Scope of application of doctrine of privity of contract and privity of consideration in India

Written by: Abhyudaya yadav

Law of contract has always been one of the most discussed and debatable subjects of the legal world. Doctrine of privity of contract and privity of consideration has always been one of the most fundamental aspects of Contract law throughout the world. Both of these rules are regarding the interference of third parties in the contract. Here in this blog, we shall discuss the meaning, scope, application of these doctrines in Indian legal system along with a comparative analysis of these rules with English law and recommendations of the Law commission of India for amendments in contract law.

Doctrine of privity of contract

Privity in common parlance means “Privacy”. As a general rule, Principle of privity of contract states that a contract can’t confer or impose obligations on the party other than contract because of the fact that rights created under a contract is “Right in personam” and not “Right in rem”, and hence personal rights can only be enforced personally and not by other person.

Under English law, prior to 1833, a lot of English court’s decisions were there which allowed contractual provisions to be enforced by the party not to the contract. But those decisions were based on principles of equity, justice and good conscience, now in Indian Contract Act, 1872 a lot of provisions have been made based on equity principles but still it does not confer powers on the judges to go beyond statute.

The rule of privity of contract in English law was duly established with the case of Price v. easton[1], in this case a contract was entered into by two persons for the work to be done in the exchange for payment to the third party, the party failed to perform his promise of paying to third party and consequently third party sued the party who failed to perform. The court held that third parties are not privy to the contract and hence the claims of third parties to enforce the contractual obligation failed.

Further in the case of Twiddle v. Atkinson[2], a well authoritative judicial pronouncement came in which it was conclusively held that the plaintiff in the case is not the party to the contract and hence can’t attempt to file suit for the enforcement of contractual obligations. The rule for which the foundation was laid down in Price v. Easton case[3] and was conclusively held in Twiddle v. Atkinson case[4] was further reaffirmed by House of Lords in Dunlop Tyre Co. v. Selfridge.[5] Concludingly it can be said that doctrine of privity of contract debars the third party to enforce the contract and it also forbids parties from enforcing any contractual obligations from strangers and the position is well settled in English law.

Doctrine of privity of Contract in Indian Law

The general rule of privity of contract is also applicable to India. In India an authority of abovementioned rule of privity of contract is the judgment of Privy council in Jamna Das v. Ram Avtar.[6] Facts of this case were that a person mortgaged his property to another person, now for the recovery of loan mortgagor sued the person to whom the possession of property was transferred by mortgagee. It was held that since there was no contract between mortgagee and possessor of the property, the mortgagee can’t sue the possessor of property to enforce the contract to recover the money. In the abovementioned set of facts the rights which were created as a result of contract were contractual rights not property rights. Further in the case of Advertising Bureau v. C.T. Devraj[7], the legal position with respect to the application of rule of privity of contract was reaffirmed.

Having the same foundational basis of the rule of privity of contract under both the jurisdictions, the doctrine has two aspects. Firstly, No one but only parties to the contract are entitled under the contract. And hence even in the case when due to contractual obligations certain benefits were to be conferred upon third party, third party can neither sue nor rely on the defences based on contract. Secondly, the parties to the contract can’t impose obligations on strangers (means third party).[8]

Concludingly we can say that the rule of privity of contract has been uniform in Indian and United Kingdom. A very rigid adherence to the rule of privity of contract will cause hardships and hence certain exceptions have been created. Though the statutory exceptions could be different in both the jurisdictions but the jurisprudential base is same.

EXCEPTIONS TO THE RULE OF PRIVITY OF CONTRACT

In operation, the application of this rule is not absolute, certain exceptions have been created having a base of equity. The mechanical application always creates problems. Some of these equity based exceptions are thereby incorporated as statutory provisions under the Indian Contract Act whereas other exceptions are well protected under judicial precedents in the form of precedents. Some of these exceptions are as follows

1- Protection of bonafide purchaser in property law

The general rule of privity of contract does not apply to agreements where through a contract a property interest is created. The most fundamental part of property law is that property rights are in nature of “in Rem” and the essence of property law and property rights vests in Transitional exigibility[9], hence the rule of privity of contract does not apply to property rights. In the case of Hill v. Tupper[10], it was held that if the right created through a contract is a property right and not merely a contractual right, it will bind whole world and not only the parties.

2- Beneficiary under a Trust

Another exception to the rule of privity of contract was evolved by English court in the case of Dunlop Pneumatic Tyre Co. v. Selfridge & co.[11] It was held that in a case where a right is created in the favour of a person being a beneficiary under a trust then such rights may be conferred by the way of property. This exception is on the same lines with first exception though some differences are there.

3- By the way of Estoppel

Third exception in the continuance of the first two was evolved by the judiciary. It states that if any of the party to the contract recognises the right of third party, by the way of his conduct or a formal acknowledgement, to sue him, the party recognising shall be held liable on the basis of Law of estoppels. In the case of Narayan devi v. Tagore Commercial Corp. Lt[12], the abovementioned exception was duly recognised by Court.

Other exceptions include Collateral contracts or sale of defective goods, where third party is affected by the non-performace of contractual obligations, and contracts of insurance companies and Restrictive agreements.

