Discuss Criticisms of the Doctrine of Privity of Contract

Privity of contract is fundamental criteria in a contract and in parallel with doctrine of consideration. Uncertainty in this area of contract often gets critics and various approaches taken in order to avoid the topic itself. In order for us to understand in depth of application of privity of contract in Trident General Insurance Co Ltd v Mc Niece Bros Limited(1988), we will be looking at history of application of it in Australia. The doctrine of Privity was introduced to Australia By Coulls v Bagot’s (CB 261). Strictly speaking the doctrine of privity under this case precludes a third party from enforcing a contract or coming under obligation of a contract. In order to enforce a contract the third party must prove that it not only is a contractual party, but that it has provided consideration. Consideration was used as test to prove or disprove contractual membership in cases where a third party sought to enforce a contract.

Doctrine of privity stems from the bargain theory of contract. Thus third parties may not enforce a contract in which they are named to receive a benefit, even if the benefit does not eventuate. They have not submitted a consideration to the party granting a benefit, even though another party has (promisee) intended that the third party receive a benefit. We also need to look into critism received by Trident’s case and the raised questions about the legitimacy of privity in the modern commercial world. Already statutory reforms had been made in 1984 to ensure that where third parties are names as assured in insurance contracts than the insurance company is obliged to indemnify them. Other countries had enacted legislation that granted third parties a set of enforceable rights in contracts for example in the United States and recently in England in 1999 the Law Commission recommended that the doctrine of privity be relaxed to allow a person who is not a party to a contract to sue on it, provided that the contract contains an express term to that effect and it purports to confer a benefit on the third party.

The main criticisms of privity can be found Andrew Burrows’ comments on p.205 of the text. The relevant criticisms that applied to Trident’s case were that privity denied what was manifestly evident in the intentions of the contracting parties. Privity did not account for any detriment that might be suffered if the beneficiary reasonably believes they are indemnified. Often the promisee has a trust relationship with the third party. Privity does not recognize an obligation to enforce the contract under a trust. Where a promisor receives an agreed consideration and fails to fulfill its obligation to a third party it is unjustly enriched, however privity sees no injustice. Some have argued that the promisee can enforce the contract, however the resolution for the third party is only at the discretion of the promisee, and may only amount to nominal charges. Finally international trends were recognizing third party rights, and accepted commercial practice at the time conducted itself as if the right of a third party in insurance contracts already existed. Why should the common law suggest otherwise?

In their dissenting judgments Dawson and Brennan JJ focused entirely on argument brought before them. McNiece Bros. contended that the courts should recognize the special circumstances that exist for third party insurance contracts and that privity was an obstacle to justice. Brennan J rejected such an argument, stating the fact that whilst commercial practice typically honours the promise of an insurer, despite no consideration from the beneficiary moving to the insurer, this ‘does not establish …a new principle of the common law’. Neither did Brennan J accept that the belated Insurance Contracts Act 1984 infer that it was legislation intended to be retrospective. Brennan J then took an objective approach to the case, stating that Blue Circle could not be the agent of McNiece because consideration did not move from McNeice to Trident through Blue Circle. Dawson J simply quoted the established precedent in Vandepitte and Windeyer’s J comments in Coulls v Bagot’s that the rule was ‘incontrovertible’.

The remaining five judges did not disagree with Brennan and Dawson JJ. However they added additional themes in their judgments that turned the case in McNiece’s favour. In their combined judgments Mason CJ and Wilson J recognized the ineffectiveness of action on behalf of the third party from the promisee. Because the promisee has suffered no detriment they may only be entitled to nominal damages. The case law that existed in England at the time was conflicting, and Mason CJ and Wilson J were reluctant to apply it in Australia. However Mason CJ and Wilson J found a relief for McNiece Bros. in equity.

The application of equity on the grounds of a trust existing had been criticized in practice due to the reluctance of courts to recognize a trust relationship. However Mason CJ and Wilson J conceded that a trust may be determined by ‘the language of the parties…and the matrix of circumstances’. Deane J went further and said a trust need not be expressly raised where in the context of the contract when it is the express intention of the promisee to enable the third party to insist upon performance. In the context of liability insurance Deane J found this to be undeniable. Deane J stressed that McNiece could not pursue such an action on their own. This remedy was available in equity and to do this they must join with Blue Circle as the respondent.

Mason CJ, Wilson and Deane J explored estoppel in their judgments. Mason CJ and Wilson J refrained from exploring the role of estoppel in allowing a third party to enforce a contract, but did admit that in situations like insurance policies “the likelihood of some reliance on the part of the third party …is so tangible that the common law should be shaped with that likelihood in mind”. Deane J did not go so far as to amend the common law, but stated that the conduct of the insurer in inducing McNiece into assuming it was indemnified under its contract with Blue Circle, and McNiece’s reliance on this, was grounds for an estoppel. Deane J pointed out that there existed laws outside the doctrine of privity that ‘avoid injustice in particular categories of case’. These were estoppel, trust and unjust enrichment. The doctrine of privity needed no such modification as was requested by McNiece Bros.

Gaudron J explored the unjust enrichment principle in more detail, citing that a promisor who has accepted agreed consideration to benefit a third party is unjustly enriched if at the expense of a third party the promise is unfulfilled. Principles of estoppel and trust operate to prevent unjust enrichment in circumstances like Trident’s case.

Toohey J, in a comparatively short judgment, admitted the arguments of McNiece Bros., however stressed that such an exception was to only apply in circumstances identical to this case. ’What defences are available to the promisor in such cases?

The above discussion shows the critics received in the case of Trident General Insurance Co Ltd v Mc Niece Bros Limited(1988) however there might be answers for most of the critics stated in the case if we compare with application today in England and our country Malaysia.

Looking at Contract Act 1999 in England (Rights of third parties) where it recognizes the rights of third parties to enforce contracts which have been made for their benefits , however does not affect the established principle that burden cannot be imposed on without his consent.

Eventough in accordance to Contract Law Act 1950, there is no express provision pertaining Privity of contract however the application is clearly visible in the local cases like Kepong Prospecting Ltd & Ors v Schmidt [1968], where in this case it was held that S.2(d) of Contract Act 1950 extended and covers the consideration part of third parties in law of contract fulfilling the requirement of privity of contract.

Similar approach was followed and reaffirmed in the case of Fima Palmbulk Services Sdn Bhd v Suruhanjaya Pelabuhan Pulau Pinang & Anor [1988],where it was decided in High Court by Justice Dzaddin that English law of privity contract is applicable in Malaysia and this was futher confirmed in the Court of Appeal in the recent case of Razshah Enterprise Sdn Bhd v Arab Malaysian Finance Bhd [2009] .