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You are here: BAILII >> Databases >> The Law Commission >> Privity of Contract: Contracts for the Benefit of Third Parties [1996] EWLC 242(4) (31 July 1996) URL: http://www.bailii.org/ew/other/EWLC/1996/242(4).html Cite as: [1996] EWLC 242(4)

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PART IV

Precedents for Reform

4.1 In deciding on the form, and details of our proposals, we have derived great help from the recommendations for abrogation of the third party rule made by the Law Revision Committee in England, the legislative reforms enacted in New Zealand and in some jurisdictions in Australia, and the departure from the traditional common law approach brought about by the judiciary in the United States. In this Part, we examine some of the illuminating central features of these ?precedents' for reform. (1)

1. The Law Revision Committee Report

4.2 In 1937, the Law Revision Committee, chaired by Lord Wright MR, presented its Sixth Interim Report. (2) Among the topics addressed by the Committee in this Report was the common law's rejection of a ius quaesitum tertio. The Committee's Report stated that England was almost alone among modern systems of law in its rigid adherence to the application of the third party rule, and that experience had demonstrated that the rule was apt to lead to hardship thus necessitating exceptions from it. (3) The Committee regarded the trust exception, illustrated by the line of cases following Tomlinson v Gill, (4) as the most important, and said that, if this doctrine had been applied in all cases, it would be possible to say that English law did have a ius quaesitum tertio. However the application of the exception had been limited by other cases, (5) and therefore "the law on this point is uncertain and confused. For the ordinary lawyer it is difficult to determine when a contract right ?may be conferred by way of property', in Viscount Haldane's phrase, and when it may not". (6) The Report concluded that "there is a strong argument for attempting to frame a rule which will be more easily understandable". (7) A further practical reason for reform was that the enforcement of a ius quaesitum tertio by way of trust involved the addition of the trustee as a party to all legal proceedings to enforce the trust, which was wasteful and unnecessary, as the third party's position was more analogous to an assignee of a contractual right than to a beneficiary of a trust. (8)

4.3 The Committee then went on to consider the circumstances in which third party rights should arise, and considered that there should be three important limitations. First, no third party right should be acquired unless given by the express terms of the contract. (9) Secondly, the promisor should be able to raise any defences against the third party which he or she would have been able to raise against the promisee. Thirdly, the right of the promisor and promisee to vary or cancel the contract at any time should be preserved unless the third party had received notice of the agreement and had adopted it either expressly or by conduct. The Committee therefore recommended that:

where a contract by its express terms purports to confer a benefit directly on a third party, the third party shall be entitled to enforce the provision in his own name, provided that the promisor shall be entitled to raise as against the third party any defence that would have been valid against the promisee. The rights of the third party shall be subject to cancellation of the contract by the mutual consent of the contracting parties at any time before the third party has adopted it either expressly or by conduct. (10)

The Committee also recommended that the provisions of section 11 of the Married Women's Property Act, 1882, should be extended to all life, endowment and education policies, in which a particular beneficiary is named. (11)

4.4 As we shall see, (12) the Report of the Law Revision Committee was directly influential in promoting reform to the third party rule in Western Australia which, like Queensland, did not have a separate Law Reform Commission Report on the third party rule before introducing reform. However, its recommendations on the third party rule (and on the doctrine of consideration) have, of course, not been implemented in England. (13)

2. Abrogation of Third Party Rule in Other Common Law Jurisdictions

(1) Western Australia

4.5 Section 11 of the Western Australian Property Law Act 1969, in line with the proposal of the English Law Revision Committee, amended the third party rule by providing that:

...where a contract expressly in its terms purports to confer a benefit directly on a person who is not named as a party to the contract, the contract is...enforceable by that person in his own name... . (14)

All defences which would have been available to the promisor had the third party been a party to the contract are available in an action by the third party, (15) and in any action on the contract by the third party, all parties to the contract must be joined. (16) Further, the legislation permits the enforcement of all terms of the contract against the third party which are "in the terms of the contract...imposed on the [third party] for the benefit of the [promisor]". (17) The legislation also permits variation or cancellation of the contract by the contracting parties at any time until the third party adopts it either expressly or by conduct. (18)

