Privity of Contract

If your new house has a defective water heater which was installed by a third party contractor. The defective water heater had injured your baby while taking bath. This is like your developer can be sued for negligence, but the third party water heater installer may get away with it. So, you can choose to sue under 'strict product liability'. Go here to read about 4 elements of 'Strict Liability Claim'.

Example

Imagine that you visit your local supermarket and buy a frozen dinner. You come home, heat it up and get sick immediately after eating the dinner. It turns out that the dinner was tainted with bacteria. You want to sue the supermarket and the manufacturer of the meal. However, you also want to sue the middleman who delivered the meal to the store. This will be a potential problem, because you were not in privity of contract with the middleman; in other words, you had no direct relationship with the middleman at all. He did not sell you the item or market the frozen dinner.

Privity of contract is the relationship that exists between the parties to an agreement. This relationship is necessary in contracts; therefore, if you want to file a lawsuit involving a contract, you need to show that you and the other person were in privity of contract; hence, you were both involved in the contract and had an established contractual relationship.

Exceptions
There are some exceptions to privity of contract; this means that even though someone was not directly involved in the contract, that person might still be able to sue. For example, there is a trust exception. Here, a trust beneficiary, who is a person who receives money or property from a trust, can sue the trustee if the trustee is not following the contract. The trustee is the third party person who oversees the trust and gives out the property in accordance with a contract.

Next, there are property exceptions to privity of contract. For example, there may be a restrictive covenant which runs with the land; in other words, no matter who buys the property, that buyer has to abide by the restrictions on the property. An example of a restrictive covenant is where there is an easement (or right of use) on the property which allows a neighbor to use a part of the land. Even though the present owner does not have a contract with the neighbor, the covenant is still enforceable as if the owner and the neighbor had a contractual relationship.

In addition, there are assignments of contract which can lead to an exception. In this instance, a party to a contract can assign, or give, another person the right to sue. This type of situation arises when the original person in the contract transfers all of their rights to another third person. This third person stands in the place of the original person and therefore can file a lawsuit based upon the contract.

Moreover, there is a third party insurance exception. When someone makes an insurance policy for the benefit of another person, that other person may file a claim, even though they did not pay any premiums, sign the actual contract or make the original policy.

Applicability Of The Doctrine In England

The privity rule emerged as established law in England in the middle nineteenth century. The doctrine of privity emerged alongside the doctrine of consideration, one of the rules which state that consideration must move from the promisee.

[In such context, read my earlier post on 'Without consideration a valid contract?'. It outlines argument that Malaysian Contract Law does allow no consideration for a valid contract, and the consideration does not need to be from the promisee. This is variation from English Contract Law.]

In the case of Price v Easton [4] , Easton agreed to do certain work in consideration of which he would pay a specified sum to Price, a third-party. The work was done, however, Easton failed to pay Price. Price sued to enforce the contract but it was held that he was not privy to the contract so his claim failed.

The rule was further developed in Dunlop Pneumatic Tyre Co Ltd v Selfridge & Co [5] , a leading House of Lords case on the doctrine. The plaintiffs sold tyres to Dew & Co, wholesale distributors, on terms that Dew would obtain an undertaking from retailers that they should not sell below the plaintiffs' list price. Dew sold some of the tyres to the defendants, who retailed them below the list price. The plaintiffs sought for injunction and damages. The action failed because although there was a contract between the defendants and Dew, the plaintiffs were not a party to the contract.

Lord 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 who had provided consideration can sue on it. Our law knows nothing of a jus quaesitum tertio (third party right of action) arising by way of contract."

The rule has been subsequently reaffirmed by the House of Lords in various cases, including Beswick v Beswick [6] . Old Beswick was a coal merchant. Old Beswick and his wife were both over 70 years old. He had had his leg amputated and was not in good health. He agreed to transfer a business to his nephew in exchange for a salary and the payment of a weekly annuity to his widow on his death. On Beswick’s death, the nephew refused to pay the annuity. The nephew argued that Mrs Beswick was not a party to the contract, she was unable to enforce it due to the doctrine of privity of contract. The House of Lords held that she was not entitled to enforce the contract in her personal capacity, but as administratrix of the estate (as her deceased husband’s representative), she was entitled to specific performance of the contract.

However, the second rule of the doctrine, that a third party cannot claim benefits from a contract, has been widely criticised by academics, members of the judiciary and legal professionals.

Applicability Of The Doctrine In Malaysia

In Malaysia, the Contracts Act 1950 does not expressly provide for this principle but it is firmly acknowledge that the doctrine has been transplanted into our law in Malaysia. It is a fundamental rule of the common law that apart from special circumstances, for example in cases of agency, trust, assignment or statutory exception, a person who is not a party to a contract has no right to sue on a contract [7] .

It is necessary for us to look at the position in India first as the Malaysian Contracts Act 1950 is modelled on the Indian Contract Act 1872 which is in turn, mainly a codification of the English common law. It is established that the doctrine of privity applies in India [8] . In N C Chacko v State Bank of Travancore [9] , the Supreme Court held that a person who is not privy to a contract, cannot, subject to certain well recognised exceptions, enforce the terms of the contract [10] .

In Malaysia position, it was doubtful formerly whether this principle applies in Malaysia because of the wide import of section 2(d) of the Contracts Act 1950. Section 2(d) provides that:

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.

However, the decision of Privy Council in Kepong Prospecting Ltd & Ors v Schmidt [11] affirmed that the rule applies in Malaysia. In this case, Schmidt who was a consulting engineer has assisted another in obtaining a permit for mining iron ore in the state of Johore. He also helped in the subsequent formation of the company, Kepong Prospecting Ltd, and was appointed Managing Director. After the company was formed, an agreement was entered into between them under which the company undertook to pay him 1% of the value of all ore sold from the mining land. This was in consideration of the services rendered by the consulting engineer for and on behalf of the company prior to its formation, after incorporation and for future services. The issue in this case was whether services rendered after incorporation but before the agreement, were insufficient to constitute a valid consideration even though they were clearly past. It was held that past consideration did constitute a valid consideration. So Schmidt was entitled to his claim on the amount.

The Court of Appeal and the High Court also uphold the application of the doctrine throughout all these years.

In a recent case of Razshah Enterprise Sdn Bhd v Arab Malaysian Finance Bhd [12] , Abdul Malik Ishak JCA in the Court of Appeal stated that [13] :

"Our Contracts Act 1950 (Act 136) has no express provision pertaining to the doctrine of privity of contract. In fact, Kepong Prospecting gives the gloom picture that the doctrine still applies in Malaysia. Indeed Mohamed Dzaiddin J (who later rose to be the Chief Justice of Malaysia) relied on Kepong Prospecting and aptly said in Fima Palmbulk Services Sdn Bhd v Suruhanjaya Pelabuhan Pulau Pinang & Anor [14] :

"It is clear that the English doctrine of privity of contract applies to our law of contract"

Ref:

Law Teacher: http://www.lawteacher.net/free-law-essays/contract-law/english-doctrine-of-privity-of-contract-contract-law-essay.php#ixzz3fXrEFC1F
[X] Own account.