What is privity of contract?

Privity of contract is the rule that specifies only the parties directly involved in a contract can enforce the terms of the contract. It protects the parties from third-party interference.

The rule is a common law principle that essentially states that someone who isn’t a party to the contract can’t benefit from it nor can they be held liable under the contract. Even if the third party could gain something of value under the contract, they still can’t sue if they don’t receive the promised benefits.

Here’s an example. Jane buys a rental property from John, but Ann is living on the property and has a one-year lease — which Jane assumes as part of the purchase. When Jane buys the property, there’s a leak in the roof that needs to be fixed. John agrees to fix the leak, but he doesn’t.

Even though Ann is directly affected, she can’t sue John to fix the leak because she has no contract with John. She could, however, sue Jane because Jane, as her landlord, is obligated to fix the leak per their contract.

Privity of contract came about when third parties went to court to enforce the terms of contracts, even though they weren’t actually parties to the contract. This was due mostly to issues associated with ancillary contract terms that dealt with acceptance and consideration. The principle of privity of contract has its roots in the United Kingdom, where it was first settled in 1861 in Tweddle v Atkinson.

There are some exceptions to the rule of privity, in large part because of court decisions. Here are a few places where privity of contract doesn’t apply:

  • Someone who is authorized to do so enters into a contract on behalf of another. This is known as the law of agency, and it allows someone (the “principal”) to designate another person to act on their behalf (the “agent”). In this case, the principal can sue the third party or be sued by the third party.
  • A married person enters into an agreement that expressly provides a benefit to their spouse or child. That agreement can be enforced by the spouse or child, like a life insurance policy with the spouse as the designated beneficiary.
  • Any time implied warranty or strict liability comes into play. For example, if you buy a mobile phone, you expect it to work as intended. This is an implied warranty. But when you turn on the phone for the first time, it catches fire. In that case, you might be able to recover damages from the phone’s manufacturer, even though you don’t have a contract directly with the manufacturer. Strict liability means that the manufacturer is still on the hook if something goes wrong, even if they didn’t mean to put a harmful product on the market.
  • When a collateral warranty that binds third parties like subcontractors is enacted. These, along with assignments, are used a lot in construction law. For example, if you hire Doe Construction to remodel your house, Doe Construction might hire Mark Sparks to handle the electrical wiring. You don’t have a direct contract with Sparks. However, if the wiring is done improperly, you can sue Sparks for damages.
  • In insurance cases, like if you’re in an automobile accident. If a third party gets into an accident with an insured vehicle, in some cases they can sue the insurance company if they get a favorable verdict against the vehicle owner.
  • If the requirements of a restrictive agreement are upheld. For example, someone sells a house to another person with the agreement that the buyer won’t tear down the house. If the original buyer then sells the house to a third party, and some of the original requirements are met, they might not be able to tear down the house, either.

Privity of contract can be a complicated legal concept, particularly with exceptions like the ones mentioned above. While it makes sense that a third party shouldn’t be able to enforce the terms of a contract that they didn’t enter into, the law — and life itself — isn’t that cut and dried. Consumer protection, contract assignments, and insurance cases have all demonstrated that limiting protection to just the parties to the contract is detrimental to public safety.

As the law continues to evolve, courts may further erode the principle of privity of contract. However, knowing the principle can help you as you prepare contracts or assign contracts to others.

For more information, you can have a look at our complete guide on how to write a contract.

This article is originally published on Dec 13, 2019, and updated on Jan 13, 2020.
AUTHOR
Justin started his career as a traditional business lawyer. Now, he’s all for digital transformation and bringing his practice up to pace. Making law paperless and a sustainable future are his dreams.

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