Privity of contract is a legal concept which states that only parties to a contract can enforce or be bound by its terms.
This means that although performance of a contract may result in a benefit or burden to a third party to the contract, the third party cannot enforce the contract nor be subject to liabilities imposed by it.
The doctrine of privity of contract was first explored in Australia in Coulls v Bagot’s Executor and Trustee Co Ltd (1967) 119 CLR 460.
Mr Coulls granted a company the right to quarry stone from his property in exchange for payment of royalties. The agreement was headed “Agreement between Arthur Leopold Coulls and O’Neil Construction Proprietary Limited” but was signed by Mr Coulls and his wife Doris (as well as a company representative) and provided that the company pay the royalties to them as “joint tenants”.
When Mr Coulls died, his executor sought direction from the court about whether the royalties had to be paid to Mrs Coulls.
The High Court held that Mrs Coulls was not entitled to receive royalties because she was a third party and the promise was not made expressly to her.
A third party’s ability to enforce a contract was considered in Trident General Insurance Co Ltd v McNiece Bros Pty Ltd (1988) 165 CLR 107.
McNiece was the principal contractor for construction work at Blue Circle cement plant. Under Blue Circle’s insurance with Trident, the insurer agreed to indemnify “the assured” against liability for injury to non-employees.
The contract defined “the assured” as Blue Circle, all related companies, and all contractors and suppliers.
A worker who was contracted to McNiece by another company was injured on site and sued McNiece for damages.
McNiece sought indemnity from Trident under its insurance contract with Blue Circle. Trident argued McNeice had no right to sue because he was not a party to the contract.
The High Court ruled that although McNiece was a third party, the contract intended to cover any contractor working for Blue Circle.
This ruling effectively created an exception to the doctrine of privity for insurance contracts.
Mason CJ and Wilson J stated the privity rule had been eroded by statute and had the potential to cause injustice, saying: “…we consider it is the responsibility of this court to reconsider in appropriate cases common law rules which operate unsatisfactorily and unjustly.”[1]
They said in the case of insurance contracts, the privity rule would cause injustice because of the likelihood of reliance on such contracts by third parties, who organise their actions in the knowledge that another person has insured against a particular risk.[2]
The Insurance Contracts Act 1984 (Cth) was passed after the Trident case, and allows a person covered by a general insurance policy to make a claim from the insurer even though the person is not a party to the contract.
There are other statutory exceptions to the privity rule, including section 55(1) of the Property Law Act 1974 (Qld), which largely abolished the privity rule:
“A promisor who, for a valuable consideration moving from the promisee, promises to do or to refrain from doing an act or acts for the beneficiary shall, upon acceptance by the beneficiary, be subject to a duty enforceable by the beneficiary to perform that promise.”
The privity rule does not apply when a party entered a contract via an agent (a person who holds the power to enter a contract on behalf of another person).
It must be shown that the party expressly or impliedly consented to the agent acting on their behalf.
The privity rule does not apply when a party transfers contractual rights and/or obligations to a third party.
In some circumstances, a party may transfer their contractual rights to a third party, via “assignment”.
Whether a right may be assigned depends on the construction of the contract. Contractual obligations cannot be transferred but a third party may be substituted for an original contracting party, via “novation”.
Novation means privity of contract is then established between the original party and the substituted party.
There are several ways the privity rule may be circumvented, including when:
To mitigate the negative effects of privity of contract, the courts have ordered both equitable and discretionary remedies. These include damages, and when damages are inadequate, specific performance.
The doctrine of privity of contract is technical and highly complex area of law. You can discuss your contract privity matters with one of our contract lawyers today in a no-obligation, confidential consultation.
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