What privity of contract means
Privity of contract is the rule that only the parties to a contract have rights and obligations under it.
Two consequences follow.
A person who is not a party cannot sue on the contract, even where it was made for their benefit.
And a person who is not a party cannot have obligations imposed on them by it.
The first is the one that causes difficulty. A parent contracts with a school for the benefit of a child. A company contracts with a supplier for the benefit of its subsidiary. A developer promises a landowner that units will be built to a standard, and a buyer of one of those units wants to enforce it.
In each case the person who actually suffers the loss is not the person who made the contract, and the rule says they cannot sue on it.
Nigerian law follows the common law position, and the exceptions and workarounds are what practitioners rely on.
How it is used
Where somebody outside the contract needs enforceable rights, there are recognised routes.
Agency. Where one party contracted as agent for the third party, the third party is the principal and is a party in substance, and can enforce.
Trust. Where a party holds the benefit of a promise on trust for the third party, the beneficiary can enforce through the trustee.
Assignment. The benefit of a contract can generally be assigned to a third party, who then holds the right. The burden cannot be assigned in the same way, which requires novation.
Novation. The contract is replaced with a new one including the third party, with all parties agreeing.
Collateral contract. A separate contract between the third party and one of the original parties, supported by its own consideration.
And a direct agreement. In construction and development, a collateral warranty or direct agreement is the standard way of giving a funder, a purchaser or a tenant enforceable rights against a contractor they did not engage.
The practical drafting answer is usually the last: if somebody needs rights, make them a party to something.
Key features
- Only parties to a contract can enforce it
- A third party beneficiary generally cannot sue on it
- Obligations cannot be imposed on non parties
- Agency, trust, assignment and novation are recognised routes
- A collateral contract can give a third party direct rights
- The practical answer is to make the person a party to something
How this works in Nigeria
The rule bites in three Nigerian settings that are worth naming.
Construction and development. A buyer of a unit in a development has a contract with the developer, not with the contractor who built it or the engineer who designed it. Where the building is defective and the developer has dissolved or has no money, the buyer has no contract with the people who did the work. Collateral warranties or direct agreements from the contractor and consultants are the answer, and they are rarely obtained in Nigerian developments.
Group companies. A Nigerian parent contracts with a supplier, and the subsidiary that actually uses the service suffers the loss. The subsidiary is not a party. The answer is either to contract in the name of the entity that will suffer the loss, or to have the contract expressly permit the parent to claim on behalf of group companies.
Insurance and guarantees. A person for whose benefit a policy or guarantee was taken out may not be able to enforce it directly unless the arrangement was structured to give them rights.
The practical advice is consistent across all three: identify at the drafting stage who will actually suffer the loss if things go wrong, and make sure that person has enforceable rights, whether by being a party, by taking an assignment, or by a direct agreement.
A contract that protects the wrong entity is a common and expensive Nigerian drafting failure, particularly in group structures where the contracting entity and the operating entity are different.
Privity vs assignment vs collateral warranty
Three ways of dealing with somebody outside a contract who needs rights under it.
Privity is the starting rule: they have none. A third party beneficiary cannot sue on a contract they did not make.
Assignment transfers the benefit. The original party assigns its rights to the third party, who can then enforce them. Notice to the other contracting party is normally required, and the burden of the contract does not transfer this way.
A collateral warranty or direct agreement creates a separate contract between the third party and one of the original parties. It is the construction industry answer, giving funders, purchasers and tenants direct rights against contractors and consultants.
When structuring a transaction, ask who suffers the loss if something fails, and make sure that person holds a right against whoever caused it, by one of these routes.
Limits and risks
The rule can produce results that feel unjust, where the person who suffers the loss has no remedy and the person with the remedy has suffered no loss.
The workarounds are also imperfect. Assignment requires cooperation, novation requires everybody to agree, and collateral warranties have to be negotiated at the time rather than after a problem emerges.
Agency and trust arguments depend on the facts and are not available simply because they would be convenient.
And in group structures the problem is often discovered too late, when the entity holding the contract is not the entity that lost money.
Worth knowing
Ask who will actually suffer the loss before you sign, and make sure that entity is a party. Nigerian groups contract in the parent name and lose money in a subsidiary, and privity means the entity with the claim has no loss and the entity with the loss has no claim.
Questions people ask
What is privity of contract?
The rule that only the parties to a contract have rights and obligations under it. A person who is not a party generally cannot sue on it, even where it was made for their benefit.
Can a third party beneficiary sue?
Generally not under Nigerian law, which follows the common law position. Rights must be created through agency, trust, assignment, novation or a separate collateral contract.
How do I give somebody rights under a contract?
Make them a party, take an assignment of the benefit in their favour, novate the contract to include them, or enter a collateral agreement giving them direct rights.
Why does this matter in construction?
Because a buyer of a unit contracts with the developer, not with the contractor or engineer who did the work. Where the developer disappears, the buyer has no contract with anybody who built the building unless collateral warranties were obtained.
What is the group company problem?
A parent contracts with a supplier and the subsidiary suffers the loss. The subsidiary is not a party and cannot sue. Contract in the name of the entity that will actually be affected, or provide expressly for claims on behalf of group companies.
Can obligations be imposed on a non party?
No. A contract cannot impose obligations on somebody who did not agree to them, which is why obligations move by novation rather than by assignment.