The doctrine of privity
1.1 In this chapter, we further explain the doctrine of privity and illustrate its effect with some real-life examples. We then examine common law and statutory principles which have the effect of circumventing the doctrine, ie allowing a third party to enforce a jus quaesitum (a right conferred on him by the contractual parties). The last part of the chapter looks at judicial developments in other common law jurisdictions and discusses how those developments have been received by the Hong Kong courts.
1.2 As explained in the Preface, the doctrine of privity has two aspects. The first aspect, which is the crux of our present discussion, is that, as a general rule, a person cannot acquire and enforce rights under a contract to which he is not a party. The doctrine of privity at common law is generally considered to have been established in Tweddle v Atkinson.[4] The court in that case held that, in the words of Wightman J, "no stranger to the consideration could take advantage of a contract though made for his benefit." [5] That is to say, a third party to a contract, not having provided consideration himself, cannot enforce the contract even if it has been entered into for his benefit. The rule was affirmed in Dunlop Pneumatic Tyre Co Ltd v Selfridge & Co Ltd [6] when the House of Lords accepted that it was a fundamental principle of law that only a party to a contract who had provided consideration could sue on it.[7] This "consideration" rule is related to the doctrine of privity and is regarded as a possible explanation for the doctrine.[8]
1.3 When considering the effect of the privity doctrine, account needs to be taken of the remedy rule: the need to prove loss in an action for breach of contract. When a plaintiff sues for breach of contract, he must prove that he has suffered actual loss as a result of the alleged breach. Otherwise, he will only be entitled to nominal damages. This, when combined with the privity doctrine, could lead to unjust results in some circumstances. For example, suppose a contract is entered into between a parent company and a contractor for the benefit of a subsidiary company. If the subsidiary company subsequently suffers loss as a result of the contractor's breach, the subsidiary company cannot sue the contractor because it is not a party to the contract. The parent company, even though it is a party to the contract, will only recover nominal damages because it has suffered no actual loss. Hence it is not a viable option for a promisee (the parent company) to sue the promisor (the contractor). The decision of Alfred McAlpine Construction Ltd v Panatown[9] is a good example of the rule that a person can only recover nominal damages unless he has suffered actual loss.
1.4 The effect of the first aspect of the doctrine of privity on everyday life can best be illustrated by some real-life examples.
(i) Contracts to pay money to a third party
1.5 A and B enter into an agreement under which A agrees to pay a sum of money to C. Both parties fully intend that C should take the benefit of A's promise. If A defaults, C cannot sue A because of the doctrine of privity. It does not help for B to sue A for damages since B would be unlikely to have suffered any damage himself. Sometimes, the Court may be able to prevent an injustice to C if B is prepared to sue A for specific performance and the Court is prepared to make an order compelling A to perform his promise.
(ii) Contracts to purchase real property
1.6 A property developer enters into a building contract with a contractor under which the contractor promises to use good workmanship and sound materials. The contractor warrants that he would make good any defects in the building within a stated period of, say, twelve months. Shortly before completion of the building, the developer sells individual units to purchasers. If a purchaser of a unit discovers a defect in his flat, he has no direct recourse against the building contractor. This is still the case even though the developer may have obtained the building contractor's warranties specifically for the benefit of purchasers, since purchasers are not "privy" to the building contract. In practice, a developer may withhold part of the payment to the building contractor to ensure that the building contractor honours its promise. The developer may also contract with the purchaser that it would exercise its best endeavours to enforce all defects and maintenance obligations under all contracts relating to the construction of the development.[10] Nevertheless, a purchaser may find himself in a poor bargaining position because his only direct recourse, if any, is against the developer. Even that would depend upon the terms of his contract with the developer and on whether the developer is still around to honour its promise. In certain circumstances[11], the contract between a developer and the purchasers may provide that where the developer is wound up, all warranties and guarantees under all contracts relating to the construction of the development would be assigned by the developer to the owners' corporation incorporated under the Building Management Ordinance (Cap 344) or if no such corporation exists to the manager of the development for the time being to be held in trust for purchasers of the units in the development. This recourse against the contractor is indirect, and an individual purchaser may, however, encounter difficulties in compelling the owners’ corporation or the manager of the development to sue the contractor.
