In contract disputes, the parties who are permitted to bring an action following a breach of contract, and the scope of the damages which they are entitled to seek, are limited by the legal principle known as privity of contract. Black’s Law Dictionary defines privity of contract as the relationship between the parties to a contract which allows them to sue each other but which prevents a third party, outside of the contract, from doing so.
These strict limitations have loosened over time to allow third parties and their damages (under certain circumstances) to be recoverable from a contract when that third party’s involvement in the subject matter of the contract and the contract’s impact upon them produce certain foreseeable results. The difficulty arises when one attempts to delineate how far the courts are prepared to expand coverage for such “foreseeable” results.
This question is particularly relevant for businesses involved in multi-party transactions that result in a breach of contract or warranty. Consider the following hypothetical.
Apple Growers Inc. owns several apple orchards. Wholesale Apples Inc. enters into a contract for and purchases apples in bulk from Apple Growers. Wholesale Apples then enters into a separate contract with and sells a portion of those apples to either a manufacturer, such as a baby food manufacturer, or a retailer, such as a fruit market, which we will call Fruit Markets Inc. The necessary condition is that Fruit Markets, the third party, is not a party to the contract between Apple Growers and Wholesale Apples, but rather has its own separate contract with Wholesale Apples.
A breach of contract arises after the apples are found to be of a lower grade than that which was bargained for. This results in litigation between Wholesale Apples and Apple Growers, whereas Fruit Markets, in this instance, does not commence litigation of its own against Wholesale Apples but rather sits on the sidelines. (It is of course possible that Fruit Markets would commence its own litigation against Wholesale Apples, claiming a breach of their contract. This article, however, assumes that Fruit Markets does not do so, either for business reasons or because of the costs involved, and, instead, remains outside of the litigation.)
Under this hypothetical, the question is whether Wholesale Apples can claim Fruit Markets’ losses, as its own, in its litigation with Apple Growers even if Wholesale Apples has not paid Fruit Markets for its losses. Some answers can be found by applying this hypothetical to the case law.
The judicial consideration of such a scenario is surprisingly limited, with most cases focusing on facts where the reseller (Wholesale Apples) pays the third party retailer or customer (Fruit Markets) for its losses and then claims those losses in its litigation with the original manufacturer or supplier (Apple Growers). But what if Wholesale Apples’ customers, such as Fruit Markets, hold-off on commencing litigation against Wholesale Apples, or what if Wholesale Apples simply has insufficient funds to pay Fruit Markets? Will the courts still allow Wholesale Apples to claim Fruit Markets’ losses as its own? Under certain circumstances it appears that the courts may do so.
The seminal case on this area of the law is the United Kingdom case of Randall v. Raper. The majority decision of the Court was that the plaintiff could recover its customers’ losses as its own damages so long as the plaintiff was liable to compensate its customers, and the customers’ losses were a probable, natural and necessary consequence of the defendant’s breach of contract.
The subsequent United Kingdom decision in Total Liban SA v. Vitol Energy SA agreed that there was no general common law rule that liability without payment was not a recoverable loss. The Court explained that when there is a breach of contract and a proven liability to a third party, then the party claiming the third party loss must simply satisfy the Court that the loss was caused by the breaching party and that the unlawful act was not too remote from the third party loss, the same tests any claim for damages must satisfy. Interestingly, the Court went on to explain that this had to be the case, otherwise an impecunious claimant, unable to pay a third party loss, would be left with liability to that third party and no remedy with which to satisfy it, whereas the breaching party would escape part of the consequences of its breach.
The Canadian case law has only briefly touched on such a scenario. The Ontario and British Columbia Courts have, however, indicated that, in the proper case, the law as stated in Randall v. Raper, allowing a claimant to claim its customers’ losses as its own, if that claimant is “responsible for paying” for such a loss, may be correct.
Applying the hypothetical, the circumstances under which a claimant may be able to claim its customer’s losses as its own, even having not paid its customers, are as follows: (1) when there are legal obligations between Wholesale Apples (the reseller) and Fruit Markets (the customer), apart from and in addition to the separate liability between the supplier, Apple Growers, and Wholesale Apples; (2) when the breach of all the legal obligations are caused by Apple Growers; (3) when Wholesale Apples’ breach of its legal obligations to Fruit Markets is not too remote from Apple Growers’ breach of its legal obligations to Wholesale Apples; (4) when there is a probability of future claims by Fruit Markets (the customer) against Wholesale Apples; and (5) when Wholesale Apples (the reseller) is impecunious and is otherwise unable to pay Fruit Markets (the customer).