a Promisor in Breach of Obligations to a Third Party

Here we are concerned with the remedies that can be pursued against a promisor who
is in breach of his or her obligations to a third party. In our example above, who can
sue A, and what remedies are available?

Because C is a third party and not privy to the contract, C has no right of action
against A.

However, B as the promisee under the contract and a party to the contract can sue A.
Two possible remedies arise, namely, damages at common law and specific
performance in equity.

Can C require B to sue A? See Coulls, at 502, per Windeyer J.

(a) Damages at Common Law

Because the remedy of common law damages for breach of contract will always be
granted to a plaintiff, B will always succeed. However, the critical issue is the
measure of damages that will be recovered.

Critical to an understanding of the position of B in this context is the basic principle

for the assessment of damages for breach of contract. As will be explored in more
detail in the lectures on remedies, damages seeks to compensate the plaintiff for the
loss suffered as a result of the breach. If no loss is suffered then a nominal (or token)
award of damages is made in favour of the plaintiff. If real loss is suffered, an award
of substantial damages is made in favour of the plaintiff.

In our example it is likely to be the case that the measure of damages to be recovered
by B would be nominal because B suffers no loss as a result of the breach by A. Put
another way, B’s position is the same irrespective of whether or not A pays the sum of
$ 100 to C. In special circumstances it may be that B will suffer a real loss, in which
case substantial damages which reflect the value of B’s loss – not C’s loss - will be
awarded. See Coulls, at 501-502, where Windeyer J.
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Because in most cases the measure of damages recovered will be nominal, there is
little reason for B to pursue common law damages.

The fact that B cannot sue to recover as damages the measure of C’s loss from A’s
breach of contract was recently confirmed by four members of the House of Lords in
Alfred McAlpine Construction Ltd v Panatown Ltd [2001] 1 AC 518, at 522, 563, 575
and 580. The fifth Law Lord, Lord Goff was, at 538-539, 544, more skeptical,
suggesting that it was ‘an extraordinary defect’ in the law that B should have no
remedy for common law damages against A.

(b) Specific Performance in Equity

Unlike common law damages, specific performance will not always be granted to a
plaintiff upon proof of a breach of contract. There are various grounds upon which a
court will refuse specific performance. A particularly important one in the present
context is that the remedy will be refused if common law damages would be an
adequate remedy. The critical decision in this respect is Beswick v Beswick [1968] AC
58. From this case set out:

• The facts
• The issue that had to be determined by the House of Lords
• The decision and reasoning of the House of Lords as to why damages were an
inadequate remedy on the facts of the case?

See also Coulls, at 503, per Windeyer J.

4. The Case of Trident General Insurance v McNiece Bros

The most significant High Court decision on privity has been Trident General
Insurance Co Ltd v McNiece Bros Pty Ltd (1988) 165 CLR 107. From this case set
out:

• The facts
• The different views on the status of the doctrine of privity set out by the
judges of the High Court.
• What reasons did Mason CJ & Wilson J give for their ‘radical’ approach to
privity and how did they compare and contrast with those of the other ‘radical
approach’ given by Toohey J?
• What was the approach of the ‘conservative’ judges, Brennan, Deane &
Dawson JJ to the status of privity?
• To which of the above two approaches does the judgment of Gaudron J
belong?

In Winterton Constructions Pty Ltd v Hambros Australia Ltd (1991) 101 ALR 363,
Gummow J, after a long analysis of Trident, concluded, at 368, with the following
observation:
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At best ... there is support by three only of their Honours for the
proposition ... that the old rules do not apply in their full vigour.

His Honour was, of course, referring to Mason CJ, Wilson, Toohey JJ.

5. General Law ‘Exceptions’ to the Doctrine of Privity

There are a number of general law principles which enable a third party, such as C in
our example, to overcome the doctrine of privity. Because they rely upon establishing
the elements of other established legal doctrines and institutions, they are not true
exceptions. Rather they constitute means of circumventing the doctrine of privity
because these other legal principles apply on the facts of the given case. Some of the
key exceptions are discussed below.

(a) Agency

The rule here is that if one of the contracting parties contracts as an agent, then either
the agent or the principal, but not both, can sue to enforce the contract. In our
example, if B is C’s agent then either B or C can enforce the contract against A. In
these cases it is immaterial as to whether A knew that B was C’s agent.

A particular situation where agency principles arise is with contracts for the carriage
of goods. Typically the situation will be where a carrier includes in the contract an
exclusion clause and the exclusion clause is expressed to be for the benefit of not only
the carrier but third parties that might be engaged by the carrier for the purpose of
transporting the goods. A common example in the cases is in shipping contracts,
where the third party is the stevedore who unloads the goods at the port of destination.

In such cases, can the stevedore rely on the benefit of the exclusion clause when the
stevedore causes damage to the goods? See elements that have to be satisfied in
Midland Silicones Ltd v Scruttons [1962] AC 446, at 474, per Lord Reid.

Originally these principles were only applied to contracts for carriage of goods by sea.
However, they have been applied to road carriage cases: Life Savers (Australasia) Pty
Ltd v Frigmobile Pty Ltd [1983] 1 NSWLR 431. Presumably they would also apply to
contracts for carriage of goods by rail or air.

It may even be the case that these principles could apply to exclusion clauses in any
context where it is intended to extend their protection to third parties.

