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You are here: BAILII >> Databases >> The Law Commission >> Privity of Contract: Contracts for the Benefit of Third Parties [1996] EWLC 242(14) (31 July 1996)
URL: http://www.bailii.org/ew/other/EWLC/1996/242(14).html
Cite as: [1996] EWLC 242(14)
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PART XIV
Miscellaneous Issues
1. Joinder of Promisee
14.1 In the Consultation Paper, we dealt with the issue of whether a third party, seeking to enforce a contract for his or her benefit, should be required to join the promisee as a party to that action. (1) This may be thought important given our recommendation that defences and set-offs that the promisor would have had in an action by the promisee should also be available in an action by the third party. There may also be questions as to whether the promisor and promisee have varied or cancelled the contract. Furthermore, in a situation where the promisee itself wishes to sue, joinder may be thought important as a means of saving the costs and inconvenience to the promisor of being exposed to two separate actions. Section 11(2)(b) of the Western Australia Property Law Act 1969 has a requirement that the promisee, as well as the promisor, be joined as a party to the litigation when a third party sues to enforce a contract made for his benefit. But such a requirement was rejected by the New Zealand Contracts and Commercial Law Reform Committee on the grounds that it could lead to unnecessary expense and possible problems as to service of the proceedings. (2)
14.2 A clear majority of consultees were against a requirement that the promisee be joined. They argued that it will often be unnecessary to join the promisee and to do so would then serve only to increase costs: and that it may be impracticable to join the promisee because of death, dissolution or absence abroad.
14.3 We agree and therefore recommend that:
(48)there should be no requirement that the promisee be joined as a party to the litigation when a third party sues to enforce a contract.
14.4 On the other hand, it was widely recognised by consultees that it will often be desirable for the promisee to be joined. We agree. The question at issue therefore is whether the existing Rules of the Supreme Court (and the equivalent County Court Rules) are adequate to enable or ensure the joinder of the promisee in circumstances where this is desirable. We believe that they are. (3) Under the present Rules of the Supreme Court:
(i) By Order 15, rule 4, (4) if both the third party and the promisee wish it, the promisee can be joined as of right.
(ii)By Order 15, rule 6(2)(b), (5) the court (on its own motion or on application) can order the promisee to be joined as a plaintiff or as a defendant, albeit that no person can be added as a plaintiff without his consent.
(iii)By Order 16, rule 1, (6) the promisor can make the promisee a third party to the action.
14.5 We therefore recommend that:
(49)the existing Rules of Court are adequate to deal with joinder of the promisee in an action brought by a third party under our proposed reform.
2. Assignment of the Third Party's Right
14.6 Although we do not regard a third party under our proposed Act as having a "full" contractual right, his right under our proposals is clearly closely analogous to a contractual right and standard common law contractual principles should in general apply to it. We therefore see no good reason, and none was suggested to us, why the third party's right should not be assignable in the same way as a contracting party's rights under the contract.
14.7 We therefore recommend that:-
(50)although no legislative provision on this is necessary, a third party should be able to assign its rights under our proposed Act in an analogous way to that in which a contracting party can assign its rights.
3. Contracts for the Sale of Land
14.8 One consultee raised a number of points regarding the impact of our proposals on contracts for the sale of land. Such a contract may be regarded as having a number of unusual features. For example, it is a specifically enforceable contract and transfers equitable title to the land. There is generally a period of time between the contract and the conveyance, by which latter method legal title passes. The contract usually provides for the payment of a deposit, which may nonetheless be repayable in certain instances where the contract is breached. (7) Since equitable title passes to the purchaser, the vendor becomes a trustee for the purchaser under the doctrine of conversion from the time of contract, with the vendor retaining certain rights over the land to protect his interest. (8) The most important of these is the unpaid vendor's lien. (9)
14.9 If B contracts with A to purchase land from A, conveyance to be made to C, and A defaults, who recovers the deposit paid by B? Is it B, or, assuming that C has a right to enforce the contract under our proposed reform, could it be C? In our view, the answer is clearly that B and not C is entitled to recover the deposit. It is trite law that an innocent party faced with a breach of a contract for the sale of land may recover his deposit, although a party in breach sometimes cannot. (10) In addition to the common law jurisdiction to permit recovery of deposits by a purchaser who is not in breach, section 49(2) of the Law of Property Act 1925 (11) confers a wide discretion on the court to order "repayment" of any deposit even where it is the purchaser who is in breach of contract. The recovery of a deposit cannot be regarded as an "enforcement" of the contract so as to be one of the remedies available to a third party under our proposed reform. (12) The recovery of a deposit is a restitutionary remedy, (13) and is concerned to prevent the unjust enrichment of A at the expense of B (the payer).
