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Relaxations to Contractual Privity

1. INTRODUCTORY REMARKS

This topic offers a fertile ground for comparative study since the problem it addresses has occupied all the systems of the industrialised world and has received a wide variety of answers. Also, it presents a particular interest to English lawyers since they have (fairly) recently adjusted their law on this matter in a way that while it has not pleased everyone it has brought English law closer to continental European law.

The starting point is not of course in dispute. Generally speaking, persons who enter into a contract intend to create rights and obligations that will affect them, alone, and no one else. Occasionally, however, it makes commercial sense to allow third parties, who are not parties to the transaction, to claim the promised performance directly from the promisor. This chapter will deal with the main situations where this is allowed by German law. In what follows we shall continue to use the English terms promisor, promisee, and third party, but they should be taken to refer respectively to the German Versprechender (the French promettant), Versprechensempfänger

(the French stipulant) and Begünstigter (the French bénéficiaire). Incidentally, the French terms are also given here for occasional references to French law may be necessary. The reason for this is that these two great systems—French and German— have adopted slightly varying approaches to some aspects of this problem. Thus, English lawyers who seem keener than ever to adapt their law may thus be well advised to bear both variants in mind when weighing the pros and cons of the options they have chosen to favour. It is interesting however to note that other systems that have chosen to modernise their law—the Israeli for instance—have chosen to be influenced by the German model. On the whole, we shall see that this may have been a wise decision since the German approach to this problem has proved flexible and, on the whole, very carefully thought out.

The utility of the foreign material for the English lawyer becomes obvious at two levels. The comparative method can be utilised to clarify the basic approach to privity problems a legal system chooses to adopt, but is equally invaluable when it comes to deciding individual cases.

At the first and most abstract it should make him question the influential but dogmatic assertion of Lord Haldane in Dunlop Pneumatic Tyre Co Ltd v Selfridge & Co Ltd ([1915] AC 847, 853) that the common law recognises no ius quaesitum tertio on the double grounds of consideration and the doctrine of privity.

The first prong of the argument is easily rebutted For if it is formulated to read that the third party’s rights are prevented by the idea that ‘consideration must move from the promisee,’ it falls flat once one realises that consideration has, in fact,

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moved from the promisee (who is always the co-contracting party and not the third party/plaintiff). And if the consideration argument is put in the form that ‘only the person who has given consideration can enforce the contract’ then, though it can frustrate the rights of third parties, it raises the question why does the performance of the promise to the third party undermine the true aim of consideration (which, as we have seen, is to distinguish between serious binding promises and those which are not binding)? For, as Zweigert and Kötz have remarked (in a passage from the second edition of their Introduction to Comparative Law (1992), p 498): ‘if a person has made a promise in return for consideration provided by the other contractor, the seriousness of his promise to contract is established, and it should not be reckoned any weaker simply because the agreement provides that what was promised should be capable of being demanded not only by the other contracting party but by the beneficiary as well.’

As for Lord Haldane’s second objection, that third party rights run counter to the doctrine of privity, the answer must surely be that this objection is not unknown to the modern civil law as well but has been overcome easily and painlessly by these systems in their desire to accommodate commercial realities which, in many instances, do require the possibility of exceptions. If hardship to the creditors of the promisee can be avoided (often the key but unexpressed objection to granting third party rights), then what remains of the doctrine of privity may be little more than a mental block against allowing third parties to enter such arrangements.

The House of Lords nevertheless refused to change its approach to privity (see Midland Silicones Ltd v Scruttons Ltd [1962] AC 446) despite several attempts by Lord Denning to allow rights of suit by third party beneficiaries and despite the fact that judicial and academic criticism of the third party rule continued over the years, culminating in Steyn LJ’s strong attack on the privity doctrine in Darlington BC v Wiltshier Northern Ltd ([1995] 1 WLR 68, 76):

The case for recognising a contract for the benefit of a third party is simple and straightforward. The autonomy of the will of the parties should be respected. The law of contract should give effect to the reasonable expectations of contracting parties. Principle certainly requires that a burden should not be imposed on a third party without his consent. But there is no doctrinal, logical, or policy reason why the law should deny effectiveness to a contract for the benefit of a third party where that is the expressed intention of the parties. Moreover, often the parties, and particularly third parties, organise their affairs on the faith of the contract. They rely on the contract. It is therefore unjust to deny effectiveness to such a contract. I will not struggle with the point further since nobody seriously asserts the contrary.

One reason for the judicial reluctance for reform may have been that the number of exceptions to the doctrine was so great that it could be doubted whether it could be still regarded as a ‘general’ rule. In any event, it could be argued with some justification, in most cases practical justice could be done. A good example is Beswick v Beswick [1968] AC 58, also discussed in section 2, p 188. Specific performance was granted at the suit of the promisee, who was in fact dead but was represented by the third party beneficiary as his administratrix. But where specific performance is not available the result becomes questionable. One drawback of this pragmatic approach to privity clearly was that the law became increasingly complex and therefore was not regarded as being in a satisfactory condition. The English agonising on this point is well revealed in The Law Commission’s Consultation Paper No 121 entitled Privity of

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Contract; Contracts for the Benefit of Third Parties (which was published in 1992; see also, eg, para 3.6 of the Report no 242 (1996), discussed in what follows).

