Wednesday, January 26, 2011
Privity of Contract
The Privity doctrine simply means that for a person or entity to have a legal right to contract benefits, they must be a party to the Contract. Even if you are the intended beneficiary of the contract you would still not be able to legally enforce the contract as you were not a party to the contract.
There are several exceptions to the requirement that there be privity of contract to be able to enforce the contract. If a contract is formally assigned to another party, that party would be able to enforce the contract even though they were not an original party to the agreement. The second exception is when the parties to the contract agree to name a third party as a “third party beneficiary” to the contract. A third exception would be if the party separately agreed to allow direct enforcement.
For example, if the Buyer negotiates a Contract with a Supplier and then wants a third party such as an Outsource Supplier to be able to purchase from the Supplier at Buyer’s terms, on its own the Outsource Supplier has no right to do so. They do not have privity of contract with the Supplier.
If the Outsource Supplier were to purchase the products from the Supplier under their own Contract, the Buyer would not have privity of contract on those purchases. Those transactions did not occur under Buyer's contract.
With outsourcing you may need to have Outsource Suppliers make purchases on your behalf, to deal with this there are several approaches.
One approach is to have the Supplier agree to extend the Buyer’s terms to the Outsource Supplier and agree that the Buyer will be a “third party beneficiary” to those purchases. If the Supplier failed to extend the terms to the Outsource Supplier, they have breached the Contract with the Buyer and would be subject to damages. If they have extended the terms to the Outsource Supplier, then both the Buyer and Supplier have the right to enforce the contract as they both have privity of contract. The Outsource Supplier would have the rights as they are a direct party to their agreement with the Supplier and the Buyer would have privity by being named a third party beneficiary in that agreement.
Another approach has the Supplier directly agree with the Buyer that the Buyer may enforce the terms and conditions of the Buyer's Contract with the Supplier on purchases made by the Outsource Supplier on behalf of the Buyer. This makes the Buyer a form of third party beneficiary to those purchases. You would use this approach when either the Buyer or Supplier do not want to disclose to the Outsource Supplier the terms of Buyer's agreement with the Supplier.
If an Outsource Supplier will be involved in the transactions where they will be buying the product or services on your behalf as part of an outsourced arrangement, the reasons why you may want to have privity and be able to enforce the contract directly is your Outsource Supplier may not want to invest the time or expense to enforce the contract on their own, or the Outsource Supplier and the Supplier may have an existing relationship where they simply may not want to sue the third party. Being a third party beneficiary allows you to directly enforce the agreement event if the Outsource Supplier won't.
The alternative to being a third party beneficiary is to make the Outsource Supplier fully responsible for the Supplier under the Outsource Supplier's contract with the Buyer. Outsource Supplier's may be reluctant to agree to that especially if you are telling them the Suppliers you want them to use. Before agreeing to be fully responsible the Supplier would want to make sure that the Supplier has agreed to a flow down of all the terms the Outsource Supplier must agree to with the Buyer and the Supplier has the assets and resources to stand behind the commitments. If the don't the Supplier would still be liable to the Buyer.