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“Every agreement and promise enforceable by law, is a contract”

-Sir Fredrik Pollock

The Basics of Indian Contract Law

A contract is an agreement between enforceable by law. According to Salmond’s jurisprudence, it also creates and defines the rights and obligations between two or more parties. For an agreement to be binding upon the parties involved, it must have the following elements:

• Offer and acceptance
• Mutuality of Obligation
• Valid Consideration
• Capacity and Competence
• Legal Purpose

As per Section 2(a) of the Indian Contract Act, 1872 (“Act”), when a person expresses to another, his willingness to do or not do a given act, with the purpose of obtaining the assent of the other person with regard to such act or abstinence, he is said to make an ‘offer’ (also interchangeably called a “proposal”). Such an offer, when accepted by the offeree via valid communication and within reasonable time, becomes an agreement. For a valid agreement, it is important that the parties agree on the same thing, in the same manner i.e., there must exist consensus ad idem or ‘a meeting or minds’.

“Mutuality of Obligation” implies the intention to create a legal, contractual relationship. It is important for the parties to the agreement to clarify their desire to create a legal relationship i.e., if any party fails to fulfil their obligations under the agreement, they can be sued by the aggrieved, resulting in legal consequences. Thus, mere social or domestic agreements, such as a father promising to buy his son a car if he scores beyond 90% in his exams, would not create a legal relationship between such parties.

Section 2(d) of the Act defines ‘consideration’. Consideration is an act which the promisee agrees to undertake at the desire of the promisor. In layman parlance, ‘consideration’ is based on the Latin phrase quid pro quo or “something for something”. Therefore, since the offeror promises to do or abstain from doing something for the offeree to obtain his assent, the offeree, in return, has to do a given act for the offeror. Usually, ‘consideration’ involves the payment of money, but may involve other kinds of promises as well. Moreover, the consideration determined must not defeat the provisions of any law in force.

The parties to a contract must be competent i.e., they must have attained the age of 18 years, must be of sound mind while entering into the contract and must not be disqualified from contracting by any law in force. Moreover, it is crucial that the consent obtained from the offeree is devoid of coercion, misrepresentation, deception or fraud, for it to be considered as valid consent. It must be free, conscious and voluntary in nature to allow the formation of a binding contract.

Therefore, an ‘agreement’, as per Section 2(e) of the Act, is a promise or a set of promises that form a consideration for each other. In simple terms, both parties agree (or promise) to commit an act or omit from the commission of an act, thereby creating an agreement. Once such an agreement fulfils the aforementioned essentials, it is said it to be enforceable by law, i.e., it becomes a valid contract binding on the parties involved.

Privity of Contract

As observed from the previous paragraphs, a contract is a legal agreement which binds the parties to it and proceeding on the basis of simple logic, only such parties to a given contract must perform the obligations and enjoy the rights created under it. The doctrine of “privity of contract” encapsulates the common law principle which states that no person, who is not an original party to the contract, shall be entitled to or bound by the provisions a given contract. In simple terms, a person, who is not a party to a given contract is not entitled to take any action to enforce the said contract, in the event of its breach.

The Case of Dunlop Pneumatic Tyres

The best example of the application of the doctrine of privity is the landmark case of Dunlop Pneumatic Tyre Company Limited v. Selfridge & Company Limited¹. In this case, Dunlop, a tyre manufacturer, executed a contract with Dew & Company, a tyre dealer, for the supply of tyres at a discounted price upon the condition that the dealer would not resell the tyres to retailers for a price lesser than the minimum sale price, as determined by the manufacturer. Further, the contract provided that upon breach of the condition by the dealer, they would have to compensate the manufacturer to the tune of £5 per tyre as liquidated damages. Subsequently, Dew sold the tyres to the retailer (Selfridge) in accordance to terms of the contract with Dunlop. However, Selfridge proceeded to sell the tyres below the aforementioned minimum sale price.

During the proceedings, Viscount Haldane highlighted three key principles associated with the doctrine:

• Only parties to a given contract are entitled to compensation upon its breach by another party to such contract;
• For parties to be “privy” to a given contract, there must be a valid consideration flowing from to the promisee to the promisor (also called ‘privity of consideration’);
• Under the doctrine of agency, a principal not named in a given contract, can only sue if the promisor executed the said contract on his/her behalf, in the capacity of an agent.

The House of Lords ultimately held that Dunlop had a separate, independent contract with Dew, and since Selfridge was not a party to this primary contract, it was not privy to the price maintenance clause. Further, there was no valid consideration agreed between Dunlop and Selfridge and neither had Dew & Company acted in the capacity of an agent of Dunlop, while reselling the tyres to Selfridge.

Therefore, the House of Lords concluded that since there was no direct contractual relationship between Dunlop and Selfridge, Dunlop was not entitled to claim compensation from the retailer for selling the tyres below the minimum sale price.

Exceptions to the Doctrine

From the above explanation and the case of Dunlop Pneumatic Tyres, we observe that a third party to a given contract shall have no rights with regard to the said contract whatsoever. But in reality, there may be several situations where a third party may be impacted by the rights and duties created between two or more contracting parties.

For example; suppose ‘A’ wishes to send a consignment to ‘B’ through a courier company and pays the company for the services rendered. However, the courier company fails to deliver the consignment. Here, ‘B’, the receiver of the consignment, is impacted by the agreement between ‘A’ and the courier company. In technical terms, ‘B’ acts as the ‘beneficiary’ under the primary contract.