The pursuant Report No 242 (1996) of the Law Commission with the same title and subject came out in favour of abolishing the traditional third party rule and was accompanied by clearly phrased corresponding recommendations and a draft Bill. (See for comments on the Report: Adams, Beyleveld and Brownsword, ‘Privity of Contract’ (1997) 60 MLR 238; Burrows, ‘Reforming Privity of Contract’ [1996] LMCLQ 467 and Tettenborn, ‘Third Party Contracts’ [1996] JBL 602.) This report, and in the face of judicial reluctance to tackle the problem, finally paved the way for introducing by legislation the concept of a contract for the benefit of a third party into English law. It suffices here to point out that one of the main arguments for reform of the Law Commission was that the ‘legal systems of most of the member states of the European Union recognise and enforce the rights of third party beneficiaries under contracts’ (Law Com No 242 (1996), para 3.8).

The intended reform followed just a few years later with the passing of the Contracts (Rights of Third Parties) Act 1999 (or ‘the 1999 Act’). (On which see Burrows, ‘The Contracts (Rights of Third Parties) Act 1999 and its Implications for Commercial Contracts’ [2000] LMCLQ 540; Dean, ‘Removing a Blot on the Landscape’ [2000] JBL 143; Kincaid (ed), Privity—Private Justice or Public Regulation (2001); Macaulay, ‘Warranting Third Party Rights’ [2000] Constr LJ 265; Merkin (ed), Privity of Contract—The Impact of the Contracts (Rights of Third Parties) Act 1999 (2000); Roe, ‘Contractual Intention under Section 1(1)(b) and 1(2) of the Contracts (Rights of Third Parties) Act 1999’ (2000) 63 MLR 887; and Stevens, ‘The Contracts (Rights of Third Parties) Act 1999’ (2004) 120 LQR 292.) For the first case on the 1999 Act, see Nisshin Shipping Co Ltd v Cleaves & Company Ltd and Others [2003] EWHC 2602 (Comm), [2004] 1 Lloyd’s Rep 38 (discussed by Stevens, ‘The Contracts (Rights of Third Parties) Act 1999’ 309–10 and McKnight, ‘A Review of Developments in English Law during 2003—Part II’ (2004) 19 JIBLR 151, 169–71). But the change has not left everyone happy; rarely does reform have such an effect. Thus one author (Stevens (2004) 120 LQR 292, 322), after discussing the reasons given for the reform, concluded that:

The illness diagnosed was not as serious as it was thought and the operation may have caused more problems than it solved. Developments in the remedies available to the promisee meant that by the time of the passing of the Act the need for surgery had largely disappeared. If the third party has no right to compel the promisee to seek a remedy on his behalf, for example under a contract or trust, the robust response is tough luck. In addition to the uncertainty generated by the Act the fear is that the unwary will be caught out by conferring enforceable rights on third parties when they do not intend to do so. This appears to be behind the widespread exclusion of the operation of the Act.

It should be clear from the outset, and is self-evident from a comparative perspective, what are not the implications of the 1999 Act. The acceptance of the notion of a contract for the benefit of a third party does not bring in its wake the abolition of the general rule that a third party cannot derive rights from a contract. The Act merely adds a wide-ranging exception to the privity doctrine but does not replace it with a different general rule (see Law Com No 242 (1996), paras 5.16 and 13.2). The doctrine of privity or, to use the German term, of ‘relativity of contract’ continues to apply to prevent strangers from enforcing a contract. The effect of importing the concept of a

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contract for the benefit of a third party into English law is to allow enforcement by a third party whom the original parties intended should receive a benefit and be able to claim it.

Under the Act the third party has a direct remedy in contract against the promisor. The central provision of the English Act is its test of enforceability contained in section 1(1). According to this section, a contract is for the benefit of a third party if it purports to confer a benefit on an expressly identified (including identifiable by class) third party: section 1(3). Under the first limb of the test, section 1(1)(a), the parties expressly declare the contract to be one in favour of a third party. The more difficult to apply is, obviously, the second limb, section 1(1)(b). It is interesting to note that the English Act opted for a presumption in favour of such a contract if the contract confers a benefit on a third party, a solution which was rejected by the fathers of the BGB as being too sweeping (see § 328 BGB; see for discussion, Kötz, International Encyclopedia of Comparative Law, chapter 13 (1992), p 22). One might be tempted, therefore, to conclude that the scope of application of the Act is extremely wide. However, on closer analysis one can see that this might not be the case. For the presumption is founded on a specific preconception of a classic contract for the benefit of a third party, which is very similar to that presupposed by § 328 BGB. The wording is meant to convey this even if the restriction envisaged by the Commission is not an easy one. The distinction relevant to the second limb is that between ‘to confer’ a benefit and merely being (incidentally) ‘of’ benefit. The first situation triggers the presumption and corresponds to the classic contract for the benefit of a third party. The special feature of this situation is that the third party is meant to be able to enforce the contract as a whole, section 1(5), including for instance the right to rescind a contract or, where available, to seek specific performance.

