Privity of Contract and Third Party Rights - Report 2008

B. What Are the Possible Courses of Action?

[48] If one concludes that the privity rule, in its current form, poses the type of problem which calls for reform, the question is then whether legislative intervention is a suitable solution. In that case, what options are available, and which one possibly offers greater benefits? The Working Group’s analysis of the legislation and case law leads it to conclude that privity is not an urgent matter which requires legislative intervention or, at any rate, a legislative priority at the present time. Nonetheless, the Working Group recognizes that provincial delegates might disagree with the conclusion on the first issue and want to reflect on the next issues, as well as the potential options. For that reason, the report outlines and briefly discusses the legislative and judicial alternatives and arguments for and against each one, as well as the possible avenues if legislation was deemed a better path, and secondary issues which might follow from the development of third party rights.

1. Let the Common Law Take its Course

[49] Provided that there is a problem which needs to be addressed, the next issue to consider is whether legislative intervention is preferable to judicial treatment in the Canadian context. In other words, are legislatures the better bodies to provide a satisfactory solution to the privity problem? Or is it more appropriate at this time to simply leave courts to develop third party rights?

[50] The answer could be that courts are perfectly able to consolidate and further develop third party rights. Until now, courts have made do with taking away barriers and preventing unfairness by creating ways to get around the privity rule. Courts could, without a doubt, play a more active role in defining parameters which would clearly indicate in what circumstances third parties are allowed to enforce a contract.

[51] Once the question of third party rights is clarified, courts would be able to develop the law relating to secondary issues, such as variation or cancellation of the contract, counterclaims, defences and set-offs available to the promisor, as well as the remedies available to the third party, double liability, double recovery and overlapping claims, arbitration agreements and jurisdiction agreements, existing exceptions to the privity rule, and exclusion of certain types of contract.

[52] However, clear indications of a will to reshape the privity rule need to be provided. On that point, Newbury J.A. in RDA Film Distribution Inc. v. British Columbia Trade Development, quoting Steyn L.J. of the Court of Appeal of England, pointed out:

There is a respectable argument that it is the type of reform which is best achieved by the courts working out sensible solutions on a case by case basis, e.g., in regards to the exact point of time when the third party is vested with an enforceable contractual rights: … But that requires the door to be opened by the House of Lords reviewing the major cases which are thought to have entrenched the rule of privity of contract.[48]

[53] In the same way, the Supreme Court of Canada might have to open the door by clearly recognizing “the principle that the absence of privity, per se, will not preclude an action by a third-party beneficiary to enforce a promise” whether the third party is a plaintiff or a defendant.[49]  In other words, it could be appropriate to recognize that third parties are able to enforce positively contracts made for their benefit. The shield/sword dichotomy would thus lose any remaining relevancy.

[54] Judicial treatment offers a number of benefits, such as showing greater flexibility and adaptability, allowing developments on a case-by-case basis, increasing accuracy by eliminating the “guess work”, and insuring certain maintenance. Judicial treatment has the advantage of tailoring to actual needs and of keeping the law up to date on a periodic basis.[50]

[55] Nevertheless, judicial treatment also has downsides, such as raising concerns over the growing number of exceptions, rendering the application of the privity rule unpredictable, avoiding comprehensive reform, overlooking certain secondary issues arising from the development of third party rights, and introducing inconsistencies among courts and across jurisdictions. Judicial treatment has the disadvantage of lacking certainty and effectiveness.[51]

2. Legislative Intervention

[56] The answer could be, on the contrary, that legislative intervention is necessary to plainly set down third party rights. In London Drug, Iacobucci J. expressed the majority’s view that “any substantial amendment to the doctrine of privity is a matter properly left with the legislature”.[52] As early as 1987, the Ontario Law Reform Commission in its Report on Amendment of the Law of Contract made the following comments:

Abolishing the present third party beneficiary rule would, we believe, render the law more consistent internally, and more understandable by lay persons. As was pointed out previously, the courts have been able to circumvent the doctrine of privity by one legal device or another when the desired result was the enforcement of the promise by the third party beneficiary. The present state of the law, with its anomalies and unjustified distinctions, cannot and should not continue.[53]

[57] After reviewing the approaches for getting around privity, another question is whether there still are privity issues that could be satisfactorily settled through legislative intervention? In other words, what situations, if any, are not already covered by exceptions, either statutory or common law, or separately recognized areas of law, or legal devices for working around the privity rule? And are legislatures justified to intervene for those cases? Does the availability of the exceptions and other devices always correspond with their need?[54]

