Circumventing the Privity Rule in Malaysia

• Author: Tan Pei Meng
• Position: Universiti Tunku Abdul Rahman Faculty of Accountancy and Management tanpm@utar.edu.my
• Pages: 262-273

Tan Pei Meng, Lecturer, Faculty of Accountancy and Management, Universiti Tunku Abdul Rahman.

Page 262

1. Introduction

The privity rule which stipulates that no benefit can be conferred to a third party who is not a party to the contract has long been regarded as "an anachronistic shortcoming that has for many years been regarded as a reproach to English private law".¹ The problems created by the privity rule which prevent third parties from enforcing a contract made for their benefit are widespread.² Particularly, the privity rule denies the contracting parties from fulfilling their intention to benefit a third party. A number of the Commonwealth countries had undertaken statutory reform of the privity rule and recognised third party rights in contract law. The notable reform was that undertaken by the English Parliament which resulted in the enactment of Contracts (Rights of Third Parties) Act 1999.³ Besides, the High Court in Australia and the Supreme Court in Canada had also created exceptions to the privity rule.

In Malaysia, the privity rule is deeply entrenched in the legal system. The Malaysian courts had applied the doctrine in a variety of cases involving variety of situations. In the recent case of Razshah Enterprise Sdn Bhd v Arab Malaysian Finance Bhd,⁴ Abdul Malik Ishak JCA in the Court of Appeal⁵ stated that:

Our Contracts Act 1950 (Act 136) has no express provision pertaining to the doctrine of privity of contract. In fact, Kepong Prospecting gives the gloom picture that the doctrine still applies in Malaysia. Indeed Mohamed Dzaiddin J (who later rose to be the Chief Justice of Malaysia) relied on Kepong Prospecting and aptly said in Fima Palmbulk Services Sdn Bhd v Suruhanjaya Pelabuhan Pulau Pinang & Anor [1988] 1 MLJ 269, at p 271:

It is clear that the English doctrine of privity of contract applies to our law of contract.⁶

In Razshah Enterprise, the defendant company guaranteed a loan taken by one of its directors from the plaintiff. The director (borrower) failed to pay for the loan and the plaintiff sued the defendant to enforce the guarantee. The defendant sought to counterclaim the plaintiff's action based on two letters⁷ written by the plaintiff to the director (borrower). The plaintiff attempted to strike out the counterclaim. One of the arguments relied by the plaintiff was that the defendant had no locus standi to bring the counterclaim as it was not a party to the loan agreement. The Court of Appeal rejected the plaintiff's argument because the agreement involved was a guarantee Page 263 agreement where the defendant's liability was dependent on the amount owed by the director (borrower). Thus, the defendant had the locus standi to bring the counterclaim which if successful, would reduce the amount of its liability.

No effort has been undertaken to reform the privity rule in Malaysia despite the many difficulties created by the rule. However, the Malaysian Parliament had created ac hoc exceptions to the privity rule⁸ throughout the years and there are a number of common law mechanisms available to the courts to evade the rule. The purpose of this article is to examine the common law mechanisms that had been utilized or referred to by the Malaysian courts to circumvent the privity rule and determine whether the present legal position is satisfactory.

The common law mechanisms discussed in this article include (i) liberal construction as to who is a party to the contract, (ii) collateral contracts, (iii) agency, (iv) trust (v) tort or negligence, (v) estoppel and (vi) remedies for breach of contract.

2. Difficulties Created by the Privity Rule to Contracts Made for the Benefit of Third Parties

There are two classic cases⁹ which neatly illustrate the difficulties caused by the application of the privity rule to contracts made for the benefit of third parties. The first case discussed is Tweddle v Atkinson,¹⁰ where a contract was made between the plaintiff's father and his future father-in-law (defendant) to make payments of money to the plaintiff upon his marriage. It was stated in the agreement that the plaintiff "has full power to sue the said parties in any court of law or equity for aforesaid sums hereby promised and specified." Both the original contracting parties had passed away and the defendant's administrator of estate did not fulfil the contractual obligation of paying a sum of money to the plaintiff. The plaintiff brought an action to claim payment intended for him under the contract. The plaintiff stated that he had ratified and assented to the agreement shortly after the agreement was created.

