PRINCIPLES OF PRIVITY OF CONTRACT

This article is written by R. Jemima Christy Rebekah, IFIM Law School, Final Year BBA LLB student during an internship at LeDroit India.

Keywords

• Privity of Contract
• Third party rights
• Indian Contract Act
• Exceptions to privity
• Legal obligations
• Consideration

Introduction

The significance of the privity of conract is a fundamental objective in the contract law, particularly under the legal framework of Indian laws. It basically states that only the parties who are privity to a contract have the right to sue for its execution or who are abide by the terms of a contract. This article explore the principle of privity of contract, exmaines its origin, legal implications and the exceptions under the Indian law.

The maxim, “Stranger to contract cannot sue” is strongly entrenched by the privity of contract. Throughout the years, exceptions to this rule have emerged to satisfy the circumstances in which third parties have a responsibility in the contract. The importance of understanding the privity lies in the recognition of a party who holds enforceable rights and obligations under the contract. This article mainly focuses on the principle, its applicability in India and related case laws.

Definition of Privity of Contract

Section 2 (h) of the Indian Contract Act, 1872 defines,

(h)An agreement enforceable by law is a contract;

According to the section, the term “contract” is defined as an agreement which can be enforceable by law. An agreement of this kind should be created between two or more parties who are forming consideration for one another. It is only considered as a contract if it is enforced. One of the fundamental elements of a contract is the promise that the parties make to one another, which results in the formation of a contractual relationship for the enforcement of the rights and obligations.

Meaning of Privity of Contract

Privity of Contract refers to a legal principle in contact which explains that only the parties who are directly involved in a contract have the rights and obligations under the contract. In other words, third parties who are not part  of the agreement cannot enforce its obligations or to be bound by its provisions, even if the contract may affect or benefit them indirectly.

Two fundamental concepts form the basis of this principle:

1. Under the terms of the contract, only the parties may file a lawsuit or be sued.
2. A third party, or someone who is not a party to the contract, lacks the legal authority to enforce any rights or responsibilities resulting from it.

For instance, even if A and B engage into a contract that indirectly benefits C, C, who is not a party to the agreement, cannot sue for breach of the agreement or assert any rights under it.
There are exceptions to this rule, particularly in situations involving third-party beneficiaries, such as in family settlements or trust agreements. But generally speaking, privity makes sure that the only people who can claim or be held accountable for the terms of a contract are the actual parties.

History Background of the Doctrine

The theory has its roots in English contract law. The famous case of Tweddle v. Atkinson (1861) 121 ER 762 established that a third party cannot enforce a contract they are not a member of, even if it was negotiated for their advantage. This was the first time it was legally acknowledged. In Dunlop Pneumatic Tyre Co. Ltd. v. Selfridge & Co. Ltd. [1915] UKHL 1, this idea was reaffirmed.

Legal provisions

The principle of privity of contract is not explicitly defined but it is implied through sections 2(d), 37 and 40 of the Indian Contract Act, 1872.

2(d)When, at the desire of the promisor, the promisee or any other person has done or abstained from doing, or does or abstains from doing, or promises to do or to abstain from doing, something, such act or abstinence or promise is called a consideration for the promise;

37. Obligation of parties to contract.

The parties to a contract must either perform, or offer to perform, their respective promises, unless such performance is dispensed with or excused under the provisions of this Act, or of any other law.

Promises bind the representatives of the promisors in case of the death of such promisors before performance, unless a contrary intention appears from the contract.

40. Person by whom promise is to be performed.

If it appears from the nature of the case that it was the intention of the parties to any contract that any promise contained in it should be performed by the promisor himself, such promise must be performed by the promisor. In other cases, the promisor or his representative may employ a competent person to perform it.

Third parties that are not privy to the contract are not permitted to seek for enforcement or claim benefits under the Act, which restricts enforcement to the contractual parties.

Essentials of privity of contract

Direct relationships:

According to the doctrine, parties to a contract have a direct relationship with one another. These are the sole parties with rights and responsibilities.

Limitations imposed by third parties: Generally speaking, even if a contract indirectly benefits or affects someone who is not a party, they cannot enforce its terms.

Intent under contract: Privity is predicated on the notion that parties mutual consent results in contractual duties. The contract should not bind anyone who have not agreed to it.

Beneficiary exception:

In many jurisdictions, third-party beneficiaries are granted exclusions. A third party may have legal rights if a contract is made with their advantage in mind.

Transfer of rights: Contractual rights can occasionally be transferred, even if the originating parties might not want third parties involved. 

Novation: In some circumstances, the original parties may decide to substitute a new party for one of them, absolving the departing party of its responsibilities. We call this novation.

