Privity of Contract and Privity of Consideration

That case is named in almost every commentary. It is not worked here, because the judgment could not be verified: a search returns a different modern decision in which the same surname appears as a party. The rule it illustrates comes from section 2(d) itself, which is the better authority anyway, and the chapter is written on the section.

Privity of contract: India follows England

The rule is that only a party to a contract can sue on it. A person who is not a party, however much the contract was meant to benefit them, has no right of action.

The reasons are two. A contract is a bargain between those who made it, and its obligations should not be enforceable by people who assumed none. And a person who has taken on no liability should not be able to pick up the benefits.

The Act nowhere states the rule. It comes from section 2(h), which defines a contract as an agreement enforceable by law, read with the structure of the Act, and it has been settled by decision.

The leading Indian authority

M.C. Chacko v. State Bank of Travancore, AIR 1970 SC 504.

Facts. A bank of which the appellant was the manager had an overdraft with another bank, which later merged with the respondent. The appellant's father had given letters of guarantee for the overdraft. The father then executed a deed distributing his properties among his family, which recited that the amount due to the bank was to be paid by the appellant, and that if the father had to pay anything under the guarantee, the appellant and the properties allotted to him would answer for it. The creditor bank sued and claimed that the deed had created a charge on those properties in its favour.

Held. A person who is not a party to a contract cannot enforce its terms, subject to the recognised exceptions. The recitals in the deed evidenced no intention to create a charge in favour of the bank: they set out an arrangement between the donor and the members of his family as to who would meet the liability if it arose. A letter of guarantee creates a personal obligation, and an intention to convert a personal debt into a secured debt in favour of a third person could not be inferred from such recitals.

Why it matters here. It is the Supreme Court's statement of privity in Indian law, and it shows the rule working in the commonest setting: a family arrangement that mentions a creditor does not give the creditor a right to sue on it.

The exceptions to privity of contract

These are settled and they are the substance of any answer on the topic. A stranger to the contract may sue in the following cases.

(a) A beneficiary under a trust or a charge. Where a contract creates a trust in favour of a third person, or charges specific immovable property with a payment to him, the beneficiary may enforce it. M.C. Chacko failed precisely because no charge was found on the facts, which shows the exception is real and its requirements are strict.

(b) A provision in a family arrangement, marriage settlement or partition. Where a family settlement provides for the maintenance or marriage expenses of a female member, or a partition provides for a member's share, that person may sue although not a party to the document.

(c) Acknowledgment or estoppel. Where a party to the contract acknowledges, expressly or by conduct, a liability to the third person, he may be estopped from denying it. A person who receives money from A to pay it to C, and admits to C that he holds it for him, may be sued by C.

(d) A covenant running with the land. A person who buys land with notice of a restrictive covenant affecting it is bound by it, although he was no party to the covenant.

(e) Agency. Where one of the contracting parties contracted as an agent, the undisclosed or unnamed principal may sue and be sued. Strictly this is not an exception at all, because the principal is the real party.

(f) Assignment. The assignee of a contractual right may sue on it, subject to the equities. Again the assignee stands in the shoes of a party.

The two rules side by side

A worked example

Hema settles her family's affairs by a registered deed. She transfers her shop to her son Ishaan, and the deed provides that Ishaan shall pay her daughter Jyoti twelve thousand rupees a month for life, and shall pay off a loan Hema owes to Lakshmi.

• Jyoti sues Ishaan for the monthly payment. Is she barred by privity of contract? She is not a party to the deed, so the general rule bars her. But this is a family arrangement making provision for a member, exception (b), and the deed also charges the shop with the payment on the facts as stated, exception (a). She may sue.
• Did Jyoti give any consideration? No, and it does not matter. The consideration for Ishaan's promise moved from Hema, and section 2(d) allows consideration to move from "any other person". This is the privity of consideration point, and in India it is not an objection.
• Lakshmi sues Ishaan for the loan. She is a stranger to the deed, and on M.C. Chacko a recital that a family member will discharge the donor's debt is an arrangement within the family, not a promise to the creditor. Unless the deed charges identified property with her debt, or Ishaan has acknowledged the liability to her, she cannot sue on it. Her remedy is against Hema, who owes her the money.
• Suppose Ishaan writes to Lakshmi saying "I hold your money and will pay you next month". That is an acknowledgment, exception (c), and she may then sue him.

What it does NOT mean

"A stranger to the contract can never sue in India." The general rule bars him, but the six exceptions are real, and a beneficiary under a trust or charge, or under a family arrangement, regularly succeeds.

"Because consideration can move from a third person, a third person can sue." This is the central confusion. Section 2(d) tells you the promise is supported; it says nothing about who may enforce it. The person suing must still be a party.

"A contract that mentions me gives me rights." M.C. Chacko is the answer. A recital of who will pay a debt is an arrangement between the parties to the deed.

"India has abolished privity of contract." It has not. Unlike England, which legislated in 1999, India has no statute conferring rights on third parties, and the position rests on the general rule with its exceptions.

Quick revision

• Privity of consideration: consideration must move from the promisee. India does NOT follow it, because s.2(d) says "the promisee or any other person". This is constructive consideration.
• Privity of contract: only a party may sue. India DOES follow it. M.C. Chacko v. State Bank of Travancore, AIR 1970 SC 504: a stranger cannot enforce, and a recital about who will meet a debt creates no charge in the creditor's favour.
• Six exceptions: trust or charge; family arrangement, marriage settlement or partition; acknowledgment or estoppel; covenant running with the land; agency; assignment.
• Two questions keep them apart: who gave the consideration, and who is suing.
• England legislated for third party rights in 1999; India has not.

Test yourself

1. Does Indian law require consideration to move from the promisee? No. Section 2(d) provides that consideration may be furnished by the promisee or any other person, so a promise supported by consideration moving from a third person is good. This is a departure from English law, where consideration must move from the promisee.

2. Can a stranger to a contract sue on it in India? As a general rule no, and the Supreme Court applied that rule in M.C. Chacko v. State Bank of Travancore, AIR 1970 SC 504, holding that a bank could not enforce recitals in a family deed which merely arranged, between the donor and his family, who would meet a guarantee liability. The rule is subject to the recognised exceptions.

3. List the exceptions to privity of contract. A beneficiary under a trust or a charge on specific property; a person provided for by a family arrangement, marriage settlement or partition; a person to whom liability has been acknowledged, so that estoppel arises; a person entitled under a covenant running with the land; a principal where a party contracted as agent; and an assignee of a contractual right.

4. Explain why the two privity rules are different questions. Privity of consideration asks who furnished the consideration, and it goes to whether the promise is supported at all; India answers that consideration may come from anyone. Privity of contract asks who may enforce the promise, and it goes to standing to sue; India answers that only a party may, unless an exception applies. A person may be a stranger to the consideration and still be a party entitled to sue, which is exactly the situation section 2(d) is designed to permit.

5. A deed of family settlement recites that the son will pay his father's creditor. Can the creditor sue the son? Ordinarily not, on M.C. Chacko. Such a recital is an arrangement between the parties to the deed as to who will bear the liability, and it neither makes the creditor a party nor, without clear words, charges identified property with the debt. The creditor may sue if the deed does create a trust or charge in his favour, or if the son has acknowledged the liability to him so as to raise an estoppel.