High Court rules on privity of contract Is there another way through

What you need to know

• The doctrine of privity of contract remains intact as a settled and fundamental rule of law.
• However, the doctrine does not necessarily preclude a third party having standing to seek declaratory relief about the interpretation or effect of a contract.
• A mere commercial interest in the meaning of a contract will not, on its own, give rise to a sufficient interest for standing to apply for a declaration. Yet in exceptional cases a third party may be able to demonstrate a sufficient interest.
• One relevant consideration is whether a party to the contract against whom the declaration is sought is a public authority or executive government acting in the public interest.
• Declaratory relief is distinct from the notion of a third party suing on a contract to enforce contractual rights, which the doctrine of privity is designed to protect against.

What you need to do

• Consider the potential consequences of contractual clauses that may confer a benefit on, or create an interest for, a third party.
• Take particular care when drafting such clauses, to ensure that these clauses are clear and avoid unintended consequences.
• As a third party, recognise the limitations of this High Court decision and the need for a sufficient interest to arise, and hence whether it is preferable to be a party.

The High Court today delivered an important decision about a third party's right to seek a declaration of law on the proper construction of a contract. Whilst the decision does not impact directly on the rule about privity of contract, the High Court recognised that a qualification to the privity rule does exist where a third party has a relevant interest.

Privity of contract

The doctrine of privity provides that only parties to a contract can enforce or be subject to the benefits or obligations under that contract. A third party has no such rights or obligations, even if the contract was made for the benefit of that party. This has long been considered a settled, fundamental aspect of contract law.

The doctrine has in more recent time been the subject of criticism and has to some degree been eroded by case law and statutory intervention. The criticisms include:

• injustice can arise by denying a third party a benefit or right that it reasonably expects is owed to that party;
• a party to a contract can be denied the opportunity to enforce an intention to confer benefits upon a third party; and
• a third party who has suffered a loss has no entitlement to damages because it is not a party to the contract.

The privity rule has been modified by statute to enable third parties to enforce contractual obligations in some states or certain limited circumstances. For example, the Insurance Contracts Act 1984 (Cth) provides that a person covered by a general insurance policy can recover from the insurer even though he or she is not a party to the contract of insurance. In addition, modifications to property law in Queensland, Northern Territory and Western Australia enable a third party beneficiary to enforce a contractual obligation to do or to refrain from doing an act for the benefit of the beneficiary.

Privity of contract may also not apply, or can be circumvented,  for example, in circumstances where a contracting party:

• acts an agent for a third party;
• transfers contractual benefits to a third party through an assignment or novation;
• holds contractual rights on trust for a beneficiary; or
• sues to enforce a contractual term which confers a benefit on a third party.

Hobart International Airport Pty Ltd v Clarence City Council

Dispute over calculation of payments in lieu of rates

In 1998 the Commonwealth entered into leases with operators of the Hobart Airport and Launceston Airport as part of a project to privatise Australia's federal airports. Clause 26.2(a) of the leases provided that, in lieu of paying rates, the lessees were to pay Clarence City Council and Northern Midlands Council an amount equivalent to that which would have been payable had the airports not been on Commonwealth land. The Councils sought declaratory relief as to the proper construction of clause 26.2(a) and the lessees' obligations to make payments, in circumstances where the Commonwealth and the lessees were not in dispute about the operation of, or the lessees' compliance with, that provision of the contract.

The Federal Court

The primary judge (O'Callaghan J) dismissed the proceeding on the basis that the Councils had no standing to seek declaratory relief, and that to allow such standing would "involve jettisoning the doctrine of the privity".

The Full Court (Jagot, Kerr and Anderson JJ) overturned that decision and found that the Councils did have standing, and that declaratory relief about the interpretation of the leases would not infringe the doctrine of privity. Rather, the question of standing should be determined by reference to the existence and quality of the controversy regarding the Councils' claim to declaratory relief, and the quality or character of the Councils' interest in that relief.

The High Court

On 9 March 2022, the High Court dismissed the lessees' appeal. The Court determined that a stranger to a contract seeking declaratory relief in relation to private rights may, in exceptional circumstances, for reasons other than having legally enforceable rights, have a "sufficient" or "real" interest to seek declaratory relief as to the meaning and effect of a contract between contracting parties.

The Councils had argued, among other things, that the Full Federal Court had adopted an unduly narrow characterisation of the doctrine of privity of contract and erred by excluding applications for declaratory relief from the ambit of the doctrine.

All members of the Court recognised that the doctrine of privity will ordinarily prevent a person who is not a party to a contract being able to establish standing to seek a declaration about the content of a contractual obligation based on a legal interest. However, the three judgments of the Court differed as to whether the Councils ultimately had standing.

Kiefel CJ, Keane and Gordon JJ reasoned that non-parties may have standing where they are made active participants in a process established under the contract, they notify a party of amounts they calculate as contemplated by the contract, and have a real commercial interest because it would advance their interests in future negotiations. The Court considered that the Councils were active participants in the leases and not "outsiders". Although the interests of the Councils were commercial, their commercial interests constituted exceptional circumstances, giving them standing to seek declaratory relief.

The concurring judgment of Gageler and Gleeson JJ noted that a weighty consideration in determining standing is whether the declaration is sought against a public authority or executive government which acts in the public interest. Here, the Court considered that the Councils having a fiscal or governmental interest in obtaining or being refused the declaration was significant in identifying a sufficient interest to establish standing to seek the declaration.

The dissenting judgment of Edelman and Steward JJ considered that allowing a non-party with a commercial interest to seek a declaration would undermine the rule that private rights are enforceable only by those who hold the relevant right. Their Honours emphasised that the rights between lessees and lessor are purely private rights. The language of the leases did not create liability for the lessees to make payments to the Councils, but rather contemplated that the Councils and lessees would enter into a separate binding agreement which had not yet been undertaken by the parties.

Practical implications

The High Court's decision has ramifications for contracts that may confer a benefit on third parties or affect third party rights. These contracts commonly arise in sectors where complex commercial arrangements involve a number of stakeholders, such as construction, mining and finance.

Parties entering into contracts that may have an impact on third parties should be aware of the potential for a third party to obtain declaratory relief. To minimise the risk of subsequent disputes, care should be taken when drafting clauses that confer a benefit on third parties, to ensure that effect of these clauses is clear and does not lead to unwanted or unforeseen consequences.

The potential for a third party to circumvent the privity rule by seeking a declaration on the meaning of a contract depends on its ability to demonstrate exceptional circumstances. This will be most relevant where a contracting party is a public authority or an executive government acting in the public interest. The majority expressed some caution about how this applies to purely commercial interests.

Parties should take note of the limitations of this decision. While a third party may have standing to seek declaratory relief in respect of a contract to which it is not a party, the decision does not broaden the law in respect of a third party being entitled to directly enforce rights under the terms of a contract. Multi party contracts may be preferable where there is a need for additional parties to be able to enjoy enforceable benefits under a contract.

Parties should also be aware that the doctrine of privity means that a third party seeking declaratory relief in respect of a contract will not be bound by any dispute resolution provisions in the contract. A party to a contract may, in exceptional circumstances, find itself facing court proceedings commenced by a third party, despite the contractual parties having agreed to resolve disputes by arbitration. Multi-party arbitration agreements can be used in projects where there are multiple contracts involving various entities; however, these may not be suitable or practicable in all situations.

Authors: Andrew Harpur, Partner; James MacDonald, Senior Associate; and Claire Potter, Lawyer.