[58] Despite the many exceptions and devices described above, there could be situations where third parties would not be able to circumvent the privity rule beforehand, nor be able to apply any of the exceptions afterwards. Furthermore, other courses of action might simply not be available, or as convenient or as efficient in certain circumstances. In particular it appears that privity remains a problem in cases where a third party brings an action to claim a benefit expressly or impliedly conferred upon her or him by the contracting parties, or a right to enforce a contract or a term of a contract.[55] Thus, it could be said that “the underlying concerns of commercial reality and justice” militate for the reconsideration of the doctrine of privity of contract.[56]

[59] An additional consideration is whether legislative intervention is needed to address the complexity brought about by the great number of exceptions and devices, and the uncertainty and unpredictability they cause. On that point, McCamus writes:

A number of considerations suggest that the doctrine of privity is vulnerable to further reform. The rule lacks a convincing policy foundation. It is capable of producing unjust and surprising results in commonplace fact situations. Its unsatisfactory nature has produced a long and growing list of exceptions, thus rendering application of the doctrine unpredictable.[57]

[60] Finally, one more question to consider is whether lay people are aware of the privity rule and its potential effects. Can they turn to the tools that are available in order to work around the privity rule? The various means and exceptions are only valuable if the contracting parties are fully informed of these tools, and know how to bring them into play.[58]

[61] Legislative treatment presents certain merits, such as clarifying the privity rule, solidifying third party rights, reducing transaction and/or litigation costs, echoing sound commercial practices and modern realities, directly addressing most secondary issues arising from the development of third party rights, as well as reducing complexity, promoting judicial consistency and uniformity. Legislative treatment has the advantage of not being limited to incremental changes and of enunciating a single legislative scheme.[59]

[62] On the other hand, legislative treatment also has drawbacks, such as defining third party rights too broadly, introducing irrelevance to the debate through unnecessary intervention, increasing the number of actions by third parties, blurring the boundary between tort liability and contract liability, narrowing current statutory and common law exceptions, deterring socially beneficial contractual relationships, and becoming obsolete. Legislative treatment has the disadvantage of lacking adjustability and adaptability.[60]

[63] In any event, legislatures have several options if they should decide to reform the doctrine of privity of contract.

a. Exceptions for Particular Situations

[64] The first legislative option would be to identify where the privity rule is still producing unwanted or counterproductive results in common situations, and to rectify the problems in a targeted way. In some cases, legislatures might be able to anticipate the potential effects of the privity rule and reverse them on a piecemeal basis. In other cases, legislators will have to incorporate exceptions already created by the courts.

b. General Provision

[65] The second legislative option would be to introduce a general reform provision. A general provision, in turn, raises further options.

[66] For instance, a general provision could create a positive rule that would allow a third party to enforce a contract made for benefit of the third party. When a term of a contract indicates that the contracting parties purposed to benefit a third party, it should be presumed that they also intended for the third party to have the right to enforce the contract.[61] This presumption could be rebutted by the contracting parties if they only intended to extend a contractual benefit to a third party without conferring a separate right to directly enforce the contract, that is, a right to sue on it.[62]

[67] A general provision could also allow a third party to sue on a contract that contains a provision which expressly gives the third party a right to enforce it, whether or not the contractual arrangements are for the benefit of the third party. The possibility of conferring a mere right of enforcement could be particularly useful where there is a chain of contracts. For instance, an owner could be entitled to sue a subcontractor, notwithstanding the lack of privity, provided that the head contractor and the subcontractor have conferred this right on the owner.

[68] A general provision could also allow a third party to rely on a term of a contract which limits liability for breach of contract or liability in tort, provided that was the contracting parties’ intentions. As previously mentioned, these types of case are mostly embraced by the principled exception.[63]

[69] Another option would be to enact a “negative rule”, that is, a provision to the effect that the lack of privity is not in itself a defence against third party beneficiaries’ claims under a contract.[64] In contrast to a positive rule, a negative rule would not require carving out exceptions to the privity rule. Moreover, a negative rule would still prevent floodgates of litigation by third parties as the rule would only apply when contracting parties intend to benefit a third party. It would then be a question of contract interpretation.

