Privity of Contract and Third Party Beneficiaries 2007

II. Judicial Devices, Statutory Provisions and the “Principled Exception

[33] In order to mitigate the harshness of the doctrine with respect to third party beneficiaries the common law has developed a number of means of avoiding its strict application. Similarly, in specific situations, statutory provisions have been implemented. Most recently, the Supreme Court of Canada created a “principled exception”, as a further incremental change to the application of the doctrine of privity where parties intend to benefit third parties.

(A) Judicial Devices

[34] In some cases, the courts have held that a contract which purported to benefit a third person created a trust for that person’s benefit. The device of trust, although accepted in principle by the Supreme Court has been severely reduced in effect by the insistence on a “real” intention to create a trust. Further, where the word “trust” or “trustee” is not used, there may be difficulties in determining whether or not there is the requisite intention.[33]

[35] The courts have also used the device of agency as a means of extending benefits of a contract to a third party. Where the promisee contracts as an agent of the third party (principal) the third party will be able to sue the promisor directly as a party. The difficulty with this exception is that again the courts will look to the contract for evidence of the intention to create an agency relationship.[34]

[36] Similarly, assignment may be used as a device to circumvent the privity doctrine as the person bearing the burden of the contract becomes liable to a person with whom he had no contractual relationship and whom he may not have intended to benefit.[35]

[37] In addition, the tort of negligence can be viewed as an exception to the doctrine of privity where the negligence in question constitutes the breach of contract to which the plaintiff is not a party.[36] For example, in the classic case of Donaghue v. Stevenson, where A supplies goods to B under a contract with B with no indication that they intended to benefit C, the Court found that A may owe a duty to C in respect of personal injury or damage to property caused by defects in those goods.[37]

[38] Covenants in a lease can benefit a third party who later acquires an interest in the property.[38] A person, who was not party to the covenant, may be able to enforce a covenant affecting land made by his predecessor in title and a covenant may be enforced against someone acquiring land with notice that it is burdened with a covenant.[39]

[39] Further, a contract between two parties may be found to be accompanied by a collateral contract between one of them and a third party. A collateral contract may effectively permit a third party to enforce the main contract. An example of a collateral contract is found in Shanklin Pier Ltd. v Detel Products Ltd.[40] The defendant paint supplier represented to the plaintiff pier owner that its paint was durable. On the basis of these representations, the plaintiff ordered its contractor to use the defendant’s paint in repainting the pier. The contract to supply the paint was between the defendant and the contractor. The paint proved defective. The plaintiff, although third party to the supply contract, was held entitled to sue for breach of the promise as to durability. The Court found that the transaction gave rise to a collateral contract between the plaintiff and the defendant. The defendant’s representations as to the quality of their paint amounted to a warranty and the consideration was the plaintiff instructing its contractor to use the defendant’s paint.

(B) Statutory Provisions

[40] Statutory provisions to circumvent the privity doctrine are frequently found in particular provincial legislation, such as, for example, those concerning insurance, consumer protection and the carriage of goods. For example, in Alberta, section 520 of the Insurance Act,[41] permits an injured party to enforce a judgment against an insurer, where the insured has not satisfied a judgment. S. 574 of the Act provides for the designation of a beneficiary for the purposes of life insurance. The beneficiary, although not a party to the contracted insurance, is able under s. 579 to enforce the payment of money due to him or her under the contract.[42]

[41] Further, under s. 635 of the Alberta Act, any person who has a claim against an insured under a motor vehicle liability policy, even though not a party to the contract, may on recovering judgment have the insurance money payable under the contract applied in or toward satisfaction of the judgment.[43] Similar legislation in other provinces has comparable provisions.

[42] Even with the exceptions found in the Insurance Act there are still some insurance situations where the doctrine of privity continues to apply. For example, in Azevedo v. Markel Insurance Co of Canada,[44] Deleurme had agreed to move a mobile home for Azevedo and it was damaged during the move. Azevedo obtained a judgment against Deleurme in negligence, but the judgment went unsatisfied. The carrier’s cargo liability insurance covered any loss from the move. Azevedo brought an action against Deleurme’s insurer, Markel, for payment of the judgment under its insurance policy. The Court of Queen’s Bench dismissed Azevedo’s claim against Markel and stated:

Although it is inequitable and unjust to the Azevedos in being prevented from receiving the benefit of the cargo liability insurance contract the carrier had with Markel, this inequity can only be resolved by the Legislature amending the Insurance Act, extending the rights of a Third Party with respect to a cargo liability policy similar to that which the Legislature did with respect to motor vehicle liability policies in s. 320(4) [now s. 635] of the Insurance Act.[45]

(C) The “Principled Exception”

[43] In the 1992 case, London Drugs Ltd., the Supreme Court of Canada carved out a “principled exception”[46] to the traditional privity of contract doctrine and allowed a negligent third party beneficiary to rely on a provision in their employer’s contract limiting liability for damaged goods to $40. In reaching that decision the Court stated the departure from the traditional doctrine represented only an "incremental change" to the common law.[47]

[44] In Fraser River a third party beneficiary sought to rely on a contractual provision in defence against an action brought by one of the contractual parties (the insurer). The Court held that the third party beneficiary was entitled to rely on the waiver of a subrogation clause whereby the insurer expressly waived any right of subrogation against the third party beneficiary. In reaching its decision, the Court declared the London Drugs decision was not limited to employer/employee situations and that a non-contracting third party could enforce the waiver/limitation if,