(iii) Insurance contracts
1.7 B is a sub-contractor of A. B takes out an insurance policy to cover his and A's liability to employees' compensation with an insurer (C), without joining A as a party. An employee of B is injured in the course of employment because of the negligence of A's employee. A pays the required compensation to B's employee. A, however, will have difficulties in seeking indemnity from C, since A is not a party to the insurance contract even though the parties intend to benefit him.
Legal principles which have the effect of allowing third parties to enforce rights
1.8 As illustrated in the above examples, strict adherence to the privity doctrine can prove artificial and contrary to the parties' intention, and can lead to injustice and inconvenience. There are, however, circumstances in which the doctrine does not apply, either because of supervening principles of common law or because of specific statutory provisions which allow a third party to enforce a right conferred on him by the contracting parties. The following paragraphs will first explain the principles at common law, followed by those in statutes. The merits and limits of employing these common law and statutory principles as options for reforming the privity doctrine are discussed under "Option 1" and "Option 2" respectively in Chapter 3 where other possible options for reform are also considered.
Common law
(i) Covenants concerning land
1.9 Covenants in a lease can benefit third parties who later acquire an interest in the property. Hence a person may be able to enforce a covenant affecting land made by his predecessor in title even though he was not a party to the covenant, and a covenant may be enforced against someone acquiring land with notice that it is burdened with a covenant.[12]
(ii) Trusts
1.10 A trust is an equitable obligation to hold property on behalf of a beneficiary. A chose in action may be the subject matter of a trust. For example, if A makes a promise to B to pay a sum of money to C, a trust of that promise can be construed as created by B in equity in favour of C. In such case, B would be the trustee while C would be the beneficiary under the trust. If this agreement is construed by the court as a properly constituted trust, C can, in his capacity as beneficiary, sue A to enforce the promise. Though C is not a party to the promise made by A to B, C could nonetheless enforce the promise in equity.
1.11 However, the use of this trust device to circumvent the doctrine of privity has its restrictions. A promisee (ie B in the example quoted above) is not a trustee for a third party unless he manifests an intention to create a trust.[13] Where the word "trust" or "trustee" is not used, there may be difficulties in determining whether or not there is the requisite intention to create a trust. Moreover, there must be an intention to benefit the third party. If the promisee intends the promise to be for his own benefit, there will not be any trust created in favour of the third party.[14] The main difficulty of using the trust device is that the court has confined its usage within narrow limits. The trust device has so far been applied only to promises to pay money or to transfer property.[15] According to Sir Guenter Treitel, the trust device has therefore been treated as an exception to the doctrine of privity but is of limited and uncertain scope.[16]
(iii) Tort of negligence
1.12 A contract between A and B may, in addition to creating contractual obligations between the parties, impose on B a duty of care towards a third party, C, under the law of tort. Breach of a duty of care on the part of B may render him liable to C for negligence.[17]
(iv) Collateral contracts
1.13 A contract between two parties may be accompanied by a collateral contract between one of them and a third party. For instance, A may enter into a contract of repair with B which specifies the use of the paint manufactured by C because of its special quality. If the paint supplied does not have that quality, A cannot sue C on the contract of sale of the paint to B because A is not privy to the contract.[18] The Court may, however, resort to the device of a collateral contract between A and C under which C would be held to have warranted to A the quality of the paint in consideration A's agreement with B to buy the paint.
(v) Assignment
1.14 A person who is entitled to the benefit of a contract may transfer the benefit to another person who is not a party to the contract. This process is known as assignment, and the consent of the party liable under the contract is not needed. An assignment may be seen as a circumvention of the privity doctrine because the person bearing the burden of the contract becomes liable to a person with whom he had no contractual relationship and whom he may not have intended to benefit.
(vi) Agency
1.15 Agency is the relationship between two persons, by agreement or otherwise, where one (the agent) may act on behalf of the other (the principal). One consequence is that the principal acquires rights and incurs liabilities under the contract made by the agent on his behalf with third parties, even though the principal is not a party to the contract. Agency is sometimes looked upon as only an apparent exception to the doctrine of privity because in an agency the agent is only the instrument of the principal, who is the real contracting party.[19] This view may be true if the agent acts within his actual authority, but where, for example, the principal's identity is not disclosed, an established agency is a clear exception to the doctrine of privity.[20]
Statutory provisions
(i) Conveyancing and Property Ordinance (Cap 219)
1.16 Section 41 of Cap 219 provides that a covenant is enforceable not only by the parties but also by the convenantee's successors in title, assigns, lessees and mortgagees. Section 26 of Cap 219 provides:
"[a] person may take an immediate or other interest granted to him in land or the benefit of any condition, right of entry, covenant or agreement granted to him over or in respect of land, although he may not be named as a party to the instrument."