[70] It is clear, however, that the mere fact of enacting one or a combination of the general provisions would not resolve all problems created by the privity rule in common fact situations. For instance, most of the cases encompassed in both the chain of contracts category and the rights and obligations follow the subject matter category would not be dealt with by any of the previous models of general provision. In order to properly take care of the latter two categories, a general provision should make it clear that the right of a third party to enforce a contract can be inferred from an appropriate analysis of either the contracting parties’ intentions or the fact situation (i.e. particular circumstances, class of agreement, relationship between the third party and the contracting party, common sense and commercial reality).[65]

[71] A more drastic option could be the abolition of the doctrine of privity. This option seems at first glance dangerous. Indeed, there should be limits to when and how a third party can enforce a contract. It might be hazardous to merely abolish the privity rule. All types of third party beneficiary (especially relational, situational or incidental beneficiaries) should not be granted the right to enforce agreements to which they are not privy without a thorough appreciation of the particular circumstances of each case. Moreover, complete strangers to a contract should not suddenly be able to enforce contractual arrangements because of the absence of a rule precluding people who are not party to a contract to sue on it.

c. Detailed Legislative Scheme

[72] The third legislative option also picks up the idea of a general provision, but goes further by providing details in order to insure that appropriate safeguards are in place. In recent years, a number of reform agencies have identified subsidiary issues which, in their view, needed to be addressed in a detailed legislative scheme.[66] These issues relate to (i) the enforceability of the contract; (ii) the identification of third party; (iii) the contracting parties’ right to vary or cancel the contract (crystallization test); (iv) the third party rights subject to the terms of the contract (including the arbitration and jurisdiction agreements) and the defences, set-offs and counterclaims available to promisor, as well as the remedies available to the third party; (v) the potential for overlapping claims; (vi) the possibility to opt-out; (vii) the exclusion of certain types of contract; and (viii) the existing exceptions to the privity rule.

[73] There are a number of “second generation issues”, that is, secondary issues ensuing from the development of third party rights, which may be more difficult to handle by a general provision reforming the privity rule or judicial development of third party rights on a piecemeal basis. On the other hand, these questions could be addressed in a detailed legislative scheme, that is, a comprehensive set of rules to favour expediency, predictability and consistency in the treatment of these second generation issues. In any event, it might be easier to create rules that accommodate specific results once it is established what should happen in the cases encompassed by each of the second generation issues reviewed below. However, the mere fact of looking at the second generation issues does not determine the path reform should take. An informed discussion on these second generation issues could nevertheless assist legislators and courts.

i) Enforceability of the Contract

[74] As previously noted, one of the underpinnings of the doctrine of privity is that a third party cannot enforce a promise because no consideration has flowed from the third party exchange for the promise. Consequently, a detailed legislative scheme could clarify that a third party who has not provided consideration should be able to enforce a contract as long as all other specified requirements are met. This would not call into question the doctrine of consideration in general. The consideration rule should still apply between the contracting parties, that is, the promisor and the promisee.[67]

ii) Identification of the third party

[75] The question of whether a contract should benefit a third party is not always clear-cut. Therefore, a detailed legislative scheme could include requirements to identify the third parties. It could be stipulated that the third party rights should be limited to beneficiaries expressly identified by name or description.[68] Alternatively, it could be specified that third party rights should be extended to implied beneficiaries on a proper construction of the contract, and even relational and situational beneficiaries in appropriate circumstances.[69]

iii) Right of the Contracting Parties to Vary or Cancel

[76] Contracting parties remain free to amend or rescind a contract or a term of a contract when they mutually agree. However, third party rights become valueless if contracting parties could modify or terminate a contract made for the benefit of a third party at any time. Therefore, a detailed legislative scheme could settle a point in time after which contracting parties are not able to vary or cancel a contract in a way that could affect third party rights without the consent of the third party beneficiaries. In determining when the third party rights should be considered crystallized, it is important to “strike a balance between the interests of the contracting parties to vary the contract and the interests of the third party in securing the promised benefit”.[70]

[77] The “crystallization test” differs from one jurisdiction to the next: (1) at the moment the contract is formed; (2) after the contract has been accepted or adopted by the third party either expressly or impliedly; (3) if the third party has materially altered its position in reliance on the promise made, when the promisor can reasonably have foreseen that the third party would rely on the contractual arrangements; (4) or once either contracting party is aware that the third party has assented to the contract, either by word or by conduct.[71] Some of these approaches have been criticized for being too restrictive (unduly limiting the freedom of contract) or too difficult to determine at which point the third party has become aware or has relied on the contract.[72]

[78] Contracting parties should always remain free to include in their contract a clause providing for the variation or cancellation. For instance, a contract could reserve to the contracting parties (or one of the contracting parties) an unlimited right to vary or cancel the contract.