14.10 We believe that the doctrine of conversion will operate to make A, as vendor, a trustee for C to whom the conveyance should be made. (14) The unpaid vendor's lien presents a different type of problem. If A contracts with B to purchase B's property, the purchase price to be paid partly to B and partly to C, does the lien benefit B as to the entire purchase price, or B as to his portion and C as to his, or B alone as to his portion? The answer to this appears to turn on whether one regards the security constituted by the unpaid vendor's equitable lien (15) as being designed to ensure that the purchaser performs its contract or rather as being designed to ensure restitution for the vendor. (16) If the former, B and C should each be entitled to an equitable lien for their respective portions of the purchase price. If the latter, B would be entitled to an equitable lien for the whole price (as representing the value of the land conveyed). Although this must be a matter for the courts to resolve, we would tentatively suggest that, in most circumstances, the former solution would be the most appropriate.
14.11 Finally, we were asked whether a third party with a right to enforce a contract for the sale of land would be a "purchaser" so as to fall within section 47 of the Law of Property Act 1925. If this were to be the case, the third party could insist on payment over to him by the vendor of the proceeds of any insurance maintained on property destroyed between contract and conveyance. We do not regard it as likely that, in a contract between A and B for the sale of land with conveyance to C, C would fall within the definition of "purchaser" in section 205(1)(xxi) of the Law of Property Act 1925, since he will not provide value, and does not actively take steps to acquire the property, being a mere passive recipient of a benefit. (17) Although this might seem to lead to inconvenient results, section 47 is rarely used in practice, and purchasers of property generally maintain their own insurance. We would expect third parties with rights to enforce contracts for the sale of land to do the same.
4. Choice of Law
14.12 Our proposed statute, as part of English law, will not apply if the contract or (insofar as different choice of law rules can be applied to particular provisions of a contract) (18) the contractual provision alleged to be enforceable by the third party is governed by a foreign law. Whether a foreign law governs the contract (or contractual provision) is a matter for standard choice of law rules applicable to contract (including the Rome Convention on the Law Applicable to Contractual Obligations, given force in the United Kingdom by the Contracts (Applicable Law) Act 1990). (19) Where the third party is sued in tort but seeks to rely on our proposed Act to enforce an exclusion clause in a contract to which he is not a party, the standard choice of law rules may require that the exclusion clause is valid according to not only the choice of law rule for contract but also the choice of law rules for tort. (20)
14.13 We therefore recommend that:
(51)although no legislative provision on this is necessary, the standard choice of law rules applicable to contract (or, where the third party seeks to rely on an exclusion clause, the standard choice of law rules applicable to an exclusion clause operating as a defence to an action in tort) should determine whether our proposed Act applies in respect of facts involving a foreign element.
5. Arbitration Agreements and Jurisdiction Agreements
14.14 Many contracts in common use in commerce and industry contain provisions obliging the reference of disputes to arbitration: or there may be a separate agreement to arbitrate. As was pointed out by various consultees, the Consultation Paper did not specifically consider the implications for arbitration of a reform of the third party rule. We seek to rectify that omission now. We have found this one of the most difficult issues that we have faced in this project.