(ii) Third Parties (Rights against Insurers) Ordinance (Cap 273)
1.17 Under Cap 273, a third party may in specified circumstances step into the shoes of the insured and enforce his rights under the policy by suing the insurance company directly. According to section 2, where a person who is insured against liabilities to third parties under a contract of insurance becomes bankrupt, makes a composition or an arrangement with his creditors, or is wound up, his rights under the contract of insurance are transferred to the third party to whom the liability was incurred. In other words, the third party has a direct cause of action against the insurer.
(iii) Marine Insurance Ordinance (Cap 329)
1.18 A person with a limited interest in property may insure and recover its full value, holding any amount above his own interest on account for others similarly interested. Section 14(2) of Cap 329 provides that:
"A mortgagee, consignee or other person having an interest in the subject-matter insured may insure on behalf and for the benefit of other persons interested as well as for his own benefit."
(iv) Bills of Exchange Ordinance (Cap 19)
1.19 A bill of exchange is defined in section 3(1) of Cap 19 as:
"an unconditional order in writing, addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand or at a fixed or determinable future time a sum certain in money to, or to the order of, a specified person or to bearer."
Under section 38(a), a holder of a bill of exchange may sue on the bill in his own name. A holder of a bill of exchange means a payee or an indorsee of a bill who is in possession of the bill, or a bearer of the bill (section 2).
(v) Bills of Lading and Analogous Shipping Documents Ordinance (Cap 440)
1.20 Where goods sold are to be delivered by sea, the seller will enter into a contract of carriage with the carrier, which is evidenced by a bill of lading. The goods are then consigned to the buyer, to whom the bill of lading is endorsed. At common law, a buyer of goods carried by sea cannot sue the carrier on the contract of carriage because there is no privity between them. However, under section 4(1) of Cap 440 a lawful holder of a bill of lading has "all rights of suit under the contract of carriage as if he had been a party to that contract". In other words, the buyer can sue the carrier direct, notwithstanding that he was not a party to the contract of carriage.[21]
How the Hong Kong courts have received judicial developments in other common law jurisdictions
1.21 There have been recent judicial developments in Canada and Australia relaxing the strict doctrine of privity. Although these overseas judicial developments are not binding on courts in Hong Kong, the fact that they represent the judicial opinion of the superior courts in other major common law jurisdictions may have some impact on local judicial thinking. In the following paragraphs, we first explain these overseas judicial developments, and then discuss how the Hong Kong courts have received them.
Canada
1.22 Two recent judgments of the Supreme Court of Canada have modified the law relating to privity: London Drugs Ltd v Kuehne & Nagel International Ltd [22] and Fraser River Pile & Dredge Ltd v Can-Dive Services Ltd [23]. In the "Fraser River" case, a third party beneficiary sought to rely on a contractual provision so as to defend against an action brought by one of the contractual parties (the insurer). The court held that the third party beneficiary was entitled to rely on the waiver of subrogation clause whereby the insurer expressly waived any right of subrogation against the third party beneficiary. Iacobucci J emphasised that in appropriate circumstances the courts should not abdicate their judicial duty to decide on incremental changes to the common law which were necessary to address emerging needs and values in society.[24] In the "London Drugs Ltd" case, employees of a warehouseman sought to rely on the limitation of liability clause in the contract between their employer and the client (the bailor) when the employees were sued by the bailor. The Supreme Court held that the privity rule could be relaxed where the parties to the contract had, expressly or by implication, intended the relevant provision to confer a benefit on the third parties (the employees), and the action taken out by the third parties came within the scope of the agreement between the initial parties. The employees fulfilled these two conditions, and thus could benefit from the limitation clause, despite the privity doctrine. The court recognised a limited exception to the doctrine in the circumstances of the case so as to conform to "commercial reality and justice".[25]
Australia
1.23 The decision of the High Court of Australia in Trident General Insurance Co Ltd v McNiece Bros Propretary[26] has relaxed the strictness of the doctrine. The importance of this case is its implications for the privity doctrine in Australia generally.[27]In this case, the respondent (McNiece) was the principal contractor for construction work being carried out at the limestone crushing plant of a company which took out a public liability insurance policy with the appellants (Trident) covering itself and all contractors and sub-contractors. A person injured at the construction site recovered damages from McNiece, which in turn brought an action against Trident to seek indemnity for the amount of damages paid. The High Court of Australia held that McNiece was entitled to seek indemnity form Trident even though McNiece was not a party to the insurance contract.
