The Law Commission Consultation Paper No. 121 Privity of Contract: Contracts for the Benefit of Third Parties HMSO The Law Commission was set up by section 1 of the Law Commissions Act 1965 for the purpose of promoting the reform of the law. The Law Commissioners are: The Honourable Mr. Justice Peter Gibson, Chairman Mr. Trevor M. Aldridge Mr. Jack Beatson Mr. Richard Buxton, Q.C. Professor Brenda Hoggett, Q.C. The Secretary of the Law Commission is Mr. Michael Collon and its offices are at Conquest House, 37-38 John Street, Theobalds Road, London WCIN 280. This consultation paper, completed on 23 October 1991, is circulated for comment and criticism only. It does not represent the final views of the Law Commission. The Law Commission would be grateful for comments before 30 June 1992. All correspondence should be addressed to: Mr. S. McMaster Law Commission Conquest House 37-38 John Street Theobalds Road London WClN 2BQ (Tel: 071-411 1215 Fax: 071-411 1297). It may be helpful for the Law Commission, either in discussion with others concerned or in any subsequent recommendations, to be able to refer to and attribute comments submitted in response to this consultation paper. Whilst any request to treat all, or part, of a response in confidence will, of course, be respected, if no such request is made the Law Commission will assume that the response is not intended to be confidential. I i The Law Commission Consultation Paper No. 121 Privity of Contract: Contracts for the Benefit of Third Parties LONDON: HMSO @ Crown copyright 1991 Applications for reproduction should be made to HMSO First Published 1991 ISBN 0 11 730203 1 THE LAW COMMISSION PRIVITY OF CONTRACT: CONTRACTS FOR THE BENEFIT OF THIRD PARTIES CONTENTS Paragraph PART I INTRODUCTION 1.1 - 1.6 1 PART I1 THE MEANING AND DEVELOPMENT OF THE THIRD PARTY RULE 2.1 - 2.19 7-20 1. Meaning of the third party rule 2.1 7 2. Privity and the rule that consideration must move from the promisee 2.5 9 3. Development of the third party rule 2.11 13 4. What is a contract for the benefit of a third party? 2.17 18 PART I11 EXCEPTIONS AND CIRCUMVENTIONS OF THE THIRD PARTY RULE 3.1 - 3.56 20-64 1. Recourse to other areas of the law 3.3 - 3.21 22-36 (a) The law of trusts 3.3 22 (b) The law of real property 3.6 25 (C) The law of tort 3.8 27 (a) The law of bailment 3.18 33 2. Collateral Contracts 3.22 36 3. Exemption clauses 3.23 37 4. Documentary letters of credit 3.32 48 5. Joint promisees 3.33 48 Paragraph 6. Assignment 3.34 49 7. Agency 3.36 51 8. Promisee assisting the third party 3.39 53 9. Statutory Exceptions 3.45 57 PART IV THE CASE FOR REFORM 4.1 - 4.35 65-96 1. An overall assessment of the rule 4.3 66 2. Shipping 4.8 73 3. Construction 4.12 76 4. Liability from the making of statements 4.15 78 5. Sale of Goods 4.19 82 6. Insurance 4.22 84 7. Contracts to pay money to a third party 4.23 84 8. Wills 4.25 86 9. Contractual Licences 4.26 87 10. Limits on the ability of the promisee to assist the third party 4.27 88 11. The Report of the Law Revision Committee 4.30 90 12. Contracts burdening third parties 4.33 92 13. Summary 4.34 94 PART V THE MAIN ISSUES EXAMINED 5.1 - 5.46 97-131 1. Scope of Legislation 5.1 97 2. Test of enforceable benefit 5.8 101 3. Range of benefits 5.16 106 4. Designation of third party 5.19 108 5. Ascertainability and Existence of third party 5.20 109 6. Defences and joinder 5.24 111 7. Variation and cancellation 5.27 114 a. Discretion to order variation or discharge for reasons of justice 5.32 119 (ii) Paragraph Page 9. Can the promisee sue in addition to the third party? 5.34 121 10. Overlap of remedies against both contracting parties 5.35 122 11. No creation of duties in third parties 5.36 123 12. Existing exceptions 5.38 125 13. Concurrent actions 5.39 127 14. Third party beneficiaries under wills 5.40 128 15. Conclusion 5.45 130 PART VI SUMMARY OF OUR PROVISIONAL RECOMMENDATIONS FOR REFORM 6.1 - 6.21 132-138 APPENDIX 139 CONTRACTS FOR THE BENEFIT OF THIRD PARTIES IN OTHER JURISDICTIONS 139 Western Australia 2. 140 Queensland 4. 141 The Commonwealth of Australia 5. 143 New Zealand 9. 145 United States of America 14. 151 The Republic of Ireland 21. 155 Scotland 22. 156 France 24. 158 Germany 28. 161 Roman-Dutch Law 30. 