4.6 The New Zealand Contracts and Commercial Law Reform Committee (19) made a number of criticisms of the Western Australian legislation:

(i) it does not appear to permit enforcement by third parties who are not in existence or ascertained at the time of formation of the contract; (20)

(ii)it seems to require express naming of the third party;

(iii)it seems to exclude implied terms in favour of third parties;

(iv)it requires the joinder of each person named as a party to the contract in any proceedings commenced by the third party;

(v) it does not clearly express the necessity for the promisor and promisee to have intended to confer a legal right on the third party.

4.7 It should be noted that the Western Australian legislation does not provide for the situation where, instead of paying the third party, the promisor pays the promisee. If the third party is to be regarded as having an independent right under the contract, the fact that the promisor has performed in favour of the promisee should not necessarily eliminate the third party's right to performance. In Westralian Farmers Co-Operative Ltd v Southern Meat Packers Ltd, (21) the Supreme Court of Western Australia found that, where the plaintiff third party had established the existence of a contractual payment term in its favour, and the defendant claimed that it had already made payment to the original promisee, the plaintiff third party could nevertheless maintain its claim to payment. We address the issue of overlapping claims by the third party and by the promisee in Part XI below.

(2) Queensland

4.8 The third party rule was abrogated by statute in Queensland in 1974. Section 55 of the Queensland Property Law Act 1974 (22) provides that:

A promisor who, for a valuable consideration moving from the promisee, promises to do or to refrain from doing an act or acts for the benefit of a beneficiary shall, upon acceptance by the beneficiary, be subject to a duty enforceable by the beneficiary to perform that promise. (23)

Prior to acceptance, the promisor and promisee may vary or discharge the terms of the promise without the beneficiary's consent. (24) After acceptance, the promisor's duty to perform in favour of and at the suit of the beneficiary becomes enforceable, and the promise may only be varied with the consent of the promisor, promisee and beneficiary. (25) On acceptance, the beneficiary is bound to perform any acts that may be required of him by the terms of the promise. (26) Defences that can normally be raised against an action to enforce a promissory duty can be raised by the promisor against the beneficiary. (27) The section defines what constitutes an "acceptance" so as to render a promise enforceable by the beneficiary, (28) and which "promises" will be capable of giving rise to rights in third party beneficiaries. (29) Unlike the Western Australian legislation, discussed above, the Queensland legislation does not require that the contract expressly purports to confer a benefit on the third party. (30) And it imposes no obligation to join all parties in any action by the third party. (31)

(3) New Zealand

4.9 In 1981, the New Zealand Contracts and Commercial Law Reform Committee presented a Report on the third party rule, which appended draft legislation to implement the recommended reforms. (32) The Report gave a brief account of the existing common law of New Zealand, (33) which was virtually identical to that of England and Wales. The Report then considered developments in other jurisdictions, including the absence of a third party rule in most civilian systems (34) and its abrogation, either by the courts or by statute, in the United States, Israel, Western Australia and Queensland. The Committee considered arguments that the practical difficulties caused by the rule, and the devices adopted for avoiding its operation in particular circumstances, were insufficient to justify a fundamental change in the law, but refuted the contention that the intentions of the contracting parties could usually be achieved by the courts. The Report said: (35)

We are not convinced by such arguments. We have looked in vain for a solid basis of policy justifying the frustration of contractual intentions...[W]e are left with a sense of irritation like that which, we suspect, motivated the majority of the Privy Council in New Zealand Shipping Co Ltd v Satterthwaite & Co Ltd, (36) to say, ?...to give the appellant the benefit of the exemptions and limitations contained in the bill of lading is to give effect to the clear intentions of a commercial document...' ...The case for reform is completed, in our opinion, by the observations of Lord Scarman (sometime Chairman of the English Law Commission) in Woodar Investment Development Ltd v Wimpey Construction (UK) Limited. (37)

4.10 The New Zealand Committee therefore recommended that a third party should be given a right to enforce a contract where a promise contained in a deed or contract confers, or purports to confer, a benefit on that third party. (38) The New Zealand Committee's recommendations were substantially implemented in the New Zealand Contracts (Privity) Act 1982, although one of the changes is that the 1982 Act, in contrast to the draft Contracts (Privity) Bill annexed to the Committee's Report, includes a requirement that the third party should be designated in the contract in order to obtain an enforceable right.