An illustration of the application of the principles is in New Zealand Shipping Co v A

M Satterthwaite & Co Ltd (The Eurymedon) [1975] AC 154. From this case set out:

• The facts
• The issue that had to be determined by the Privy Council
• The decision and reasoning of the Privy Council as to how the elements of
Midland Silicones were satisfied in this case.
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In The Eurymedon, the close relationship between the carrier and the third party was
crucial to establishing the third element in Midland Silicones. It now appears that if
the third party simply pleads the exclusion emption when sued for damages that will
be enough: Life Savers v Frigmobile.

If all the elements in Midland Silicones are met a contract arises between the owner of
the goods and the third party. There is, thus, no privity issue. The third party becomes
a contracting party in a later contract that was anticipated by the principal contract
between the cargo owner and the carrier. In this respect in Homburg Houtimport BV v
Agrosin Private Ltd (The Starsin) [2003] 2 All ER 785, at 851-852, Lord Millett said:

It is well established by the authorities that the Himalaya clause has the
effect of bringing into being a separate or collateral contract between the
cargo owner and a third party, usually an independent contractor such as a
stevedore, under which the third party enjoys exemption from liability to
the cargo owner. They also establish that the contract is a unilateral or 'if'
contract by which the third party undertakes no obligation to the cargo
owner of any kind, but the cargo owner promises that if the third party
does anything in the course of its employment which damages the cargo it
will have the benefit of the protective provisions of the clause. ... Such a
contract is a promise for an act, not a promise for a promise. If in the
course of its employment the third party performs an act in relation to the
goods, which it is under no obligation to the cargo owner to perform, it
will at the one and same time bring the contract with the cargo owner into
existence and supply the consideration for the cargo owner's promise of
exemption from liability.

In relation to the contract between the owner of the goods and the third party Lord
Millet went on to say, at 853:

Such a contract cannot properly be characterised as a contract of carriage.

It is rather a contract of exemption which is ancillary or collateral to other
contractual arrangements (the time charter and the bill of lading) which
were necessary to achieve the carriage of the goods on the chosen vessel.

(b) Trusts

The law of trusts can enable a third party beneficiary to initiate action that will
enforce the promisor’s obligation. Using the above example, if B had contracted with
A in the capacity of trustee for C, C as beneficiary under the trust has enforceable
rights. These rights arise because the law of trusts gives a beneficiary certain rights
against a trustee.

In the context of privity, if C is a beneficiary under a trust, C can bring an action

against B, the trustee, that has the effect of compelling B to sue A for breach of
contract. In formal procedural terms C sues in an action in which B and A are joined
as defendants.
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The use of trust law here does not give rise, in the strict sense, to an exception to the
doctrine of privity. In conceptual terms, the action against A is pursued by B, albeit at
C’s insistence.

For the trust relationship to arise 2 points need to be examined.

First, for a trust to exist their must be property that is held on trust. There can be no
trust without a trustee holding property on trust for the beneficiary. The law a trusts
has a broad and flexible definition of property. In this case the property is the promise
made by the promisor. In other words, the contract between A and B, it is the promise
made by A to B that is held on trust by B for C.

Second, for the trust to arise in this context, it must be established that there is an
intention, at the time of the contract between A and B, that B was contracting in the
capacity of trustee. On intention in this context see Trident, at 149, per Deane J.

In ascertaining whether the intention is present, a court will look to the language in
the contract, the nature of the transaction and relevant circumstances attending the
relationship between the parties: Winterton Constructions v Hambros at 370. Certain
types of contracts may be more readily amenable to finding a trust intention than
others.

Could a trust be found in the context of Trident? See Trident at 148, per Deane and at
155-157, per Dawson J. What were the reasons why Deane J found in favour of
McNiece Bros on the basis of trusts but Dawson J did not?

When the trust exception is pursued and B sues for damages, the measure of damages
that is recovered reflect the loss to C, the beneficiary of the trust. The damages that
are recovered are held by B on trust for C: Lloyd’s v Harper (1880) LR 16 ChD 290;
Eslea Holdings Ltd v Butts (1986) 6 NSWLR 175.

(c) Estoppel

Following the decision in Waltons Stores (Interstate) Ltd v Maher (1988) 164 CLR
387, a third party may be able to seek relief against a promisor on the basis of
promissory estoppel principles. To succeed the third party would need to establish the
elements of promissory estoppel. See Trident, at 145, per Deane J.

In Trident, Mason CJ, Wilson J, at 123-124, were of the view that it was likely that
estoppel could be established on the facts of the case, but it was not necessary for
them to determine the issue on the basis that they had decided the case on other
grounds.

(d) Unjust Enrichment

When we examine the remedy of quantum meruit later in this course, we shall see that
the principle of unjust enrichment is the principle that underpins the remedy. The
essence of the principle is that it requires a defendant ‘to make fair and just restitution
derived at the expense of a plaintiff’: Pavey & Matthews Pty Ltd v Paul (1987) 162
CLR 221 at 256-257, per Deane J.
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In Trident, Deane J, at 145-146, indicated that the principle could possibly be the
basis for a third party to seek relief. However, it was Gaudron J, especially at 176, in
Trident who based her decision in favour of McNiece Bros on the basis of the
principle of unjust enrichment.

The action based upon unjust enrichment is not based on the contract but independent
of it. However, usually it will correspond in content and duration with the promisor’s
obligation.

6. Statutory Exceptions to the Doctrine of Privity

Insurance Contracts Act 1985 (Cth), s. 48

Bills of Exchange Act 1909 (Cth), ss. 36-43
Cheques Act 1986 (Cth), s. 73
Motor Vehicles (Third Party Insurance) Act 1942 (NSW), s. 10(7)