Doctrine of Privity
Key Provisions of the Enactment
Impact on Insurance Contracts
Following the introduction of the Contracts (Right of Third Parties) Act in the United Kingdom in 1999, Singapore was quick to study its implications and, after comprehensive representations before Parliament's select committee followed by debates, Singapore has enacted the provisions of the UK act in pari materia (ie, they should be construed together).(1)
This update discusses the doctrine of privity, which is intrinsically an English common law development, and examines the enactment and its implications for insurance contracts, particularly in cases where a situation similar to that in Hartford Insurance Company v Chiu Teng Construction PTE(2) arises. The enactment came into effect in Singapore on October 17 2001.
The doctrine of privity of contract encompasses two distinct rules. The first rule is that a person who is not a party to a contract cannot claim the benefit of it, even if the contract was entered into with the object of benefiting that person. In the classic case of Dunlop Pneumatic Tyre Co v Selfridge(3) A sold tyres to B, a wholesaler, and included a term in the contract that B would obtain, from every third party to whom it resold the tyres, an undertaking that it would not retail the tyres below the list price. C, a third party, gave B such an undertaking, but nonetheless resold the tyres below the list price. A sued C for damages, but the suit failed on two grounds. First of all, A had not provided any consideration for the promise; the consideration for C's promise was given by B, and only a person who has provided consideration can enforce a promise. In addition, A was not a party to the contract between B and C, and only a party to a contract can enforce it.
The second rule is that a third party cannot be subjected to a burden by a contract to which he is not a party. In Dunlop v Selfridge it was held that Selfridge could not be subjected to a burden by a contract to which he was not a party.
As apparent from the Dunlop v Selfridge scenario, the privity rule can cause disaster to a third party who may have had reasonable expectations of having the legal right to enforce a contract in his benefit, and who may even have relied on the same to regulate his affairs clearly. The third party rule is unfair in that the person who has suffered the loss of the intended benefit (the third party) cannot sue, while the person who has suffered no loss (the promisee) can sue.
To sidestep the unfairness of the third-party rule, a number of statutory and common law exceptions have been developed. These exceptions are still evolving and are the subject of extensive litigation. Clearly, having a myriad of exceptions is cumbersome and gives rise to uncertainty.(4)
With a view to curbing this uncertainty, the Contracts (Rights of Third Parties) Act 2001 creates a statutory avenue in the doctrine of privity which allows enforceable rights to be conferred on a third party, if certain criteria are met.
Key Provisions of the Enactment
Section 2 of the act sets out the main requirements for a third party to have the legal right to enforce a contractual term. With a view to preventing a flood of third party 'claimants', the third party must be identified by name, class or description. It is imperative that the terms of the contract are clear in this regard, but this does not mean that the third party must be specifically named at the time of contracting. What is required is that at the time that the right to enforce the contract is alleged to have crystallized, the third party must be clearly ascertainable from the specified rule.(5)
After the identification requirement of the third party is met, it must be shown that the identified/ identifiable third party has enforceable rights under the contract. It must be shown that either (i) the parties had expressly conferred the right to sue on the third party,(6) or (ii) the term in the contract "purports to confer a benefit" on the third party, and there is nothing in the contract to show that the parties had not intended the third party to be able to sue,(7) - that is, that the third party did not have enforceable rights.(8) Once it is shown that a term purports to confer a benefit on a third party, a rebuttable presumption arises that it is enforceable by the third party. It is then up to the promisor to resist the enforcement by showing that on a proper construction of the contract, the parties had not intended the third party to be able to sue.
The third-party rule applies in the same way in contracts of insurance and reinsurance. Since a contract of insurance is usually a contract of indemnity, insurers will agree that the third-party rule is more fundamental in insurance contracts than in others. In insurance contracts there are several classes of quasi-insureds/beneficiaries whose rights (if any) derive from their relationship with the insured. Sometimes they cannot be identified when the contract of insurance is concluded; at others they clearly exist and expect to gain in some measure from that contract. Invariably, however, their rights are not clearly specified, a factor which has given rise in recent years to considerable case law.(9)
The Contracts (Rights of Third Parties) Act was not enacted to replace the doctrine of privity or any of the legal mechanisms which have evolved to avoid the third-party rule. Although the act allows parties to state clearly whether a third party has enforcement rights, it was not intended to alter the rule that a contract cannot impose obligations on third parties for want of privity. What it did was to create a broad statutory exception to the doctrine of privity, allowing the parties to a contract, in specified circumstances, to confer enforceable rights on a third party.
There are many instances in which it is practically impossible to provide any definitive legislative guidelines. The premise for such enforceable rights will still be the contractual intention of parties. Disputes in this regard will still have to be determined by the courts.(10)
Insurers are naturally anxious as to the implications of a legislative backing to third-party rights in insurance contracts. The Hartford Insurance Case is an example of how it could apply in insurance contracts.