4.11 The Act, in section 4, provides that:

Where a promise contained in a deed or contract confers, or purports to confer, a benefit on a person, designated by name, description or reference to a class, who is not a party to the deed or contract...the promisor shall be under an obligation, enforceable at the suit of that person, to perform that promise.

Thus the section starts from the premise that all promises benefiting sufficiently designated third parties are to be enforceable at the suit of that third party. The section is not limited to express promises, and extends equally to implied promises. However the section goes on to provide that it does not apply:

to a promise which, on the proper construction of the deed or contract, is not intended to create, in respect of the benefit, an obligation enforceable at the suit of that person.

4.12 Section 4 thus creates a reverse onus of proof in respect of the contracting parties' intention to create a legally enforceable obligation in favour of the third party. It is up to them to establish that their promise was not intended to have this effect. The New Zealand Act therefore controls liability by the requirement that the third party be sufficiently designated in the contract and by resting liability on the intentions of the contracting parties to confer a right of enforceability (albeit under a reversed burden of proof).

4.13 The Act goes on to provide that promises benefiting third parties may not be varied or cancelled without the third party's consent once the third party has either (i) materially altered his position in reliance on the promise; (39) (ii) obtained judgment on the promise; or (iii) obtained an arbitration award on the promise. (40) However, where there is an express provision permitting variation in other circumstances, which is known to the third party, such variation is permitted. (41)

4.14 In 1993, the New Zealand Law Commission considered the operation of the Act, (42) and concluded that most of the problems which had arisen in its operation concerned the scope of what became section 4, and particularly the requirement of designation. These caused difficulties particularly in connection with pre-incorporation contracts and contracts involving nominees. The New Zealand Law Commission examined the decisions under the Act, but recommended no changes to it. The precise difficulties identified by the Commission will be discussed in Part VIII of this Report when we consider designation, and existence, of the third party.

(4) United States

4.15 There is a vast literature on third party rights in the United States, (43) which no short account can adequately summarise. The following paragraphs merely highlight some of the main difficulties revealed by the case law.

4.16 Since the decision of the New York Court of Appeals in Lawrence v Fox, (44) it has become generally accepted that a third party is able to enforce a contractual obligation made for his benefit. However, the problem of defining what is meant by a third party beneficiary has never adequately been solved. Section 133 of the first Restatement of Contracts published in 1932 distinguished donee beneficiaries, creditor beneficiaries, and incidental beneficiaries: only donee and creditor beneficiaries could enforce contracts made for their benefit. A person was a "donee beneficiary" if the purpose of the promisee was to make a gift to him, or to confer upon him a right not due from the promisee. A person was a "creditor beneficiary" if performance of the promise would satisfy an actual or asserted duty of the promisee to him. A person was an "incidental beneficiary" if the benefits to him were merely incidental to the performance of the promise.

4.17 It became apparent that a number of third party beneficiaries did not fall within the "donee" and "creditor" categories, (45) such that some courts simply disregarded the categorisation approach and allowed beneficiaries to recover who were neither creditors nor donees. (46) The inflexibility of the categorisation approach led to changes in the second Restatement of Contracts published in 1981, under which intended beneficiaries, who can enforce contracts, are contrasted with incidental beneficiaries, who cannot. Section 302 of the Restatement (Second) provides:

"(1)Unless otherwise agreed between promisor and promisee, a beneficiary of a promise is an intended beneficiary if recognition of a right to performance in the beneficiary is appropriate to effectuate the intention of the parties and either