1.24 In the High Court of Australia, three of the Justices criticised the doctrine of privity. Mason CJ and Wilson J (who delivered their judgment jointly) were of the view that there was "much substance" in the criticisms directed at the doctrine of privity.[28] Toohey J considered that:
"the law which precludes him [ie a non-party assured] from doing so [ie suing the insurer] is based on shaky foundations and, in its widest form, lacks support both in logic or in jurisprudence".[29]
1.25 Mason CJ, Toohey and Wilson JJ decided the case on the basis of a specific abrogation of the privity rule in relation to insurance contracts. Mason CJ and Wilson J put forward their arguments as follows:
"In the ultimate analysis the limited question we have to decide is whether the old rules [of privity] apply to a policy of insurance. The injustice which would flow from such a result arises not only from its failure to give effect to the expressed intention of he person who takes out the insurance but also from the common intention of the parties and the circumstances that others, aware of the existence of the policy, will order their affairs accordingly ... In the nature of things the likelihood of some degree of reliance on the part of the third party in the case of a benefit to be provided for him under an insurance policy is so tangible that the common law should be shaped with that likelihood in mind."[30]
Hong Kong courts
1.26 The "Trident" case was considered in B + B Construction Ltd v Sun Alliance and London Insurance Plc,[31] the facts of which were similar to those of the "Trident" case. Pak Kee, a sub-contractor, took out an insurance policy with an insurer (the defendant), and the "insured" was described in the contract as "Pak Kee and his contractors". An employee of Pak Kee was injured because of the negligence of an employee of the principal contractor (the plaintiff), which was then held liable to pay damages for negligence and to reimburse Pak Kee for employee's compensation. The plaintiff brought an action against the defendant as the insurer for an indemnity. Since the defendant did not take the point that the plaintiff was not a party to the insurance contract, the Hong Kong Court of Appeal proceeded on the footing that the plaintiff's claim, if otherwise good, was enforceable in the usual way. Hence, at issue was whether the scope of the indemnity extended to the plaintiff.[32] Godfrey VP (with whom Ribeiro JA agreed) nonetheless stated incidentally:
"[the court is] aware of the judicial abrogation of the rule effected in Australia by the decision of the High Court (split 4 to 3) in [the "Trident" case], a case the facts of which bear many similarities to our own. ...But here, in Hong Kong, the law remains as magisterially stated by Viscount Haldane LC in Dunlop Pneumatic Tyre Co Ltd v Selfridge & Co Ltd [1915] AC 847 at 853: '... only a person who is a party a contract can sue on it. Our law knows nothing of a jus quaesitum tertio...' ".[33]
1.27 No Hong Kong case can be found in which the "Fraser River" case has been considered. The Privy Council in Re the Mahkutai[34] mentioned both the "Trident" case and the "London Drugs Ltd" case. Lord Goff of Chievely of the Privy Council stated in an obiter dictum:
"the time may well come when, in an appropriate case, it will fall to be considered whether the courts should take what may legitimately be perceived to be the final, and perhaps inevitable, step in this development, and recognize in these cases a fully-fledged exception to the doctrine of privity of contract, thus escaping from all the technicalities with which courts are now faced in English law. It is not far from their Lordships' minds that, if the English courts were minded to take that step, they would be following in the footsteps of the Supreme Court of Canada (see [the "London Drugs Ltd" case]) and, in a different context, the High Court of Australia (see [the "Trident" case]). Their Lordships have given consideration to the question whether they should face up to this question in the present appeal. However, they have come to the conclusion that it would not be appropriate for them to do so, first, because they have not heard argument specifically directed towards this fundamental question, and second because, as will become clear in due course, they are satisfied that the appeal must in any event be dismissed."