[79] In order to avoid situations where contracting parties are “locked in” to a contract because the third party cannot consent to a variation or cancellation of the contract, it could be advisable adopt a safeguard conferring on the courts the discretion to authorize such a variation or cancellation in appropriate circumstances.[73]

iv) Third party Rights Subject to the Terms of the Contract and other Defences, Set-offs, Counterclaims and Remedies

[80] It is said that a third party beneficiary should not be placed in a better position than the contracting parties. Consequently, a detailed legislative scheme could specify that the right of the third party to enforce a contract should be subject to the terms of the contract.[74] This would not mean that contracting parties can impose obligations upon third parties; it would only indicate that contracting parties can subject third party rights to certain conditions.

[81] Similarly, third party beneficiaries should be bound by any arbitration or jurisdiction agreements insofar as contracting parties are free to impose such conditions. Thus, detailed legislation could confirm that a third party who wishes to enforce a contract made for its benefit should be obliged to refer to arbitration and/or exclusive jurisdiction when the contract so provides.[75]

[82] Furthermore, a promisor should be able to invoke against the third party the usual defences or set-offs which would have been available if the third party had been a party to the contract or the promisee had enforced the contract. A third party should also be entitled to the remedies which would have normally been available in an action for breach of contract if the promisee had sued on the contract. Such defences, set-offs and remedies should be clearly limited to situations arising out of the contract which the third party is seeking to enforce. In addition, a promisor should be free to counterclaim when the promisor has a right of action against the third party. However, the promisor should not be able to counterclaim against the third party for a matter relating to the promise.[76]

[83] Nevertheless, difficulties might arise where the forfeiture of a contracting party could penalize an innocent third party beneficiary or where the recourse to a defence, set-off or counterclaim could result in an inequity.[77] Here again, it might therefore be advisable to confer on the courts a measure of discretion in particular contexts.[78]

v) Overlapping Claims

[84] One of the arguments in support of the privity rule relates to the risks of double liability against the promisor and/or double recovery for the third party.[79] Therefore, detailed legislation could make it clear, on the one hand, that a promisor cannot face double liability because both the promisee and the third party have the right to enforce the contract; and, on the other, that a third party cannot obtain double recovery because both the promisor and the promisee are liable.[80] Once a promisor has wholly fulfilled its contractual obligations to either the third party or the promisee, the promisor should to be discharged from its obligations under the contract. Likewise, once a third party has recovered its losses from either the promisor or the promisee, the third party should to that extent be stripped of its rights under the contract.[81]

vi) Possibility to Expressly Contract Out

[85] It is generally acknowledged that “most rules of contract law are voluntary default rules that the parties can bargain around if they so choose”.[82] Therefore, a third party rule should be fashioned to give effect to the contracting parties’ intentions, either when they intend to confer to an enforceable benefit upon a third party or preclude any third parties from enforcing the contract.[83] A detailed legislative scheme could affirm that contracting parties remain free to “contract out”, that is, exclude any rights in favour of third party beneficiaries.

[86] However, difficulties could arise when an “anti-third party beneficiary clause” appears to functionally contradict the contracting parties’ intentions to confer to the third party a right to enforce the contract.[84] Furthermore, excluding a third party beneficiary regime could also be problematic where one of the contracting parties cannot “freely” choose to contract out, such as in the context of a contract of adhesion. Detailed legislation could provide a solution to such problems.

vii) Types of Contract to which a Reform would not Apply

[87] In addition to the contracting parties’ right to opt out, a detailed legislative scheme could also explicitly exclude particular contracts from its application. For instance, the Law Reform Commission of Ireland had concluded that certain types of contract “should be excluded, either for policy reasons or because third parties already have enforceable rights and/or obligations under existing rules, and the creation of additional rights could cause uncertainty and undermine the policy behind the existing rules”.[85]

[88] Carving out exceptions to a new third party rule as part of a detailed legislative scheme could, however, become a lengthy and complex process.[86] A simpler solution could be to specify that the proposed legislation is a mere “fall back rule”, that is, a rule that only applies when the other recognized exceptions or devices do not offer a satisfactory remedy against the consequences of the privity rule.[87] Thus it could still be possible to reform the doctrine of privity without having to set out a list of excepted contracts in cases where circumventing the privity rule could create inequities or jeopardize well-established principles.[88]

viii)  Existing Exceptions to the Privity Rule

[89] The question is whether a new provision in regards to third party rights would supplant or preserve the current statutory and common law exceptions to the privity rule.[89] If the exceptions were abolished, it might be essential to pinpoint in a detailed legislative scheme situations where existing exceptions should be retained because they give more secure rights, serve additional functions or facilitate a transition in ways of doing business. If the exceptions were retained, it might again be necessary to indicate that proposed legislation provides an alternate rule which only comes into play when the current exceptions do not apply in order to prevent third parties from cherry-picking the most advantageous settlement.[90]

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