(a) the performance of the promise will satisfy an obligation of the promisee to pay money to the beneficiary; (47) or

(b) the circumstances indicate that the promisee intends to give the beneficiary the benefit of the promised performance. (48)

(2) An incidental beneficiary is a beneficiary who is not an intended beneficiary." (49)

4.18 However, the Restatement (Second) fails properly to explain the distinction between intended and incidental beneficiaries, given that "the parties, or more simply the promisee, may intend a third party to receive a benefit but not intend that party to have standing to enforce the promise". (50) The "intent to benefit" test has, in practice, failed to achieve consistent results, (51) in particular in the field of public service contracts. (52)

4.19 Other difficult questions under the Restatement (Second) include the following. Should reference be made to the contract alone, or to all the prevailing circumstances when determining whether the appropriate intention exists? (53) Some states have adopted a requirement that the intent to benefit the third party be expressed within the contract. However, even in the states that have adopted this strict test of intent, the requirement has not been consistently applied. (54)

4.20 A further problem is the question of whose intent is relevant to establish a third party right. Section 302(1) refers to the intention of the parties, although section 302(1)(b) refers to the promisee's intention. Different jurisdictions apply different tests: (55) some require proof only of the promisee's intention; others focus upon the intent of both parties, and some have adopted a midway position, requiring that the promisor should have reason to know of the promisee's intent to contract for a benefit to a third party. (56)

4.21 On the question whether the contracting parties may vary or revoke their promise, section 311 of the Restatement (Second) provides that the contracting parties may create rights that cannot be modified, but that otherwise they are free to modify unless the beneficiary "materially changes his position in justifiable reliance on the promise or brings suit on it or manifests assent to it at the request of the promisor or promisee".

Footnotes to Part IV

(1)The relevant legislation in Western Australia, Queensland and New Zealand is set out in Appendix B. The law on contracts for the benefit of third parties in several other jurisdictions was set out in the Appendix to Consultation Paper No 121. We have also found of help and interest the Ontario Law Reform Commission, Report on Amendment of the Law of Contract (1987) ch 4 and, especially, the clear and elegant Report of the Manitoba Law Reform Commission Report No 80, Privity of Contract (1993). The former concluded that a detailed legislative scheme was not the appropriate method of reform; rather there should be a simple abrogation of the third party rule by statute, with the details left to the courts. The latter proposed a draft Bill based on the New Zealand Contracts (Privity) Act 1982, with some amendments. Neither report has yet been implemented.

(2)2 Law Revision Committee, Sixth Interim Report, Statute of Frauds and the Doctrine of Consideration, (1937) Cmd 5449.

(3)3 Law Revision Committee, Sixth Interim Report, para 41.

(4)4 (1756) Ambler 330, 27 ER 221. See also Gregory and Parker v Williams (1817) 3 Mer 582; 36 ER 224; Lamb v Vice (1840) 6 M & W 467; 151 ER 495; Robertson v Wait (1853) 8 Exch 299, 155 ER 1360; Lloyd's v Harper (1880) 16 Ch D 290; Les Affréteurs Réunis Société Anonyme v Leopold Walford (London) Ltd [1919] AC 801. See Law Revision Committee, Sixth Interim Report, para 42.

(5)5 In Re Empress Engineering Company (1880) 16 Ch D 125, 127 per Jessel MR "I know of no case where, when A simply contracts with B to pay money to C, C has been held entitled to sue A in equity"; Dunlop Pneumatic Tyre Co Ltd v Selfridge and Co Ltd [1915] AC 847, 853 per Viscount Haldane LC; Vandepitte v Preferred Accident Insurance Corporation of New York [1933] AC 70 (PC). See Law Revision Committee, Sixth Interim Report, para 43.

(6)6 Law Revision Committee, Sixth Interim Report, para 44.

(7)Ibid.