Applying such a test to the Hedley Byrne-type situations (Hedley Byrne & Co v Heller & Partners [1964] AC 465 and the subsequent English negligent misstatement cases) means excluding them from the scope of the Act (as also suggested in The German Law of Torts, p 302). This result also derives support from a comparative perspective. The insight that the third party must have an interest in the performance of the contract as such lies at the heart of the contract with protective effects towards third parties (to be discussed in section 3, p 204), which is recognised alongside § 328 BGB (the classic contract for the benefit of a third party) and serves a function similar to that of the English tort of negligence. Ironically, the Law Commission stressed that the intention test did not embrace the wider German concept of a contract with protective effects towards third parties (reference to Markesinis, ‘An Expanding Tort Law—the Price of a Rigid Contract Law’ (1987) 103 LQR 354; see para 7.25, note 22, of the report). This is yet another indication that the Commission regarded the second limb of the test to be confined to cases where the parties intended to grant the third party ‘primary enforcement’. (Accordingly, an exclusion clause operating for the benefit of a third party was analysed in German law as an instance of the contract with protective effects towards third parties. See The German Law of Torts, p 540; BGH JZ 1962, 570 and 333. By contrast, the Law Commission regards the 1999 Act to be applicable to such a situation: see para 7.43 of the report.)

Overall, however, the presumption contained in section 1(1)(b) of the 1999 Act is limited in a very similar way to the German (classic) contract for the benefit of a third party defined in § 328 BGB. Hence, if the second limb of the enforceability test is

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construed by the courts in the way that the Law Commission suggests, comparative law could thus provide invaluable assistance in deciding in which circumstances a contract ‘confers a benefit’ in a third party, ie in which situations the presumption is raised. (See for examples, Unberath, Transferred Loss (2003), pp 26–33.)

In imposing a change of paradigms, the English legislator used comparative material on the first and most abstract level as an argument for reform. This change in the basic attitude towards third party rights also altered the practical purpose of the comparative method. Henceforth, foreign material is of use to the English lawyer primarily at a secondary and more specific level. For here the foreign solutions not only reveal which of a possible range of technical answers may be most desirable to a given problem, they also suggest the best technical way of achieving these results. It is thus intriguing to note that it is in this area of ‘detail’ that English law, arguably, stands to gain most from the study of the modern civil law.

Consider also the following illustration that further underlines the point just made. It is, of course, a truism to state that the validity of the life insurance contract paved the way for the recognition of an important area of exception to the starting point about contractual privity. How this was achieved in three major systems—the English, the French and the German—is instructive. For, to begin with, we note that in England, a case law country, it took a statute—the Married Women’s Property Act 1882—to create a right in favour of the spouse or children of the insured, whereas in France, a country with a codified system, it required the intervention of the Court of Cassation (D1885.1.150; D1934.1.141.) to establish, unequivocally, such a right. But the paradox, in itself, though interesting is not that important. What is important is to note is that in England the exception to the rule is defined in a very narrow way, with the result that those persons who are not the spouse or the children of the insured will not be allowed to recover under the policy unless a trust has been expressly constituted in their favour under the policy. The injustice of this result has been noted both by writers on the subject (eg, Colinvaux, The Law of Insurance (1984) 361) and by courts which have striven, sometimes through fictions, to avoid it. (Cf In Re A Policy No 6402 of the Scottish Equitable Life Assurance Society [1902] 1 Ch 282; In re

Schebsman [1944] 1 Ch 83.)

The (wider) result favoured by French law is also achieved by § 330 BGB which stipulates that, in case of doubt, the third party (beneficiary of the policy) acquires the right directly against the insurer to demand payment of the insurance monies (the word ‘directly’, incidentally, having been interpreted to mean that the monies do not go through the deceased’s estate, thus avoiding potential clashes between the interests of the beneficiary and the deceased’s creditors. (See RGZ 128, 187; BGH NJW 1965, 1913.) The German example thus shows that legislation not only can provide an answer to these problems, but that it can do so with suitable flexibility. Indeed, one could argue with Professor Werner Lorenz that one reason why the German Code has withstood the passage of time is because it (and its practitioners) managed so skilfully to combine the phrasing of a sufficiently general rule with a precise regulation of the triangular relationship. (See ‘Contract and Third Party Rights in German and English Law’ in Markesinis (ed), The Gradual Convergence (1994), p 65). The discussion that follows reveals other areas where particular problems are susceptible to different answers and that the ones given by the German legislator have much to commend them to the impartial observer.