Acknowledging the existence of several such possibilities, the legal fraternity has recognized the need for exceptions to protect the rights of third parties. In the case of Pandurang Tidke v. Vishwanath Pandurang², it was held that despite not being a party to the contract, a third-party seeking benefit under the said contract was entitled to sue in the event of its breach.

In light of the impact on third parties, the doctrine of privity was made subject to the following exceptions:

1. Agency: Where an agent, acting in the due course of business, executes a valid contract with another party, the principal of such agent shall be entitled to enforce the contract.
2. Trust: Where a contract is executed between ‘A’, the trustee, and ‘B’ for the benefit of ‘C’ (the beneficiary), ‘C’ can enforce his rights under the said contract, despite being a stranger to it.
3. Assignment of Contract: Where a contract or a right under a contract is assigned to a third party, the said third party can enforce his rights under the primary contract, despite being a stranger to it. A common example is the assignment of a right to collect a debt by a creditor to an assignee. Here, although the original contract was created between the creditor and the debtor, upon assignment, the assignee can sue the debtor under the contract for repayment.
4. Official Receiver during Insolvency or Liquidation: When a Liquidator or Receiver is appointed to carry out the liquidation of an entity, the Liquidator shall, despite not being the true owner of the assets of the entity, proceed to sell off the properties of the entity.
5. Acknowledgement of Debt: Where a debtor, ‘A’, gives an amount of money to ‘B’, a third-party for payment of a debt due to ‘C’, a creditor, and where ‘B’ acknowledges the existence of the debt, the creditor can enforce his rights for the payment of the amount of debt, despite the ‘B’ not being a party to the primary contract between ‘A’ and ‘C’.

Privity of Consideration

As previously observed in the case of Dunlop Pneumatic Tyres, Viscount Haldane held that since there was no consideration flowing between Selfridge, the retailer, and Dunlop Pneumatic Tyres, Dunlop was not entitled to sue the retailer for reselling tyres below the minimum sale price. Therefore, from the rationale adopted by the House of Lords, we observe the importance of a valid consideration for parties to be ‘privy’ to a contract.

The Essentials of Consideration under the Indian Contract Act

1. The consideration must flow at the desire of the promisor: Any act to be or not to carried out must only be at the desire of the promisor and not a third-party, to constitute valid consideration.
2. It can flow from the promisee or any other person: Section 2(d) of the Act stipulates that the act to be done or to be abstained may carried out or omitted by the promisee or any other person.
3. It may be past, executed or executory: The phraseology of Section 2(d) of the Act suggests consideration could be something that has been done or omitted, is being done or omitted or will be done or omitted in the future. Further, as decided in the case off Bolton v. Madden, the proportion or adequacy of the consideration is for the parties to determine at the time of execution of the agreement. The courts shall not delve into the sufficiency of consideration in a given contract at the time of its enforcement. Consideration under a contract cannot be unlawful in the eyes of law, immoral or opposed to public policy. Such consideration shall render the agreement void under Section 23 of the Act. Where these elements of consideration are fulfilled, the contract can be considered valid and enforceable by law. Such a contract binds the parties involved and creates ‘privity’ to contract. Therefore, under the principle of ‘privity of consideration’, only a person from whom consideration flows to the promisor, under an agreement, can enforce the contract and sue the opposite party.

Privity of Contract vis-à-vis Privity of Consideration

A valid contract arising from a valid consideration (along with the fulfilment of the other essentials of contract law), and therefore the ‘privity’ to contract arises from the existence of ‘privity of consideration’.

In the case of Bhavna Rajesh Doshi & Ors. v. Surya -Landmark Developers Private Limited³, the Applicants purchased certain flats, in redevelopment, in the free-sale component of a Society. Subsequently, the Society terminated the redevelopment agreement executed with the Respondent/ Developer. The Applicants thus sought redressal against the Society and the developers and filed an interim application to prevent the Society from terminating the development agreement.

In this regard, the High Court held that since the Applicants purchased the flats from the free-sale component, they lack privity of contract with the Society and therefore, the Applicants were not entitled to seeks redressal against the Society. Considering that their agreement was with the Developer, they have the liberty to exercise their rights under the contract with the Developer.

Conclusion

The doctrine of privity of contract was conceptualised to prevent unauthorized third-party involvement in the enforcement of a given contract. However, with profound development in jurisprudence and the acknowledgement of the plausible impact on parties outside the contractual arrangement led to the creation of exceptions to the doctrine. These exceptions seek to protect the interest of third parties who are impacted by a contract, especially in situations where they are beneficiaries under the said contract.

With regard to the nexus between privity of contract and privity of consideration, we observe that privity of contract flows from the existence of privity of consideration. Therefore, as observed in the recent Bhavna Doshi case, where the party is not privy to the consideration under the primary agreement, it shall bear no liability with regard to any breach or default under the said contract.

References:

¹[1915] AC 847

²[1915] AC 847

³Interim Application No. 2670 of 2020

Article by Mr. Sumer Karekar in April, 2021 while interning at the Chambers of Advocate Shankarlal Raheja.

Disclaimer: The views herein are personal and while careful attention has been given to ensure that the information is accurate the author assumes no liability or responsibility for any reliance thereon. This article is merely an information-sharing activity and is not a substitute to legal advice. It must be noted that we shall not be liable for any loss or damage caused due to any reliance thereof.

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[1] Section 2(b) of the Act.

[2] [1915] AC 847

[3] Detailed explanation in the following chapter

[4] AIR 1939 Nag 20

[5] Usually by means of an Assignment Deed. Further, there are no limitations as to in whose favour an assignment may be made.

[6] Supra Note No. 2

[7] Interim Application No. 2670 of 2020