14.15 Ultimately our recommendation is that arbitration agreements and jurisdiction agreements should fall outside our proposed reforms because such agreements cannot operate satisfactorily unless any entitlement of the third party to enforce the arbitration agreement carries with it a duty on the third party to submit to arbitration (or to comply with the jurisdiction agreement). Yet our reform is concerned only with the conferring of rights and benefits on third parties and not with the imposition of duties and burdens. In our view, a third party should in general (21) only be bound by an arbitration or jurisdiction agreement if it has agreed to be so bound in which case it becomes a true contracting party to the agreement and is no longer a third party to it. (22)
14.16 We were for a long time attracted by the idea that an arbitration agreement (or, analogously, a jurisdiction agreement) could operate as a procedural benefit to the third party and could also constitute a procedural condition on the third party's right to enforce the substantive promise. That is, if the third party wished to enforce its substantive right, it would be bound by the procedural condition to proceed via arbitration. So if A contracted with B to pay C £1000 for work done by B and there was an arbitration agreement referring to arbitration disputes relating to C's right to the £1000 our idea was that: (i) the arbitration agreement would be enforceable by C so that C could compel A and/or B to arbitrate as regards C's right to the £1000 notwithstanding that they did not wish to do so; and (ii) the arbitration agreement qualified C's right to the £1000, so that A and/or B would be entitled to a stay of litigation if C brought an action in the courts to enforce the promise of £1000.
14.17 We are now persuaded, however, that this approach is unacceptable for several reasons:
(i) Our approach to conditional or qualified benefits rests on the condition or qualification operating as a defence that could be raised against the third party under recommendation 21 or 23. Yet it is clear law that an arbitration agreement (or a jurisdiction agreement) cannot be regarded as a defence to an action (unless an arbitration clause is of the Scott v Avery (23) type). (24) Rather the agreement is simply enforceable by and against the parties to it through a stay of litigation.
(ii)The qualification of the benefit approach cannot work where the third party is being sued in, for example, tort because there is then no substantive benefit to the third party that can be qualified. Say, for example, the third party is being sued by A in tort and there is an arbitration agreement between A and B that refers to arbitration all disputes arising out of the performance of the contract, including tort claims against B's sub-contractor (C). C can in no sense here be ?bound' to arbitrate. Yet it would plainly be unsatisfactory for C to be able to take the benefit of the arbitration clause without being so bound: C would otherwise be entitled to a stay of litigation of the tort action against him, while not being bound to arbitrate, hence leaving A without a forum for enforcing its tort claim against C. Even if one confined the operation of our proposed Act to arbitration (or jurisdiction) clauses relating to disputes as to the third party's right to enforcement under our Act - which in itself would constitute an unprincipled restriction - the same problem would apply if the third party were being sued in tort but was seeking to enforce an exclusion clause in the contract between A and B; that is, a conditional benefit approach cannot work where the enforceable benefit under our proposed Act is negative rather than positive.
(iii)It would seem that the qualification of the right approach could only, in any event, operate where the third party seeks to enforce the substantive promise. Yet A may wish to seek a declaration of its rights (for example, as to A's obligations to C) or may seek rescission of the contract on the basis of the promisee's fraud, even though C is not yet seeking to enforce the substantive promise. If the third party were not bound by the arbitrator's award, the declaration or rescission would be of little value to A. Yet it is hard to see how the qualification of the right approach can bind C to such an award of an arbitrator.
(iv)If the third party were entitled to, or bound to, arbitrate there would be difficulty in some situations in choosing the arbitrator. For example, what would be the position if the arbitrator is left to be agreed by the contracting parties or, as commonly happens, each party is to appoint an arbitrator and the two arbitrators are to choose an umpire? It is not at all clear that that sort of approach would be appropriate where a third party is involved in the arbitration.
14.18 We have therefore reluctantly come to the view that arbitration and jurisdiction clauses must be seen as both conferring rights and imposing duties and do not lend themselves to a splitting of the benefit and the burden. (25) Following on from that, one radical approach would be to bind the third party to those agreements in respect of a dispute affecting the third party's rights as if he were a party to them. While we have considered this possibility at length, we have ultimately rejected it essentially because it would contradict a central philosophy of our reform in that we are concerned only with the conferring of rights, and not the imposition of duties on third parties. (26) Our preferred approach therefore is that arbitration agreements and jurisdiction agreements should fall outside our reform and can neither be enforced by, nor are enforceable against, a third party. (27)
14.19 We therefore recommend that:
(52)a third party shall have no rights of enforceability under our proposed reform in respect of an arbitration agreement or a jurisdiction agreement. (Draft Bill, clause 6(2)(d) and (e))
6. Commencement of the Legislation
14.20 We do not intend that our reform should affect contracts entered into prior to the enactment of legislation based on our proposals. We further believe that any legislation should not commence its application until a reasonable time has been given for the professions and the public to become familiar with it and to redraft standard form contracts should they consider this to be desirable. We believe six months to be an appropriate time period.