Doctrine of privity of contract in English law

When it comes to applying the theory of privity, English law is more strict than Indian law. This is to ensure that strangers to contract and strangers to consideration are on same ground since English law only acknowledges consideration that originates from the promisee and not from someone else. Because the individual is unfamiliar with consideration, the promisee loses his right to enforce a contract when he fails to provide it himself.
The case of Tweddle v. Atkinson (1861) established the concept of privity of contract in English law. In this case, John Tweddle and William Guy signed a contract committing them to each other to giving their engaged children a certain amount of money. But William, the bride’s father, died before he could complete his duty. Before he introduced a lawsuit, the groom’s father also passed away. To obtain payment of the amount, the groom sued William’s executor. The Court decided that the son’s claim could not be maintained since he was unaware with the contract and the consideration. [1]

When the theory was referenced in the well-known case Dunlop Pneumatic Tyre Co. Ltd. v. Selfridge & Co. Ltd (1915), its applicability was once again confirmed. In this case, the Dunlop Company, a tire manufacturer, signed a contract with retailers Dew & Co. Dew & Co. committed to avoid selling the tires for less than the agreed-upon price, and Dunlop engaged into the arrangement to preserve a regular market pricing for the tires. Additionally, Dunlop demanded that the terms of the dealers’ contracts with the stores be identical. Dew & Co. signed a contract with the retailer Selfridge that said that they would have to pay Dunlop & Co. five pounds per tire as damages if the tires were sold for less than the agreed upon price. Dunlop filed a lawsuit against Selfridge for damages when they sold certain tires for less than the agreed upon price, and the court decided in Dunlop’s favor. However, the ruling was overturned on appeal, and it was decided that Dunlop had no right to sue for damages because the contract only applied to Dew & Co. and the store Selfridge. [2]

Exceptions to privity of contract

Third-party beneficiaries:

A third party may enforce a contract if it is formed specifically for their benefit. The people that the parties obviously meant to help are known as intended beneficiaries.

Transfer of rights:
Through assignment, one party to a contract may give another party its rights. To enforce such rights, the third party then assumes the role of the original party.

Organization:
A contract formed on behalf of a revealed principal may be enforced by an agent. The third party cannot enforce the contract against the agent, and the agent is not personally obligated to it.

Statutory limitations:
Some legislation establish exceptions to privity. For example, even in cases where a consumer did not enter into a direct contract with a manufacturer or supplier, consumer protection laws may grant rights against them.

Contracts for collateral:
A collateral contract is an independent agreement that is connected to the primary agreement. A collateral contract may grant rights to a third party.

Trusts:
Beneficiaries of the trust may have the right to enforce a contract involving a trust.

Covenants that accompany the land:
Certain pledges made in real estate deals may continue with the land and bind later owners, even if they were not involved in the initial agreement.

Fair exceptions:
A third party may be entitled to enforce a promise made for their advantage under equitable theories like promissory estopple.

Case laws

M.C. Chacko v. State Bank of Travancore

A ‘charge’ may be created on immovable property when either through express words or implied from deed, it is clear that party intended to make a specified property or fund, belonging to him, liable for debt due by him.

The deed only outlined an internal agreement between the donor and family members that granted them an indemnity right against M.C. Chacko and his inherited property; no such charge was established in favor of State Bank in this particular case. Nevertheless, it was not possible to infer any intention to turn a personal debt into a secured debt in the bank’s favor. Due to the fact that K was personally liable for the obligation, all of his heirs were required to use his wealth, which they received, to pay off the bill after his death. But in that scenario, M.C. Chacko would have reimbursed the other members for any portion of the loan they paid.

The idea that “a stranger to a contract could enforce the obligations thereunder” is totally disregarded by the definition of promisor and promisee found in S.2 as well as the constructive reading of ICA considering comparable provisions in English law. Unless he is a beneficiary of the agreement or it is a family arrangement, which grants him equitable rights even though they are not contractual, a non-party to the contract cannot enforce its provisions.

Because State Bank is not a party to the deed and was not a beneficiary under the contract, it would not have been able to enforce it even if a charge had been made in its favor. Since the statute of limitations had passed, State Bank was unable to collect any money under the letter of guarantee from K’s other heirs or from MC Chacko, who never personally guaranteed payment.

Jamna Das vs Pandit Ram Autar Pande

1. This case is straightforward. A mortgagee files a lawsuit to hold a buyer of the mortgaged property accountable for an agreement he made with his vendor. The mortgagee is not entitled to use that. The sale did not involve him. The buyer is not personally obligated to pay this mortgage debt, and they did not engage into a contract with him. As a result, he is not a person from whom the remaining amount is legally recoverable under the terms of the 90th section of the Transfer of Property Act.

2. As a result, Their Lordships will respectfully recommend to His Majesty that this appeal be denied together with costs.

Conclusion

A key component of contract law that maintains the integrity of agreements between parties is the notion of privity of contract. Even though its stringent implementation makes it impossible for third parties to enforce contracts, there are a number of exceptions that guarantee justice in some situations. Both court rulings and legislative actions have acknowledged and broadened these exclusions. Indian courts have modified the strict privity concept to account for justice and pragmatism as the legal environment changes, especially in business and family relationships. Nonetheless, the fundamental idea that a third party to a contract cannot file a lawsuit is still upheld by the Indian legal system.

Reference

1. Doctrine of privity of contract under the Indian contract law, 1872 – blogipleaders
2. Privity of contract- Indian case law
3. The doctrine of privity of contract under Indian and English Law- legal service India
4. Doctrine of privity of consideration- legal vidhiya

[1] Tweddle v. Atkinson, casemine, https://www.casemine.com/judgement/uk/5a8ff8d060d03e7f57ecdbc0

[2] Dunlop pneumatic tyre co. ltd. v. Selfridge & co. ltd., Aequitas Victoria foundation,

https://www.aequivic.in/post/aijacla-dunlop-pneumatic-tyre-co-ltd-v-selfridge-co-ltd