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3.3 Privity of Contract Lecture – Hands on Example

The following scenario seeks to assess your understanding of the concept of “privity of contract” and “third person action or enforcement” on a practical standpoint.

In answering the issues, you should apply the theory and principles, alongside the cases discussed above. While referring back to the notes may be helpful, not all of the content will be relevant here.  Hence, you should be able to identify the applicable heads and related case law.  Further, given that the notes do not (and cannot possibly) capture all decided cases until date, you should be able to research on, review and understand other relevant cases on the subject, and apply them to the scenario.  This, however, should be done once you have obtained a thorough conceptual understanding, for which the notes should help. 

While the solutions may be quite subjective and case-specific, probable answers are provided at the bottom of the page.  Start by identifying the legal issues involved in each problem.

Given that you have now gained expertise on the topic, go ahead solving the problem.  A few guidelines may help:

  • Is the claimant a party to the contract? Does consideration flow from the claimant?
  • Whether the contract expressly allows a third person action?
  • Does the contract purport to confer any benefit to a third person?
  • If yes, whether the parties still intended in the contract to not allow third person action?
  • Did the third person have trust of contractual right? Was the promisee an agent of the third person in the context of the execution of the contract?
  • Is there any collateral contract, express or implied, between the third person and the promisor?

Scenario

The facts concern the following two transactions between Panaroma Ltd (P), Lily Ltd (L), and Motion Line Ltd (M), all companies registered in the UK:

  1. P acquired another company Crossword Ltd (C) in the services sector from L.  In the share purchase agreement, a non-compete covenant was included as follows-

“7.1L will not engage in any competing business or transactions for a period of five years from the closing of the share purchase deal.  Competing business will mean the business of C, or related business in which any of P’s affiliate companies is engaged. For the purpose of this clause, “affiliate” shall include all of P’s subsidiaries and group companies.”

L nevertheless starts a joint venture with Stephen (as a second shareholder) next year for the construction of flats- akin to the business of M engaged in residential building construction, in the same locality.  M is a wholly owned subsidiary of P.  As a result, M suffers significant losses in terms of cancellation of flat bookings against construction already commenced.

M sues L for breach of the non-compete clause 7.1, and losses suffered. Can M succeed in its claim? In the alternate, would P be able to seek remedy for M?

  1. P owns a land, on which certain construction is to be undertaken by L.  For certain logistics and taxation purposes, P routes the contract via M, such that the contract is executed between M and L.  L undertakes the work on site and produces periodic invoices to M.  M fails in making part payment of the bills, following which L terminates the contract and sues P for restitution against benefits already accrued to P from the portion of construction already completed. P denies L’s claim stating that the contract between M and L is not binding on P, which is not privy to the agreement. Would L be able to enforce the contract and the claim for restitution against P?

Answers

  1. The issue is whether M (as a third person to the share purchase agreement) can enforce clause 7.1 against L.

At the outset, the agreement does not expressly provide for such right of enforcement to M.  Hence, the first condition of the test under the 1999 Act is not fulfilled in the given facts. 

Next, on the second condition of benefit being conferred upon M, it is clear that the non-compete sought to purport the protection to not only C, but also to the business of any of its other group companies.  Thus, although M is not expressly stated, it is identified by way of description as an affiliate/subsidiary company. Accordingly, the protection extended to M- a 100% subsidiary of P. 

Now being a beneficiary under the agreement, M has a right to seek enforcement of the clause in its own capacity under section 1(1)(b) of the 1999 Act, if not otherwise intended by the contracting parties (section 1(2)).  In the absence of such contrary intention, it may be concluded that M has a right of action against L.

In the alternate, M, through P, can seek an order of specific performance by way of divesture of L’s joint venture. P, as the promisee, may sue L for such an order, alongside damages for the losses suffered by M. The above results may be affirmed by the case of Axon Well Intervention Products Holdings AS v Craig [2015] CSOH 4.

  1. The issue is whether L may have an enforceable claim of restitution against P, which is not a party to the contract under which the claim arises.  Inferring from the case of MacDonald Dickens & Macklin v Costello [2011] EWCA Civ 930, it may be concluded that such a claim would fail.  This is because, although P benefitted from the work done by L on its site, allowing such a direct claim would undermine the foundation of contractual arrangements premised on free will and voluntary intention between the parties.  The fact that L agreed to contract with M, and not P, clarifies the intention of both parties, more particularly, the knowledge of L regarding its counter party.

This conforms to the general rule of party autonomy in contract law as per which parties define, allocate and restrict their mutual obligations by way of an agreement- a sound policy towards legal and commercial certainty, as upheld in Pan Ocean Shipping Co Ltd v Creditcorp Ltd (The Trident Beauty) [1994] 1 WLR 161 and Lumbers v W Cook Builders Party Ltd (In Liquidation) [2008] BLR 581.  Thus, L may bring an action against M (and not P directly) to claim restitution, and recover damages.  In such a suit, discretion however lies upon the court to pierce the corporate veil and reach out to P, if situation so warrants.


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