14.21 We therefore recommend that:
(53)the proposed legislation should not affect contracts entered into prior to its commencement date, which should be six months after receiving the Royal Assent. (Draft Bill, clause 9(2))
Footnotes to Part XIV
(1)1 Consultation Paper No 121, para 5.26, 6.11. Note that it is a requirement for the enforcement of an equitable assignment that the assignor be joined in any action by the assignee against the debtor: see Chitty on Contracts (27th ed, 1994) paras 19-022-19-023.
(2)2 New Zealand Contracts and Commercial Law Reform Committee, Privity of Contract (1981) para 7.1.
(3)3 It should also be noted that we do not think that any amendment to the rules as to the award of costs are required as a result of our proposed reforms.
(4)4 By O 15, r 4(1), "[T]wo or more persons may be joined together in one action as plaintiffs or as defendants with the leave of the Court or where - (a) if separate actions were brought by or against each of them, as the case may be, some common question of law or fact would arise in all the actions, and (b) all rights to relief claimed in the action (whether they are joint, several or alternative) are in respect of or arise out of the same transaction or series of transactions."
(5)5 By O 15, r 6(2), "[A]t any stage of the proceedings in any cause or matter the Court may on such terms as it thinks just and either of its own motion or on application -... (b) order any of the following persons to be added as a party, namely - (i) any person who ought to have been joined as a party or whose presence before the Court is necessary to ensure that all matters in dispute in the cause or matter may be effectually and completely determined and adjudicated upon, or (ii) any person between whom and any party to the cause or matter there may exist a question or issue arising out of or relating to or connected with any relief or remedy claimed in the cause or matter which in the opinion of the Court it would be just and convenient to determine as between him and that party as well as between the parties to the cause or matter."
(6)6 By O 16, r 1(1), "Where in any action a defendant who has given notice of intention to defend -... (c) requires that any question or issue relating to or connected with the original subject- matter of the action should be determined not only as between the plaintiff and the defendant but also as between either or both of them and a person not already a party to the action; then ... the defendant may issue a notice... containing a statement of the nature of the claim made against him and, as the case may be, either of the nature and grounds of the claim made by him or of the question or issue required to be determined."
(7)See Cheshire and Burn's Modern Law of Real Property (15th ed, 1994) pp 137-138; Law of Property Act 1925, s 49(2).
(8)See Cheshire and Burn's Modern Law of Real Property (15th ed, 1994) pp 124-127. It has been said that "although the vendor because of his duties to the purchaser is called a trustee, it is wrong to argue that because he is so called he has all the duties of or holds the land on a trust which has all the incidents associated with the relationship of a trustee and his cestui que trust": Berkley v Poulett [1977] 1 EGLR 86, 93, per Stamp LJ. See also Gray, Elements of Land Law (2nd ed, 1993), pp 268-270.
(9)See para 14.10 below.
(10)This will depend on whether the sum paid is regarded by the courts as a genuine deposit or a part payment, in which latter case it is always recoverable provided that there has been a sufficient failure of consideration.
(11)See Universal Corporation v Five Ways Properties Ltd [1979] 1 All ER 552; Dimsdale Developments (South East) Ltd v De Haan (1983) 47 P & CR 1.
(12)See para 3.33 point (ii) above.
(13)See Goff & Jones, The Law of Restitution (4th ed, 1993) p 428ff.
(14)Using the maxim "Equity looks on as done that which ought to be done" (ie conveyance to C).
(15)The unpaid vendor's legal lien will be ignored for our purposes: it depends on possession and thus could not benefit a third party to whom payment of part of the purchase price was to be made.
