Privity of contract is a common-law concept, which provides that the benefits and obligations of a contract extend only to the contracting parties - third party may not enforce them. Accordingly, if A contracts with B to pay £5 to C, B could sue A to enforce payment, but C (the intended beneficiary) could not.
The concept is attributed to the 1861 decision in Tweddle v Aktinson, in which the fathers of a prospective husband and wife agreed to pay the husband £200 and £100 respectively, adding that the husband should have the right to sue for payment. The husband subsequently sued the wife's father for payment. The case was dismissed as the husband was not a party to the contract.
The justification for privity is that it supposedly reflects the bargain struck by the contracting parties. However, could it not be said that one aspect of the bargain was that the husband should be able to sue for payment?
Beswick v Beswick
Strict application of the privity rule can produce harsh results. In the leading modern authority, Beswick v Beswick (1968), a coal merchant transferred his business to his nephew in return for certain promises, including that the nephew would, after his uncle's death, pay his aunt £5 per week.
Following the uncle's death the nephew made only one payment. The aunt sued, both in her personal capacity and as administratrix of the uncle's estate. Despite the obvious intention of the contracting parties that she was to benefit from their bargain, the House of Lords decided the aunt could not sue on the contract in her personal capacity, as she had not been a party to it.
However, they found that she could do so as administratrix because in that capacity she stood in the shoes of the uncle, who had been a party.
Nevertheless, as the nephew's failure to perform the contract did not cause a loss to the estate (as opposed to the aunt personally) damages could only be nominal.
The Contracts Act 1999 seeks to alter the privity rule. It applies to every contract entered into after 11 May 2000, and provides that a third party may enforce a term of a contract to which he is not a party, provided:
Had the Act applied to the relevant contracts the husband in Tweddle v Atkinson would probably have received his £100 and the aunt in Beswick v Beswick would have benefited to the tune of £5 per week.
Scope and impact
The Act does not have universal application. The parties to a contract may expressly exclude its application. Further, a third party will be unable to enforce a contractual term if a contrary intention is evident from a proper construction of the contract.
The impact of the Act in insurance situations has yet to become clear. Such impact might be divided between direct effects (allowing a non-party to enforce a right in, or in relation to, an insurance contract) and indirect (being the potential for a wider source of claims). These are best illustrated by way of examples.
Direct effects
An insured obtains insurance via a broker and Lloyd's broker, but finds, on making a claim, that the insurer has no record of cover being placed. Prior to the Act, had such a scenario become litigious the assured would have sued the producing broker, who would have joined the Lloyd's broker, who would potentially have joined the insurer. In certain circumstances the insured might have pursued the Lloyd's broker direct, but would not have succeeded except by establishing that the Lloyd's broker owed the insured a duty of care direct.
The Act introduces the possibility of the insured suing the Lloyd's broker direct by asserting a right in the contract between the producing broker and the Lloyd's broker, upon the basis that the contract was intended to benefit the insured.
One area ripe for impact is that of professional indemnity (PI) insurance in that the Act exposes professionals to a wider source of possible claimants. For example, a tax adviser may be instructed by a wealthy private client to devise a (legitimate) scheme for avoiding inheritance tax. If the adviser negligently devises a scheme that fails, causing the intended beneficiaries to incur an otherwise avoidable tax liability, he may face a claim in negligence from those beneficiaries. Prior to the Act, the beneficiaries would have had to establish that the adviser owed them a duty of care directly. Now they have an opportunity to sue the adviser under the Act.
As a consequence, professionals are seeking to exclude the Act from their standard terms of business, and an underwriter considering a proposal for PI insurance may inquire whether this is done. That said, the informed client is unlikely to agree to its exclusion.
The Act is well intentioned and provides an opportunity to mitigate the potentially harsh effects of the privity rule. Nevertheless, in a commercial context the danger is that it will be `strangled at birth' by exclusion clauses. We await developments.
Champagne for questions
This week we are approaching the question section a little differently.
In the penultimate paragraph of this article, reference is made to "the informed client".
Look at the General Insurance Standards Council (GISC) commercial code and, in no more than 500 words, give your opinion as to whether or not you think an insurance broking firm has a responsibility, having excluded the Act in its terms of business, to explain such an exclusion to a customer and give reasons to support your opinion.
Send your answers (via email if preferred) to RWAssociates (see below) by Friday 29 March and there will be a prize of a bottle of champagne for the best argued case.
Do not be put off if you are not an academic. You will be judged on content not standard of writing or spelling.
The answer will be dealt with in more detail in three weeks' time.
How to use CPD
This free Insurance Times reader service is intended to help you improve your skills and understanding from the comfort of your office or home. All you have to do is read the text and answer the multiple-choice questions. The answers will appear in next week's issue.
Why CPD is important
The Financial Services National Training Organisation (FSNTO)'s mission is to improve the quality and skills of the workforce as a fundamental requirement for the sustainable competitiveness of the industry. We fully support the practice of continuing professional development (CPD) as a major contributor to achieving this aim. Many people across the sector are required to undertake CPD by virtue of the work they do or the professional body to which they belong, but everyone can benefit from continuing to develop their knowledge and skills.