  1. the parties to the contract intended to benefit the third party; and
  2. the third party was performing the very activities contemplated by the contractual provision.[48]

[45] In both London Drugs and Fraser River, the Court stopped short of abolishing the doctrine of privity of contract. It referred to the difficulty faced by the judiciary in anticipating the complex repercussions of the wholesale abolition of the doctrine and emphasized that such sweeping legal reforms were the responsibility of the legislature. The Court believed, however, that it was appropriate to undertake an incremental change in keeping with commercial reality and justice.[49]

[46] The scope of the London Drugs and Fraser River “principled exception” is unclear. Some commentators assert that the exception is so broadly framed that it could amount to an abolition of the privity doctrine entirely.[50] Others assert that there has been an abolition of the doctrine only with respect to exclusion clauses and not with respect to a third parties’ ability to enforce their rights under a contract.[51] In reviewing the judgments of the Supreme Court it is not clear whether they intended to limit the application of the “principled exception” to a situation where a third party seeks to resist an action in the face of a limitation, waiver or exclusion clause contained in a contract to which they are not party. In London Drugs the Court indicated that it was proposing a “very specific and limited exception to privity in the case at bar; viz permitting employees who qualify as third party beneficiaries to use their employer’s limitation of liability clauses as Ashields in actions brought against them.”[52] Similarly, the Court in Fraser River, while emphasizing that the “principled exception” was not limited to employment contracts, did point out that the third party beneficiary was “...seeking to rely on a contractual provision in order to defend against an action initiated by one of the contracting parties.”[53]

[47] Relying on these statements from the Supreme Court, some subsequent lower court decisions have interpreted the “principled exception” narrowly such that it could not be used by a third party as a sword, but only as a shield. That is, the exception would not allow a third party to sue on a contract, rather it would only apply where a third party seeks to rely on a provision in a contract to which it is not party in its defence. Others have interpreted the exception more broadly.

[48] There are few cases in Alberta that have considered this issue. In Parwinn Developments Ltd v. 375069 Alberta Ltd., the Court of Queen’s Bench found the plaintiffs were not the type of third-party beneficiaries contemplated by the Supreme Court of Canada in Fraser River.[54] There was no evidence that the parties to the purchase contract intended to extend the benefit of the commission provided for in the purchase agreement to the plaintiffs. Further, the exception in Fraser River was to be used only as a shield by third parties, rather than as a sword.[55]

[49] In contrast, in the more recent case of Fenrich v. Wawanesa Mutual Insurance Co., the Alberta Court of Queen’s Bench, affirmed by the Alberta Court of Appeal, would have found both the conditions in Fraser River met and allowed a third party beneficiary to sue on a contract of insurance, except that the contract itself made clear that only the parties to the contract could sue on it.[56]

[50] Courts in other Canadian provinces have also made the shield/sword distinction. For example, the Ontario Court of Appeal in Tony & Jim’s Holdings Ltd. v. Silva,[57] distinguished between cases where a third party is relying on a contractual provision as a defence and those where it is asserting a right to sue. The former types of cases did not raise concerns with respect to double recovery, floodgates of litigation, reciprocity or the right of contracting parties to rescind or vary their contracts, whereas the latter did.[58]

[51] Similarly, the British Columbia Court of Appeal in R.D.A. Film Distribution Inc. v. British Columbia Trade Development Corp., agreed with the Trial Court that the incremental nature of the “principled exception” was such that it was intended to be used by third parties as a shield rather than a sword.[59]

(D) The Enforceability of An Agreement by a Third Party Beneficiary

[52] In consultations, some Alberta lawyers identified this uncertainty in the law as a real problem for their clients. For example, one firm, who acts for the owners of a large oil sands project has encountered this issue when they obtain insurance (property risk, wrap-up liability and workers compensation) intended to cover an entire project. Their hope was that by obtaining such comprehensive insurance, the insurance premiums and costs would be lower than if all the contractors and sub-contractors on a project were to get coverage individually. The difficulty, however, was that the owner has a contractual relationship only with the contractor. Accordingly, the current uncertainty in the law as to whether a third party can enforce a contract intended for their benefit means that it was not certain that sub-contractors, and other third parties would be able to seek indemnification from the owners, even though the owner's insurance was intended to cover them. The sword/shield distinction made by the courts does not reflect the parties’ intentions or commercial realities.

[53] On the other hand, counsel with two large oil companies did not encounter this issue in their work. Their client’s projects are structured such that the contractors and sub-contractors are responsible for obtaining their own insurance.

[54] In light of the current uncertainty in the law, reform of the doctrine of privity could clarify that third party rights are enforceable. That is, that a third party cannot only rely in defence on an exclusion clause, limitation or waiver in a contract to which they are not party, but also to sue on that contract to enforce their rights.

[55] It is difficult to justify the limitation that a third party can use the “principled exception” as a shield, but not as a sword. First, the considerations against the doctrine of privity, relied on by the Supreme Court in creating the “principled exception”, would equally apply to the situation where a third party is attempting to sue on a contract. In particular, this distinction does not reflect the intent of the parties or the commercial realities. Second, in other jurisdictions, the principle reason for legislative reform of this issue is to ensure the enforceability of an agreement by a third party beneficiary. Finally, as Prof. David Percy observes, the “repercussions that arise from recognizing that people may have enforceable rights under contracts for which they have provided no consideration are not significantly greater than those which have already occurred as a result of Supreme Court of Canada decisions.”[60]

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