163 Summary Table of Foreign Juridictions 165 (iii) PART I INTRODUCTION 1.1 Although a contract or its performance can affect a third party,l the doctrine of privity means that, as a general rule, a contract cannot confer rights or impose obligations arising under it on any person except the parties to it.2 There are several different aspects of the doctrine: (i) a person cannot enforce rights under a contract to which he is not a party; (ii) a person who is not party to a contract cannot have contractual liabilities imposed on him; (iii) contractual remedies are designed to compensate parties to the contract, not third parties. 1 This paper is primarily concerned with the general rule that l a person cannot enforce a right under a contract to which he 1- As when C guarantees a debt owed by A to B and A pays, thus releasing C who thereby indirectly gains a benefit, or where the contract or its performance creates a property right in a third party. 2- Before Donoghue v. Stevenson Cl9321 A.C. 562, the privity doctrine was seen as precluding actions in tort by third parties arising from negligence by a party to a contract in carrying it out: Winterbottom v. Wright (1842) 10 M. & W. 109; 152 E.R. 402. 1 is not a party,3 and references in it to the "third party rule" are to this. 1.2 Whilst it is self-evidently desirable that a complete stranger to a contract should not have contractual obligations forced upon him,4 the general rule that a third party cannot acquire rights under a contract to which he is not privy has been much criticised. This criticism has come from academics,5 law reform bodies (including the Law Revision Committee6) and the j~diciary.~In 1967, in Beswick v. Beswick,8 Lord Reid cited with approval the Law Revision Committee's proposals that when a contract by its express terms purports to confer a benefit directly on a third party, it shall be enforceable by the third party in his own name. While implying that the way forward was by legislation, he stated that the House of Lords might find it necessary to deal with the matter if there was a further long period of Parliamentary procrastination. In Swain v. 3- Atiyah, An Introduction to the Law of Contract (4th ed., 1989). pp. 371-372. 4. We shall see that different considerations apply when P is taking the benefit of a contract to which he is not a party and D wishes to rely on defences in that contract. Here, although D purports to burden P, the latter is not a complete stranger. In seeking to take the benefit of a contract to which he is not privy, fairness dictates that he should, in principle, take the burden. 5- Corbin, (1930) 46 L.Q.R. 12; Furmston, (1960) 23 M.L.R. 373; Wylie, (1966) 17 N.I.L.Q. 351; Markesinis, (1987) 103 L.Q.R. 354; Flannigan, (1987) 103 L.Q.R. 564; Reynolds, (1989) 105 L.Q.R. 1; Kincaid, Cl9891 C.L.J. 243; Adams & Brownsword, (1990) 10 L.S. 12; Beyleveld & Brownsword, (1991) 54 M.L.R. 48. 6- (1937), Cmd. 5449. See para. 4.30 below. 7- See Part IV below for the details of these criticisms. 8. [1968] A.C. 58, 72. 2 Law Society,' Lord Diplock referred to the general I non-recognition of third party rights as "an anachronistic shortcoming that has for many years been regarded as a I reproach to English private law". In Woodar Investment I ) I Development Ltd. v. Wimpey Construction (U.K. Ltd., lo Lord ' Salmon regarded the law concerning damages for loss suffered by third parties as most unsatisfactory and hoped that, unless it were altered by statute, the House of Lords would reconsider it.ll Lord Scarman reminded the House that twelve years had passed since Lord Reid had called for a reconsideration of the rule in Beswick v. Beswick, and hoped I that all the cases which "stand guard over this unjust rule" might be reviewed.l2 1.3 The Law Commission first became interested in this subject after its creation in 1965. Item 1 of the First Programme of law reform was the codification of the law of I contract. Item 3 included the topic of third party rights. A ~ substantial amount of work was done on this topic in I conjunction with work on consideration. At that time it was felt that reform of privity could not usefully be undertaken without reform of the doctrine of consideration. After the decision in 1973 to suspend work on the production of a ' contract code,13 other contract projects have taken 9- [1983] 1 A.C.