(16)In a standard two-party contract, one need not choose between these two aims. See generally S Worthington, "Equitable Liens in Commercial Transactions" [1994] CLJ 263. Where title to land is unregistered, an unpaid vendor's lien is registrable as a Class C (iii) land charge under the Land Charges Act 1972. Where title is registered, the lien should be protected by lodging a caution or registering a notice, unless the vendor remains in actual occupation. In such circumstances, the lien can be protected under Land Registration Act 1925, s 70(1)(g) as an overriding interest: Nationwide Anglia Building Society v Ahmed and Balakrishnan (1995) 70 P & CR 381.
(17)Section 205(1)(xxi) defines "purchaser" as "a purchaser in good faith" for valuable consideration and includes a lessee, mortgagee or other person who for valuable consideration acquires an interest in property.
(18)See Dicey & Morris, The Conflict of Laws (12th ed, 1993) pp 1205-1208.
(19)Ibid, ch 32.
(20)Ibid, pp 1429-1430. Choice of law in tort is now largely governed by the Private International Law (Miscellaneous Provisions) Act 1995, Part III.
(21)Ie subject to the possible application of the normal exceptions to the rule that a person who is not a party to the contract is not bound by it: see para 2.1 note 5 above. For example, a bailor may be bound by an arbitration or jurisdiction agreement in a contract of sub-bailment to which it is not a party.
(22)For a possible analogy see the example of A contracting with B to loan £1000 to C to be repaid by C after a year, mentioned in para 10.26, note 29, above. In the event that the third party does bind itself to arbitrate by becoming a contracting party, procedural difficulties may arise involving, for example, the appointment of arbitrators. These difficulties would have to be solved by the application of the standard principles applying to multiparty arbitration agreements.
(23)(1865) 5 HL Cas 811; 10 ER 1121. Although our recommendation is that arbitration agreements shall not confer a right of enforceability on a third party, we see no difficulty in allowing a Scott v Avery clause to operate as a defence under recommendation 21 above. Although C could not force A to arbitrate, if A refused to do so, A could no longer rely on the Scott v Avery defence. See Mustill and Boyd, Commercial Arbitration (2nd ed, 1989) p 164: "The second situation where a Scott v Avery clause is not available as a defence exists where the conduct of the defendant disentitles him from relying on it. [For example,] where the defendant has ... deprived the claimant of a proper opportunity to fulfil the condition precedent". See, eg, Toronto Railway Co v National British and Irish Millers Insurance Co Ltd (1914) 20 Com Cas 1: at p 23 Scrutton J said, "Conditions precedent may be waived by a course of conduct inconsistent with their continued validity...."
(24)See Mustill and Boyd, Commercial Arbitration (2nd ed, 1989), ch 13.
(25)This derives support from the Privy Council's reasoning in The Mahkutai [1996] 3 WLR 1. Lord Goff said, at p13, that an exclusive jurisdiction clause "can be distinguished from terms such as exceptions and limitations in that it does not benefit only one party, but embodies a mutual agreement under which both parties agree with each other as to the relevant jurisdiction for the resolution of disputes. It is therefore a clause which creates mutual rights and obligations".
(26)If the third party were bound to arbitrate, without having agreed to do so, there is also some risk of there being a contravention of Article 6(1) of the European Convention on Human Rights, unless the arbitrator was "independent" as well as "impartial". And what is not clear, and raises concerns as regards English arbitrations, is whether an arbitrator, who is a member of the chambers to which one of the party's barristers belongs, would be regarded as ?independent'.
(27)We understand that the approach that we here recommend is supported by French law. In France, arbitration clauses are generally void, unless they are included in contracts made between certain commercial parties: see Code Civil, art 2061; Code Commercial, art 631. Subject to this, as against a third party beneficiary of a stipulation pour autrui, (see Consultation Paper No 121, Appendix, p 158), we understand that an arbitration clause is res inter alios acta, and the third party can neither be bound by it, nor take the benefit of it. However the third party beneficiary can independently bind himself by the arbitration clause, whether expressly or impliedly, and if he does so, is bound by it: Code Civil, art 1134.