In this case the insurers had agreed to indemnify the insured under an 'all risks' policy against such claims which the insured would become legally liable to pay as damages consequent upon accidental loss or damage to property belonging to third parties occurring in direct connection with construction works carried out by the insured. While construction was in progress damage was caused to some of the houses in the estate, and as a result the main contractor had to carry out rectification works and sought to recover the loss it suffered on account of the rectification works from the insured. However, the insured was wound up by an order of court and the official receiver was appointed as liquidator. In view of the insured's winding-up the main contractor had to obtain leave of court to commence proceedings against it. A judgment was subsequently obtained by the main contractors (third party) against the insured, and the third party commenced proceedings to recover the judgment sum from the insurers. The insurers' defence was, among other things, that the judgment sum obtained by the third party was not binding on them.
It was held that a judgment is generally only binding as between the parties to the action, except in the case of express indemnity given by the third party to a party to the action.(11) At common law, the third party would have no claim against the insurers.(12) However, because of the winding-up of the insured, Section 1(1) of the Third Parties (Rights against Insurers ) Act (Cap 395, 1994 Ed) allowed the insured's right to be indemnified in respect of the liability to be transferred to the third party. Applying the Contracts (Rights of Third Parties) Act 2001, the third party will automatically have a right of action against the insurer as long as he can show that the contract purports to confer a benefit on him(13) and he is expressly identified in the contract as answering a particular description.
This example shows that the 2001 act provides an enabling framework under which contracting parties can spell out enforceable rights of third parties. The basis of third-party enforcement is the intention of the parties, so it is possible to exclude the possibility of any third-party rights by appropriately formulated clauses in the contract. However it is clear that the 2001 act would be undermined if the original parties to the contract were entitled to vary or revoke the terms without reference to the third party to whom rights have been granted under it. The 2001 act therefore states that the parties cannot by agreement between them rescind or vary the contract so as to extinguish or alter the rights of the third party without the consent of that third party.(14) This, it is submitted, is a just and proper provision which is in the interest of the affairs of businesspeople today, and it will not be necessary to enter duplicitous contracts in connected matters to safeguard third-party rights.
However, insurance and reinsurance contracts are often varied by endorsement, a written variation of the clause in question which is usually prepared by the broker and signed by the insurer or reinsurer. It would be impractical for the contracting parties to obtain third-party consent to every minor variation. To get around this predicament it would be prudent for an express term to be included in the insurance contract which clearly specifies that any aspect of the contract can be rescinded or varied without the consent of the third party.(15)
The 2001 act has opened up a statutory avenue for third parties to enforce contracts directly, unless they are excluded from doing so by name, class or description in the contract. It represents the current stage of evolution of the privity rule and has potentially wide-ranging effects on insurance contracts affecting third parties. However, the effect and meaning of its provisions is likely to be challenged in the courts, especially in relation to contractual intention and enforcement rights in matters involving big payouts, until adequate judicial pronouncements over some years clarify matters.
For further information on this topic please contact Balu Rao at B Rao & KS Rajah by telephone (+65 535 2188) or by fax (+65 534 3972) or by email ([email protected]).
(1) The Contract (Rights of Third Parties) Bill 2001 LRRD No 2/2001 (Revised October 11 2001).
(4) The Contract (Rights of Third Parties) Bills 2001, p 2.
(5) Yeo Tiong Min,"When do Third Party Rights Arise under the Contracts (Rights of Third Parties) Act 1999?", Singapore Academy of Law Journal (Volume 13, March 2001) p 38-39.
(6) Section 2(1)(a) of the act.
(7) Yeo Tiong Min, "When do Third Party Rights Arise under the Contracts (Rights of Third Parties) Act 1999?", p 42-43.
(9) Article by Christopher Henly in Privity of Contract - The impact of the Contracts (Rights of Third Parties) Act 1999, edited by Robert Merkin, LLP Professional Publishing, 2000, at p 213.
(10) Yeo Tiong Min, "When do Third Party Rights Arise under the Contracts (Rights of Third Parties) Act 1999?" p 36-53 and "Report on the Proposed Contracts (Rights of Third Parties) Bill 2001" by the Law Reform and Revision Division of the Attorney-General's Chambers.
(11) See Mercantile Investment and General Trust Co v River Plate Trust, Loan and Agency Co,  1 CH 578.
(12) See Re Harrington Motor Co,  1 CH 105.
(14) Yeo Tiong Min, "When do Third Party Rights Arise under the Contracts (Rights of Third Parties) Act 1999?", p 53.
(15) Article by Christopher Henly in Privity of Contract - The impact of the Contracts (Rights of Third Parties) Act 1999, at p 248.