What is privity of contract?

Privity of contract refers to the relationship between parties in a contract.

It stipulates that only the parties who are directly involved have legal rights and obligations under that contract.

In other words, if you are not a party to a contract, you generally cannot enforce the terms of that contract or be held liable for its obligations.

This is the case even if you are involved in completing them.

Under common law, privity of contract exists to protect contracting parties from being responsible for any liability or damages to those not covered in the agreement.

During document creation and contract tracking, it’s easy to overlook contractors, distributors, and other key players.

But what third-party protection (or lack thereof) do you actually need to include in your legal contracts?

In this guide, we explain the principle of “privity of contract” and how it affects your business agreements.

What is privity of contract?

Privity of contract is part of common law. It refers to the parties that are directly bound to a contract and protects them from being held liable to those who aren’t part of it.

In other words, privity of contract means a contract can only bind and be enforceable by the original parties to it.

Only these individuals or entities have a legal right to claim the benefits of the agreement.

In legal terms, any parties outside of the contract have a lack of privity.

There’s no contractual obligation or liability between them and the parties to the agreement.

Privity is often applicable in situations like contract of sale agreements.

Exceptions may exist depending on the legal jurisdiction in which a dispute is being decided.

Examples of privity of contract

There are many examples where privity of contract applies to real-world agreements. Here are a few of them.

Rental or lease agreements

A rental agreement is signed between a landlord and renter.

Let’s say the tenant signs a 12-month lease but decides to move out and sublet in the middle of the contract.

They obtain written permission from the landlord to sublease the apartment. The subletter then spends six months throwing parties and neglecting the property.

Upon moving out, it turns out that $10,000 in damages have occurred.

Thanks to privity of contract, the original renter is liable for these damages and not the subletter.

Subcontractors

A construction company signs a contract with a buyer to build a property.

They contract certain tasks out to specialists like roofers, plumbers, and electricians, creating legal agreements between the company and the subcontractors.

Only the construction company is liable if the buyer finds faults or defects in the property.

Likewise, if the subcontractors have a contract dispute, they can’t seek compensation from the property owners.

Contract of sale

Someone buys from an online retailer, but the order is fulfilled by a third party.

Imagine the authorized seller either fails to deliver the goods, or they arrive damaged.

The buyer demands a refund. Privity of contract means the retailer is the liable party in this situation.

Privity of contract exceptions

There are certain exceptions to the rules underpinning privity of contract. These include:

Life insurance

A policy agreement is formed between a signatory and an insurance company.

The beneficiary is listed, but privity of contract would seemingly preclude them from receiving benefits after the signatory has passed.

However, this would be inequitable, hence why life insurance beneficiaries are protected by horizontal privity that includes a named third party.

Manufacturer’s warranties

These agreements are created at the time of the transaction to purchase the goods in question.

Modern doctrines of strict liability also extend a contract of this type to third-party beneficiaries (such as a partner or children).

Negligence

Anyone who is injured may sue a negligent party despite not having entered into a contract with them.

Use PandaDoc to take care of your contract management

Once a contract effective date commences, you want to be confident that you’ve mitigated risk wherever possible.

Still, it can be easy to overlook any potential threats down the road.

Privity of contract protects you and other parties from inequitable and unjust lawsuits.

If you don’t understand when and how it applies, though, you may be in for a world of hurt.

Instead of remaining unsure about privity of contract and when it comes into play, try using PandaDoc to generate a legally compliant agreement.

Our document templates will guide you through the contract creation process and take care of the hard work for you.