DOCTRINE OF PRIVITY OF CONSIDERATION

The rule of privity of contract has to be distinguished by the rule of privity of consideration. Rule of privity of contract and privity of contract does not coincide jurisprudentially. In English contract law and Indian contract law, the law regarding enforceability of only those contracts which are backed by consideration is the same. The rule of privity of contract is related to the types of promises which can be enforced.[13]

Under English law the rule of privity of consideration states that promisee can’t enforce the contract if the consideration for the promise has been provided by someone else[14] and hence a stranger to contract in no condition can maintain any action for enforcement of contract. Illustratively A agrees to B for certain services to C, the consideration was to be paid by C and not B, so under English contract law there will be no valid contract between A and B. The position of law is not the same in Indian law.

The jurisprudence of Doctrine of consideration has been provided under section-2(d) of the Indian contract act. According to which a consideration may flow from either promise of or third party. Section-2(d) of the act states ,“promise or any other person” which means that the bar of flow of consideration only from promisee does not apply to Indian law. In simpler terms we can assert that as long as a promise is backed by consideration, without any objection by promisor, it is immaterial who is furnishing the consideration.

An authoritative judgment in this regard was passed by Madras High Court i.e. Chinnaya v. Ramaya[15]. The facts of this case were that an old lady transferred her property to her daughter through a gift deed in exchange of the consideration to pay a certain amount of money annually. Later on that old lady died, and the sister to whom she promised to pay so filed suit against her for recovery of money. The court categorically held that under Section 2 (d) of the Contract Act the consideration need not flow from the promisee and hence even a third person could sue as promisee though no consideration flowed from him. The law laid down by madras high court in this judgment is still considered as a good law which was further reaffirmed in the case of Samuel v. Ananthanatha.[16]

Though learned authors Pollock and Mulla in their writings do not agree completely with the views held by the judges in above mentioned cases. They criticized the approach of the judges by stating that clause 2(a), 2(b) and 2(c) of the act have been overlooked and only clause 2(d) has been emphasized. Even though under clause 2(d) of the act, consideration may flow from any person other than promise, but still contract law and procedural laws of the country would not agree to entitle the third party (who has paid the consideration) to enforce the contract till the time that third party has accepted the proposal of the promisor and became promise under section 2(c) of the act.[17]

Hence in the end we can state that the position of law with respect to rule of privity of consideration is different in India from English Law. Combined reading of Section-2(d) of the Indian Contract Act and the judgment of Chinayya Rau v. Ramayya expressed the clear terms that the law is different.

LAW COMMISSION’S RECOMMENDATION

In 2008, The Law commission in its final report on the working of Indian Contract Act. It attempted to modify a number of changes in the principal act. In its report the law commission stated that third parties should be able to enforce its right under the contract in certain situations. For that purpose a draft bill was proposed titled “Contract Law (Privity of Contract and Third party Rights) Rules, 2008”. Law commission acknowledged the hardship caused by rule of privity and hence proposed certain dilution. Those situations under which third parties were to be made able to enforce the contract are following:

1- When the terms of contract expressly confers benefits on the third party, also provided that the intention of the contracting parties were to make third party able to enforce terms of contract or third party to be entitled to bring a suit to enforce contractual obligations

2- When the terms of contract expressly conveys the right of third party enforcement even when that third party is not benefitted.

3- When the terms of a contract permit a third party to rely on exclusion or limitations on liability.

4- When a contract expressly confers benefits on a third party has been adopted by a third party then contracting parties can’t substitute, alter or rescind the contract so as to affect the rights of third party.

The provisions of the draft bill were closely associated with “The Contract (Rights of Third Parties) Act, 1999. The final report and draft bill was a replica of the 1999 act with certain minor modifications. But till now the amendments to the Indian Contract act has not been made in the lines recommended by the 13th Law commission report. Law commission recommended the addition of section 37A in the Indian contract act so as to confer certain benefits on third party.

CONCLUSION

Indian Contract Act has been admired for one of the most beautiful pieces of legislation even in Indian Jurisdiction. But howsoever beautiful it could be, every law needs to change with the changing society. The principal act was enacted in 1872 and after now presently in the ever dynamic commercial world, the law should be changed. In the opinion of the author, the parliament should consider the recommendation of law commission. The draft bill recommends the exception or dilution to the rule of privity based on equity and hence should be followed.

[1] (1833) 4 B & Ad. 433(C)

[2] (1861) 1 B & S 393

[3] Supra note 1

[4] Supra note 2

[5] (1915) AC 847

[6] (1911) 30 IA 7

[7] AIR 1995 SC 2251

[8] ID

[9] Harshad Govardhan Sondagar v. International Assets Reconstruction Co ltd, (2014) 6 SCC 1

[10] (1863) 2 H&C 121 159 ER 51

[11] (1915) AC 847

[12] AIR 1973 Cal 401

[13] Sir Jack Beatson and Andrew Burrows, Anson’s Law of Contract 616 ( Oxford Publication, London, 29th edn., 2010)

[14] Sir Jack Beatson and Andrew Burrows, Anson’s Law of Contract 98 ( Oxford Publication, London, 29th edn., 2010)

[15] (1882) ILR 4 Mad. 137

[16] (1883) ILR 6 Mad. 351

[17] P. Balamba v. K krishnayya (1914) ILR 37 Mad 483.