Last edited 01 Oct 2013

Privity of contract

Contents

[edit] Introduction

The doctrine of privity of contract states, as a general rule, that only a party to a contract can take the benefits of that contract or is subject to its burdens or obligations. For example, if A promises to B to pay a sum of money to C, as a general rule, C cannot enforce that obligation against A.

This can prove problematic, for example where the purchaser of a property does not have a contractual relationship with the designers.

The courts have often said in such circumstances that the law of contract provides for a chain of indemnity connecting the ultimate user with the original producer: for example D is the ultimate user or consumer who purchased from C the retailer, C having purchased from B the wholesaler and B having purchased from A the manufacturer. D can sue C for breach of contract but not B or A. However, if C is sued by D, then C will have a right of indemnity against B who in turn has a right of indemnity against A, creating 'the chain of indemnity' that links the manufacturer to the ultimate user.

Unfortunately, the strength of a chain of indemnity is only as great as its weakest link. If C the retailer becomes insolvent a critical link in the chain between D and A will have been broken.

Mechanisms that can allow third parties to be introduced into the obligations or benefits of contracts include:

[edit] The Contracts (Rights of Third Parties) Act.

The Contracts (Rights of Third Parties) Act, 1999 enables third party rights to be created by a contract. This is seen by some to offer an alternative to collateral warranties (see below).

There are two categories of potential third parties given this new right:

  • The first category, where the contract expressly confers the right, would permit, for example, the express selection of certain terms of the contract and make them enforceable by named third parties.
  • The second category is where the term of the contract 'purports to confer a benefit' on the third party, but this is subject to the provisions of section 1(2) of the Act which states, 'Subsection 1(b) does not apply if on a proper construction of the contract it appears that the parties did not intend the term to be enforceable by the third party.’

For more information see: The Contracts (Rights of Third Parties) Act.

[edit] Collateral warranties

Collateral warranties are agreements which are associated with another 'primary' contract. They provide for a duty of care to be extended by one of the contracting parties to a third party who is not party to the original contract.

They came into being as a result of the courts deciding that defects in buildings were not recoverable in tort, as they were an economic loss which was only recoverable through a contractual relationship. Collateral warranties therefore create direct contractual relationships between parties that would not otherwise exist.

A typical example would be where an architect of a new office development owes a duty of care to an occupier of the development in so far as any subsequent defects which may arise are concerned. Privity of contract would prevent any liability arising between the architect and occupier without the existence of a collateral warranty.

For more information see: Collateral warranties.

[edit] Assignment

Assignment is the right to transfer 'choses in action' defined as 'all personal rights of property which can only be claimed or enforced by action and not by taking physical possession'. This definition includes benefits arising under a construction contract such as the right to payment, but not burdens such as the obligation to pay. The definition also includes claims for breach of contract.

A common error is to assume that the right to assign must be agreed as part of a contract, like a novation. Assignment is a unilateral right created by statute, Section 136 of The Law of Property Act 1925 or by the law of equity ( law developed by the Chancery Division of the High Court of England and Wales). Whilst not a contractual right, the right to assign can be excluded, or restricted, by contract, for example, it is common in collateral warranties to restrict to one assignment without the written permission of the warrantor.

For more information see: Assignment.

[edit] Novation

Novation is a process by which contractual rights and obligations are transferred from one party to another. Whilst the benefits of a contract can be transferred by assignment, if the parties wish to transfer both the benefits and the burdens then this must be done by a novation agreement.

A novation occurs when there is a rescision of one contract and the substitution of a fresh contract in which the original contractual obligations are carried out by different parties. In building design and construction, novation normally refers to the process by which design consultants are initially contracted to the client, but are then 'novated' to the contractor. This is common on design and build projects where the design team are appointed by a client to carry out initial studies or prepare a concept or detailed design, but then when a contractor is appointed to carry out or complete the design and construct the works, the design team (or part of it) is novated to work for them.

For more information see: Novation.

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