The Privy Council here raised the possibility of "a fully-fledged exception" to the privity doctrine. Nevertheless, as Godrey VP reiterated in the "B + B" case, the privity doctrine is still part of the Hong Kong law.
[4] (1861) 1 B & S 393. Kepong Prospecting Ltd v Schmidt [1968] AC 810, a decision of the Privy Council on appeal from Malaysia, seems to support the view that the doctrine of privity is distinct from the rule that consideration must move from the promisee. G Treitel, The Law of Contract, Sweet and Maxwell, 11th Edition, 2003, at 587.
[5] (1861) 1 B & S 393, at 397.
[6] [1915] AC 847.
[7] The existence of the doctrine of privity was, however, later doubted by Denning LJ in Smith and Snipes Hall Farm Ltd v River Douglas Catchment Board [1949] 2 KB 500 in 1949 and Drive Yourself Hire Co (London) Ltd v Strutt [1954] 1 QB 250 in 1954. See also G Treitel, The Law of Contract (cited above), at 588. However, the House of Lords (with Lord Denning dissenting) once again affirmed the existence of the doctrine of privity in 1961 in Sruttons Ltd v Midland Silicones Ltd [1962] AC 446.
[8] G Treitel, The Law of Contract (cited above), at pages 588. Chapter 2 will discuss whether the rationale is valid, and will also critically discuss other possible reasons for supporting the privity doctrine.
[9] [2001] 1 AC 518.
[10] R5C(2)-(5) of the Solicitors’ Practice Rules (Cap 159); Circular No 04-53 (PA) of the Law Society of Hong Kong and Circular Memorandum No.40A of the Legal Advisory and Conveyancing Office (last visit on 7 April 2004).
[11] R5C(2)-(5) of the Solicitors’ Practice Rules (Cap 159); Circular no 04-53 (PA) of the Law Society of Hong Kong and Circular Memorandum No.40A of the Legal Advisory and Conveyancing Office (last visit on 7 April 2004)..
[12] Tulk v Moxhay (1848) 2 Ph 774.
[13] Swain v Law Society [1983] 1 AC 598, at 620.
[14] G Treitel: The Law of Contract (cited above), at 648.
[15] G Treitel: The Law of Contract, (cited above), at 650.
[16] G Treitel: The Law of Contract (cited above), at 650
[17] Dononghue v Stevenson [1932] AC 562.
[18] Shanklin Pier Ltd v Detel Products Ltd [1951] 2 KB 854.
[19] G Treitel, The Law of Contract, (cited above), at 645.
[20] According to Sir Guenter Treitel, other scenarios are where an agent acts without actual but within his "usual" authority and in certain cases of agency of necessity. G Treitel, The Law of Contract, (cited above), at 646.
[21] At common law, where a carrier delivers the goods to a buyer, an implied contract may arise from the carrier's attornment to the buyer and the buyer's acceptance of the goods, to the effect that the goods were delivered in the same apparent good order and condition as when received by the carrier. This device enables a third party to sue the carrier on an implied contract having similar (but not necessarily identical) terms to those in the bill of lading. See Brandt v. Liverpool [1924] 1 KB 275.
[22] (1992) 97 DLR (4th) 261
[23] [2000] 1 Lloyds Rep 199
[24] [2000] 1 Lloyds Rep 199, at 208 (para 44). "[T]he Courts may... ,bound by both common sense and commercial reality, ... determine whether the doctrine of privity... should be relaxed in the given circumstances" (See The Canadian Encyclopedic Digest: Ontario, 3rd Edition, at Title 32 Contracts, para 58.1).
[25] S Waddams, The Law of Contracts, 4th Edition, 1999, Canada Law Book Inc, at 202.
[26] [1987-1988] 165 CLR 107
[27] Carter and Harland, Contract Law in Australia, 4th Edition, 2002, Butterworths, at 352.
[28] [1987-1988] 165 CLR 107, 118.
[29] [1987-1988] 165 CLR 107, 168.
[30] [1987-1988] 165 CLR 107, 123-4.
[31] [2000] 2 HKC 295.
[32] [2000] 2 HKC 295, at 301 I to 302 D. The plaintiff lost and appealed to the Court of Final Appeal ([2001] 3 HKC 127) which also decided on the scope of the indemnity, without even mentioning the privity doctrine.
[33] [2000] 2 HKC 295, at 301B to 301F.
[34] [1996] 2 HKC 1.
