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The Doctrine of Privity of Contract: Judicial Activism in the Supreme Court of Canada

From: University of Toronto Law Journal
Volume 57, Number 2, Spring 2007
pp. 269-291 | 10.1353/tlj.2007.0022

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University of Toronto Law Journal 57.2 (2007) 269-291
The Doctrine of Privity of Contract:
Judicial Activism In The Supreme Court Of Canada In the case law, two factual scenarios have typically arisen.

First, third parties might be entitled to money, services, or goods under a contract. A simple example would be that A agrees to purchase a new laptop computer from B and instructs B to deliver it to C, A's daughter who is attending university in another province. If B does not provide the laptop, then, under the third-party beneficiary rule, C, as a third party, has no right to sue B. Furthermore, A may also lack viable legal recourse against B. A may have lost nothing due to B's failure to provide the laptop to C; if he sued B, therefore, A might be entitled only to nominal damages. In this scenario, C would wish to assert an affirmative right of action in the contract between A and B.

Second, employees or subcontractors, who are deemed to be third parties for the purposes of the rule, might be entitled to a limitation of liability or other contractual defence to a lawsuit. For example, A contracts with B, a long-distance trucking company, to transport goods worth $500 000. The contract between A and B limits B's liability for negligently inflicted damage to the goods to $1 000. B's driver, C, drives negligently and has an accident on the highway; as a result, the goods are irreparably damaged. If B is sued by A, its liability for this damage would be limited to $1 000 under the contract. C, however, as a third party, would not be entitled to rely on the limitation clause and would be liable in tort for the full $500 000. This ability to recover from C may undermine the ex ante allocation of risk between A and B, whereby A was to bear the risk of damage in shipping. In this scenario, C would wish to assert a defence under the contract between A and B.

While the strict privity rule has attracted considerable criticism from scholars, law reform commissions, and judges, it nonetheless continues to be regarded as a well-established principle of law. Over time, however, legislators have statutorily overturned some of the more egregious decisions; they have also acted in cases where they foresaw the dangers of the rule, such as life insurance. Judges have also recognized various 'exceptions.'

In two cases, London Drugs Ltd. v. Kuehne & Nagel International Ltd. and Fraser River Pile & Dredge Ltd. v. Can-Dive Services Ltd., the Supreme Court of Canada confronted insurers suing negligent 'third parties' by way of subrogation. The Court was once again faced with the difficult question of determining when third parties should be given legally enforceable rights. Speaking through Iacobucci J., the Court created, and later expanded, a new 'principled' exception to the doctrine to allow the third parties to benefit from exclusions or limitations of liability.

In this article, I will argue that these two different situations have been grouped confusingly under the third-party beneficiary doctrine. I will separate the two situations and use economic analysis to argue in each case for an optimal voluntary default rule (that the parties can bargain away from if they wish). I will then use this framework to examine the development of the privity jurisprudence, before assessing whether Iacobucci J.'s 'principled exception' moves the law closer to these optimal rules.

II The Economics of Third-Party Contracts

An economic framework of analysis of the privity of contract doctrine would...