Should the privity of contract rule be reformed in order to allow the third party to sue on contract in their benefit?

This article is written by Pranav Khatavkar. Pranav Khatavkar has recently completed his coursework in BBA LLB from Symbiosis Law School, Pune. His area of interest is Commercial Litigation and he has obtained several additional qualifications and has done internships in the same practice area.

Before attempting to answer the above mentioned question we should first consider the implications of this doctrine:-

1. A contract cannot confer rights or impose obligations arising under it on any person except the parties to it.
2. Parties to a contract cannot impose liability on a third party.

On a deeper perusal it will be more than clear that the real objective of this doctrine is to protect the interests of the contracting parties and to ensure that a contract does not confer rights or impose obligations arising under it on any person except the parties to it. Considering the fact that a contract is essentially a private arrangement, this doctrine reaffirms the sanctity of the concept. However there have been attempts to amend this doctrine.¹

After a due consideration of the implications and the core objective of this doctrine, let us analyze the arguments in favor of this doctrine:-

1. If the third party is allowed to sue, then it would be unjust to the contracting parties as the third party will have the right to sue but at the same time, no liability can be imposed upon the third party.
2. Enabling the third party to enforce the contract, denies the contracting parties the flexibility to vary or terminate the contract.

Additionally, even if the third party cannot directly sue, nothing stops the party making the contract to sue for specific performance for the benefit of the third party even where the amount of damages payable are nominal.

An argument that can be made against this doctrine is that if the third party relies on the contract to regulate his affairs, might suffer an unfair loss and can frustrate the intention of third party to benefit from the contract. In order to counter situations like these, the law provides for exceptions to this doctrine which are largely in favor of the third party encompassing various situations that can arise.

Exceptions to the law of privity of contract

The exceptions to this principle are as follows:-

1. Creation of trust – Courts have required that the intention to constitute a trust must be affirmatively proved by substantial evidence. Another important condition for the application of this principle is that there must be an intention to benefit the third party. The intention to benefit the third party should be irrevocable. To establish that a trust of the promise has been created, it is necessary to establish an intention of the promisee to enter into contract as a trustee. A trust does not arise simply because a party to a contract undertakes to confer benefit on a stranger. (Seth Bhabhootmal Seth Nathmal Oswal v Moolchand Munnalal Sagotia AIR 1943 Nag 266; MC Chako v State Bank of Travancore AIR 1970 SC 504)
2. Insurance – The principle of privity has been applied also to the insurance policies effected for the benefit of third parties.
3. Family Arrangements and Marriage Settlements – The Specific Relief Act, 1963 enables specific performance of a contract being a settlement on marriage, and family arrangements at a suit of any person beneficially entitled thereunder and creates an exception to the rule that a party to a contract cannot sue. (Janaki Bala Debya v Maheshwar Das AIR 1942 Pat 460.)
4. Creation of a charge – A stranger to a contract can sue for the money made payable to him by it where the money is charged on immovable properties, or also where specific money in suit is allocated by the promisor in favour of such third party. In order to create a charge, there must be evidence of intention disclosed by the deed that a specified property or fund belonging to a person was intended to be made liable to satisfy the debt due by the creator of the charge in favour of the person seeking to enforce it.
5. Covenants running with land – The privity of contract doctrine has been relaxed for commercial reasons to allow certain restrictive covenants to run with the land so as to benefit or burden persons not party to the contract imposing such covenants. Third parties can acquire rights in this manner under a covenant to which they were not a party. These are properly classified as belonging to the law of property.
6. Benefit of exclusion clauses – The extent to which third party to a contract can take benefit of clauses in those contracts excluding or limiting liability for loss or damage have been a challenge to the doctrine. However on the basis of available precedent, this exception is applied when in order to support established commercial practice, and to avoid the redistribution of the risks perceived and contemplated by the contracting parties at the time of making the
7. Collateral Contracts- A collateral contract between a third party and one of the parties to a main contract may be associated with the main contract. Such a contract may enable a third party to enforce the main contract.
8. Multilateral Contracts- This exception can be applied mainly in cases of club or unincorporated associations.
9. Assignment- Where an assignment of benefits under a contract is validly made, whether according to the provisions of statute or otherwise, the promisor is faced with an action brought by a person who he did not regard as a party, or whom he did not intend to benefit. An assignee will also be bound by an arbitration clause in the contract assigned.
10. Contracts requiring tortious duty of care towards third parties – A contract between two or more persons can create a tortious duty of care towards the third party. That party’s negligence constitutes a breach of contract for which the affected third party may seek relief.
11. Acknowledgement and estoppel – A promisor may create privity between himself and the third party by conduct , by acknowledgement or otherwise constituting himself an agent of the third party, entitling the third party to sue.
12. Contract for benefit of third person- It has been held that where a contract is made for the benefit of a third person, there may be an equity in favour of the third person to sue upon the contract, and it has been suggested that a person who takes benefit under a contract may sue on contract. Thus, a stranger having beneficial interest under a contract can sue in equity to enforce, although he himself is a stranger to the contract.

 Another counter argument that can be made to the above mentioned argument is that even though under the application of this doctrine third party cannot sue on contract in their benefit, but the doctrine also ensures that no liability can be placed on any other person apart from the contracting parties. Therefore this doctrine also guards the third party from unwanted liability.

The doctrine of privity of contract is therefore the foundation of the law of contracts, and its alteration might frustrate the rationale behind having a law regulating contracts in the first place.

¹ The law commission of India recognized that a rigid adherence to the doctrine of privity of contract caused hardship and, and recommended incorporation of separate section into the Act. The amendment proposed purported to remove to make a contract enforceable by the third party in his own name, if the contract expressly conferred benefit on him, but subject to any defences available to the contracting parties. It also proposed that the parties to the contract should be unable to vary or rescind or alter the contract, once the third party had adopted the contract. (Nilima Bhadbhade : Mulla, Indian Contract and Specific Relief Acts, 12^th Edition 2005, Pg.109).

Law Commission of India, eighty seventh report 1958, para 16, recommended adding S.37A as follows:-37A. Benefits conferred on third parties:

• Where a contract expressly confers a benefit directly on a third party, then, unless the contract otherwise provides, it shall be enforceable by the third party in his own name, subject to any defences that would have been valid between the contracting parties.

• Where a contract expressly conferring a benefit directly upon a third party has been adopted, expressly or impliedly, by a third party, the parties to the contract, cannot substitute a new contract for it or rescind or alter it so as to effect the rights of the third party.

1. It would also put a double burden on the promisor and he would be held accountable to the promisee and the third party. That would be actually unfair to the promisor.

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