Is privity of contract here to stay?

This article was written by Justin McDonnell, Shane Ogden and Joe Koe.

Introduction

The Federal Court of Australia recently handed down a decision on privity of contracts in Clarence City Council v Commonwealth of Australia [2019] FCA 1568. The case was an attempt by a third party to avoid the strict consequences of the doctrine of privity of contract. The case raised questions about the only Australian common law exception to privity of contract for those named in an insurance contract which was introduced in Trident v McNiece. It is unlikely to be the last attempt to avoid the consequences that can flow from a strict application of the doctrine of privity of contract.

The case

Privity of contract is generally known as a "fundamental" and "settled" common law rule relating to contracts. It is the rule that no outsider to a contract can take advantage of a contract even if the contract is made for the outsider's benefit. An outsider is a person who is not a party to the contract although they may be mentioned in the terms of the contract.

Despite being "settled" law, two Tasmanian councils recently sought declarations that they were each owed the benefit of contracts to which they were not parties. The contracts were two leases of land which commenced during the 1990s privatisation of Australia's national airports. One between the Commonwealth of Australia and the operator of Hobart airport. The other between the Commonwealth of Australia and the operator of Launceston airport.

Each lease provided that the airport operator would pay rates to the relevant government authority for those parts of the airport sites on which "trading or financial operations" are undertaken. There was no statutory obligation for the airport operators to pay rates as the land was Commonwealth land and so exempt. The only basis requiring the councils to pay rates was under the leases and the lease terms described such payments as "ex gratia".

There was no dispute between the Commonwealth and the airport operators. The airport operators had been paying the ex gratia rates. The dispute arose because the parties to the leases and the councils disagreed about how much of the airport sites were being used for "trading or financial operations" and about how to calculate the ex gratia rates to be paid. The councils believed that a greater area of the airport sites were "rateable".

The Commonwealth required the airport operators to pay the ex gratia rates, at all, because in 1995 it had entered into the "Competition Principles Agreement" with the States and Territories. Under this agreement, the Commonwealth had agreed to adopt a principle of "competitive neutrality" so that "contestable" businesses would be required to pay "fictional" rates equivalent to their competitors not located on Commonwealth land. In the case of the airports, not all land was used for "contestable" services or facilities because the activities were not subject to competition. The councils' concerns centred on the use of the land.

However, the court did not ultimately decide the contractual interpretation question being posed by the councils. The court instead found that the councils lacked standing to bring the proceeding because they were outsiders to the lease and the doctrine of privity of contract prevented the councils from enforcing the terms of the leases. The councils had no standing to dispute the terms the leases because they were not parties to them.

Case analysis

The doctrine of privity is, for the most part, entrenched in the Australian common law. A third party seeking to rely on a benefit provided under a contract must rely on other legal principles such as trust, agency, assignment, or statute – but those are not considered to be true exceptions because they are entirely different legal principles.

There is only one "true" exception to the doctrine of privity in Australia. An exception exists for insurance contracts and was introduced by the High Court of Australia in Trident v McNiece. The case created a wedge in the strict application of the doctrine of privity of contract. The High Court, in a split decision, considered it as unjust not to allow a third party named in an insurance contract to benefit from it despite finding that there was no trust.  Since Trident v McNiece, other litigants have sought to widen the exception to non-insurance contracts, but no principle of wider application has emerged.

The councils placed significant reliance on a later High Court judgment of CGU Insurance v Blakeley. In that case, liquidators sought a declaration than an insurer was liable to indemnify two of the directors of the company in liquidation. The insurance policy was between the directors and the insurer. The liquidators and company in liquidation were not parties to the insurance policy. The councils argued that, because the liquidators were able to seek declaratory relief, the councils should be permitted to do the same. The councils' argument was not accepted. The liquidators in CGU Insurance v Blakeley were able to rely on statute to bring their claim. Something the councils could not do.   

The councils also argued that they were not "outsiders" to the leases. The councils said that they were directly and financially concerned in the correct interpretation of the leases and so should have standing to seek declaratory relief. However, the court rejected this argument and said that CGU Insurance v Blakeley did not represent any abandonment of the doctrine of privity of contract.

Comparative analysis

The councils' argument that they ought to have standing because they were directly and financially concerned in the terms of the leases was an interesting one. The potentially negative consequences which can follow from the strict application of the doctrine of privity of contract have been recognised. The Law Commission of the United Kingdom has even referred to the strict application of the doctrine of privity to deny a remedy to a third party which has suffered loss as "unjust".

Many common law jurisdictions moderate the effects of the doctrine of privity of contract by statute. Queensland and Western Australia each provide a statutory right for third parties, in certain circumstances, to enforce contracts under which they receive a benefit. The Insurance Contracts Act 1984 (Cth) s 48 also introduced a statutory right for third parties named in insurance contracts. New Zealand, the United Kingdom, and the United States each ameliorate the effects of the doctrine of privity of contract for third parties generally and not only for insurance contracts.

The developing law of class actions in respect of common fund orders also appears, so far, to have avoided issues raised by privity of contract. While the power to make common fund orders may be statutory, there is a shortage of judicial commentary about how common fund orders should be permitted to bind possibly thousands of uninterested class members to funding terms agreed only for the benefit of a few. This may be part of a progressive erosion of the doctrine of privity of contract.

Perhaps it is merely a question of time until Australia recognises a general right for a third party who benefits under a contract to be able to enforce the contract. The High Court accepted it in Trident v McNiece for insurance contracts and ever since a question has lingered – will the doctrine of privity of contract in Australia be further developed for the benefit of third parties?