The court held that the plaintiff's action must fail because he was not a party to the contract and consideration of the contract did not move from him. It is very clear that the outcome of this case was inconsistent with the contracting parties' intention as evidenced by the term of the agreement allowing the plaintiff to enforce the contract.

In Beswick v Beswick,¹¹ the deceased transferred his business of a coal merchant to his nephew in return for the nephew's promise that the deceased would be appointed as a consultant to the said business and after his death, the nephew would pay annuity to the deceased's wife. After the death of the deceased, the nephew refused to make payments to the widow after making the first payment. The widow brought an action against the nephew in her capacity as administratrix and also in her personal capacity for specific performance of the agreement. The House of Lords in a unanimous decision held that the widow could not enforce the contract in her personal capacity even though the contract was clearly intended to benefit her because she was not privy to the contract.¹²

3. Liberal Construction as to who is a Party to the Contract

If the courts adopt a more liberal interpretation of the contract and decide that a third party acquires the status of a contracting party, he can then enforce the contract. In Malaysia, the determination of the issue as to who is a party to a contract rests generally on the participation in the formation of contract and construction of the terms of contract. A person who participates in the contract in any capacity other than that of the promisor and promisee is not considered to be a contracting party.¹³ The fact that the performance of the contract is intended for a third party is not important.¹⁴ Thus, a third party who does not participate in the formation of the contract or named as a party to the contract is not entitled to enforce the contract. Page 264

Nonetheless, the High Court in Parimala a/p Muthusamy v Projek Lebuhraya Utara-Selatan adopted a very liberal approach in determining who are parties to the contract.¹⁵ In Parimala, the plaintiffs were passengers in a motorcar driven by the deceased along the highway at the time of accident. The deceased died on the spot after hitting a stray cow which had found its way to the highway through a breach in the fencing system. The plaintiffs claimed damages for injuries that they suffered as a result of the accident. The High Court allowed the plaintiffs' claim based on the common law tort of negligence¹⁶ and breach of statutory duty.¹⁷ However, Suriyadi J went on to hold that there was also a breach of contract by the defendant. The moment a ticket was extracted at the toll gate, a contract was struck between the plaintiffs and the defendant. There was an implied warranty that the highway would be safe for the use of the deceased and the plaintiffs.

Syed Alsagoff has rightly pointed out that it is difficult to understand how the plaintiffs were in a contractual relationship with the defendant.¹⁸ Following the facts of Parimala, the deceased who purchased the toll ticket was clearly one of the contracting parties. On the contrary, the plaintiffs had done nothing to indicate that they were parties to the contract. Neither could it be argued that the deceased and the defendant intended the plaintiffs to be parties to their contract. Hence, it is not surprising that there is no subsequent case which applies Parimala although it was referred to without disapproval in Mohamad Khalid bin Yusuf v The Datuk Bandar Kuching Utara.¹⁹

It is submitted that the courts in deciding whether to elevate the status of a third party to that of a contracting party should take into account the contracting parties' intention. Only if the contracting parties intend the third party to enjoy the status of a contracting party, should it be justified for the courts to do so. Otherwise, it will amount to a situation where the contracting parties are unable to determine the scope of their liability. This goes against one of the hallmark characteristics of a contract, to respect the freedom of contract of the contracting parties.

4. Collateral Contracts

The utility of collateral contracts in assisting the third party to evade the doctrine was acknowledged by Abdul Malik Ishak J in Oriental Bank Bhd v Uniphoenix Corp Bhd²⁰ where the learned judge stated that "The collateral contract provides a means of avoiding the rule as to the privity of contract."²¹ The third party argues that a collateral contract is created alongside the main contract entered into by the promisor and promisee. The parties to the collateral contract are the promisor and the third party. The promisor promises the third party that he will perform the main contract. If the promisor fails to perform the main contract, the third party is entitled to sue him for breach of the collateral contract. However, in order to invoke the creation of a...