(8)8 Law Revision Committee, Sixth Interim Report, para 46. The Committee also thought that an important practical reason for reform was the increasing role played by documentary letters of credit in world trade. The Committee concluded that "it is very undesirable that the validity in law of a commercial contract of such importance should remain in doubt": Law Revision Committee, Sixth Interim Report, para 45. Of course, the legal validity of documentary letters of credit is now well-settled. Our Consultation Paper concluded that documentary letters of credit were valid through an exception to the doctrine of consideration, and did not constitute infringements of the third party rule: see Consultation Paper No 121, para 3.32; Hamzeh Malas & Sons v British Imex Industries Ltd [1958] 2 QB 127.

(9)9 The Law Revision Committee was adamant that no third party right should be acquired by implication (eg, because the performance of the contract would benefit the third party). See Law Revision Committee, Sixth Interim Report, para 47.

(10)10Law Revision Committee, Sixth Interim Report, para 48.

(11)Law Revision Committee, Sixth Interim Report, para 49. In its section on consideration, the Law Revision Committee included a recommendation that the rule that consideration must move from the promisee should be abolished: see para 37.

(12)12See paras 4.5-4.7 below.

(13)13For possible reasons for inaction, see J Beatson, ?Reforming the Law of Contracts for the Benefit of Third Parties - A Second Bite at the Cherry' (1992) 45(2) CLP 1, 14-15.

(14)14Western Australia Property Law Act 1969, s 11(2) (W Austl Acts 1969, No 32).

(15)15Western Australia Property Law Act 1969, s 11(2)(a).

(16)16Western Australia Property Law Act 1969, s 11(2)(b). This requirement was criticised by the New Zealand Contracts and Commercial Law Reform Committee, see para 4.6, below.

(17)17Western Australia Property Law Act 1969, s 11(2)(c).

(18)18Western Australia Property Law Act 1969, s 11(3).

(19)19New Zealand Contracts and Commercial Law Reform Committee, Privity of Contract (1981) pp 49-50.

(20)We are not entirely convinced that this and the following point are accurate criticisms of the Western Australian legislation. The fact that the third party is "a person not named as a party" does not necessarily mean that it is only where the third party is named that he can enforce the contract.

(21)21[1981] WAR 241. See Consultation Paper No 121, Appendix, para 3. See also J Longo, ?Privity and the Property Law Act: Westralian Farmers Co-Operative Ltd v Southern Meat Packers Ltd' (1983) 15 University of Western Aust LRev 411.

(22)22Queensland Stat No 76 of 1974, s 55.

(23)23Queensland Property Law Act 1974, s 55(1). The New Zealand Contracts and Commercial Law Reform Committee, Privity of Contract (1981) p 52 regarded the Queensland legislation as "deficient in not providing that the duty may be created by deed as well as by simple contract."

(24)24Queensland Property Law Act 1974, ss 55(2).

(25)25Queensland Property Law Act 1974, s 55(3)(a) and (d).

(26)Queensland Property Law Act 1974, s 55(3)(b).

(27)27Queensland Property Law Act 1974, s 55(4).

(28)28Queensland Property Law Act 1974, s 55(6)(a):"?acceptance' means an assent by words or conduct communicated by or on behalf of the beneficiary to the promisor, or to some person authorized on his behalf, in the manner (if any), and within the time, specified in the promise or, if no time is specified, within a reasonable time of the promise coming to the notice of the beneficiary".

(29)29Queensland Property Law Act 1974, s 55(6)(c): "?promise' means a promise - (i) which is or appears to be intended to be legally binding; and (ii) which creates or appears to be intended to create a duty enforceable by a beneficiary...".

(30)Although the promise must appear to be intended to confer a legal right enforceable by the third party: see note 29 above.

(31)31If criticisms (i) and (ii) in paragraph 4.6 above are accurate, the Queensland legislation also differs in that the beneficiary need not be named or in existence or identified at the time of the contract: see s 55(6)(b). See Ontario Law Reform Commission, Report on Amendment of the Law of Contract (1987) pp 62-64; Manitoba Law Reform Commission, Privity of Contract (1993) Report No 80 pp 32-34.

(32)32New Zealand Contracts and Commercial Law Reform Committee, Privity of Contract (1981).

(33)33Ibid, paras 2.1-2.3.

(34)34The Report, at para 3.1, considered the law of France, Germany, South Africa, Denmark, Norway and Scotland.

(35)New Zealand Contracts and Commercial Law Reform Committee, Privity of Contract (1981), paras 6.2-6.3.

(36)36[1975] AC 154, 169.

(37)37[1980] 1 WLR 277, 300-301. Lord Scarman's observations are set out above at para 2.64.

(38)38Privity of Contract (1981) Appendix C, Draft Contracts (Privity) Act, clause 4.

(39)39Or his position has been materially altered by the reliance of any other person on the promise.

(40)40New Zealand Contracts (Privity) Act 1982, s 5.

(41)New Zealand Contracts (Privity) Act 1982, s 6. For the New Zealand approach to defences, see para 10.7 below.

(42)42New Zealand Law Commission, Contract Statutes Review, NZLC R 25, (1993), pp 217-218.

(43)See the standard accounts in Corbin on Contracts, Vol 4, and Williston, A Treatise on the Law of Contracts, Vol 2, which well illustrate the complexity of American law. See also, eg, D Summers, ?Third Party Beneficiaries and the Restatement (Second) of Contracts' (1982) 67 Cornell L Rev 880; S De Cruz, ?Privity in America: A Study in Judicial and Statutory Innovation' (1985) 14 Anglo-Am L Rev 265; H Prince, ?Perfecting the Third Party Beneficiary Standing Rule under Section 302 of the Restatement (Second) of Contracts' (1984) 25 Boston College L Rev 919; A Waters, ?The Property in the Promise: A Study of the Third Party Beneficiary Rule' (1985) 98 Harvard L Rev 1109. See also the Ontario Law Reform Commission's Report on Amendment of the Law of Contract (1987), pp 55-58.

(44)20 NY 268 (1859).

(45)In a private construction context, subcontractors were neither donee nor creditor beneficiaries: D Summers, ?Third Party Beneficiaries and the Restatement (Second) of Contracts' (1982) 67 Cornell L Rev 880, 884.

(46)Ibid. For an example of a third party taking the benefit of an exclusion clause as a third party beneficiary, see Carle & Montanari Inc v American Export Isbrandtsen Lines Inc 275 F Supp 76 (1967).

(47)Eg where B promises A to discharge a debt owed by A to C.

(48)Eg where B promises A to make a gift to C.

(49)Eg where B promises A to build a structure which has the effect of enhancing the value of C's land.

(50)H Prince, ?Perfecting the Third Party Beneficiary Standing Rule under Section 302 of the Restatement (Second) of Contracts' (1984) 25 Boston College L Rev 919, 979.

(51)There have been several varieties of the "intent to benefit" test: the contract must have been for the "sole and exclusive" benefit of the third party; the "primary intention" of the promisee must have been to benefit the third party; the contract must have been "necessarily" for the benefit of the third party; the direct benefit must have been "express or unmistakeable" or "sufficiently immediate": Prince, ibid, pp 934-937.

(52)A Waters, "The Property in the Promise: A Study of the Third Party Beneficiary Rule" (1985) 98 Harvard L Rev 1109, 1186-1188.

(53)In Beckman Cotton Company v First National Bank of Atlanta 666 F 2d 181 (1982), by considering the surrounding circumstances the court was able to confer a right of enforcement on a third party beneficiary, although not named in the contract.

(54)See H Prince, ?Perfecting the Third Party Beneficiary Standing Rule under Section 302 of the Restatement (Second) of Contracts' (1982) Boston College L Rev 919, 926-931.

(55)Ibid, p 931.

(56)On one view, only the promisee's intention should be relevant, since the promisor's motivation for entering into the contract will frequently be the consideration he receives from the promisee. However, this is not invariably so: the promisor may have an interest in seeing that the third party is benefited, as where he is a relative: Re Stapleton-Bretherton [1941] Ch 482.