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Exemption Clause in Standard Form Contract and its Impact on Third Part

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This is an analysis of exemption clause in a standard form contracts and an attempt has been made to understand operation of exemption clause on a third party to a contract.

by ABRAEO

Introduction

In this paper the researcher shall argue that exemption clause relating to the third party in a standard form contract should be considered to be void and hence unenforceable. However, this does not mean that any party seeking to enforce such a clause has all windows closed for it. Under the proposed framework, if the party seeking enforcement of that exemption clause in the standard form contract can prove that exemption clause to be fair, then such a clause can be enforced.

Researcher first begins by critically analysing the principle of privity and develops an understanding of privity laws over time with the help of different case laws and statutes. After this the researcher observes exemption clauses in a standard form contract in the light of present stand on principle of equity and draws a rule for application of doctrine of privity to an exemption clause in a standard form contract. In the next step the researcher focuses on the idea of ‘unfairness associated with standard form contract’. An understanding of the same is developed with the help of different case laws and statutes and a final position is arrived by analysing different legal positions and their relations with exemption clause and its impact on the third party.

Once a conclusive stand is reached on what rules should be applicable to third parties seeking enforcement of their rights despite the presence of an exemption clause and how fair or unfair is an exemption clause that is unilaterally formulated in a standard form contract, researcher proposes certain rules that can be applied in dealing with exemption clauses relating to third parties in a standard form contract.

The entire purpose of this paper is to derive a just and fair framework to deal with exemption clauses pertaining to third party in a standard form contract in such a manner that interests of all the stake holders are protected. Researcher relies his arguments on the notion of fairness and justice that have developed over time and on case laws decided and statutes formulated in different common law jurisdiction, with a special emphasis on Indian legal system.

 

Exemption clause in a standard form contract can have multiple impacts on the rights and obligations of a third party. The exemption clause may exempt the drafter of standard form contract from any liability whatsoever towards the third party, arising out of a contract entered into between the drafter and the second party. A good example would be liability of an insurer towards a third party in case of insurance contracts. For instance in cases of an insurance for motor vehicles, the insurer has a responsibility to pay for the damages to other parties that might suffer damage in a road accident due to the vehicle insured by it.[1] Other examples of the same may be an insurance contract entered into by a doctor and an insurance company, whereby the insurance company insures doctors against liabilities that might arise out of medical negligence.[2] A third party might have interest lying in this case as well. Another instance of an exemption clause affecting the third party is when the drafter of standard form contract puts in certain clauses whereby all its rights and exemptions or limitations are automatically transferred to a third party in the case of contracts of bailment.[3] In such contracts exemption clause is generally beneficial for the third party, but generally affects the rights of a non-drafting party to the standard form contract.[4] Good example of such a contract would be a contract which tries to exempt sub-contractors and employees of the main contractor from any liabilities for damage due to their negligent acts. This exemption may also flow out of contract between contractor and sub-contractor, hence again an important situation for the subject matter of this paper.[5]

In this paper the researcher shall argue that the exemption clauses in a standard form contracts shouldn’t apply to a third party in the above given two instances. In this case two major issues are the position of the third party and the non-drafter of the standard form contract. Hence, the paper first deals with the doctrine of privity and further develops this doctrine in context of standard form contracts and exemption clauses in them. Then the paper deals with the issue of unfairness that is involved in a standard form contract and derives an understanding for the impact of an exemption clauses about pertaining to the third party. Finally, the paper develops a test for dealing with exemption clause pertaining to third party in a standard form contract, based on the conclusions from the analysis of the above given two issues.

 

Position of third party

 

The question of relations of a third party to a contract might be addressed under two different headings. Firstly it is about the acquisitions of the rights by a third party and secondly it is about obligations of a third party pertaining to any contract.[6] While the first issue is contentious and has been contested over time on different grounds, the second issue is fairly settled. When we consider the second issue, it is clear that a contract entered into between two parties cannot create liabilities and obligations for a third party. It shall be unfair to impose upon a third party obligations that arise out of a contract for which it has never accented. Further, if it were ever to be done then it would result in chaos wherein a contract between any two parties may result in obligations created for a third parties without its knowledge.[7] Thus, the position of common law on this issue is fairly similar in different jurisdictions. In Britain there have never been serious challenges to this doctrine and with the passage of The Contracts (Rights of Third Parties) Act 1999[8], this position was further affirmed.[9] In India this position was never questioned seriously and even The Indian Contract Act, 1872[10], is silent on this issue. While the said act talks about who must perform the contract under sections 40 to 45 and about the consequences of breach of contract under sections 73, 74 and 75, the said act confines itself to the parties which are a part of the contract and does not deal with the idea of privity.

While the second issue was less dealt with, the first issue has been contested much. Initially addressed by case laws, it was given a concrete stand under The Contracts (Rights of Third Parties) Act 1999 in the United Kingdom. The development of privity of contract was linked with that of doctrine of consideration.[11] It was thought that only those parties should have the right to gain from a contract which supply some consideration to a contract. This very idea was also supported in the Price v Easton[12]. In this case Price could not recover certain sum of money because he was a third party to the contract between Easton and another party. Further, he could not recover the sum because of the lack of supply of consideration on his part. In Tweddle v Atkinson[13] also the court held that a non-party to a contract can’t bring about an action. The modern position in U.K. was based on Lord Haldeane’s formulation in Dunlop Pneumatic Tyre Co. Ltd. v Selfridge & Co. Ltd[14] and was further reinforced in the case of Beswick v Beswick[15]. Above two cases also helped define the difference between the doctrines of privity and consideration and the entire basis for not allowing a third party to inforce its rights in a contract has since depended on the doctrine of privity.[16] Position in India is also more or less the same and a landmark judgement for the same was passed by privy council in the case of Jamna Das v Pandit Ram Autar Pande[17]. Further, it was observed by Rankin CJ in the case of Krishna Lal Sadha v Promila Bala Dasi[18], that there was nothing in section 2 of the Indian Contract Act to show that a contract can be enforced by a person who is not a party to that contract, but this notion is rightly excluded by the definition of promisor and promise in the same section of the said act. But even this very position has been questioned in the recent times. In addition to certain exceptions and bypass legal methods to give rights to a third party many jurisdictions like the legal system of the United States and that of the Scotland give third parties the right to sue when they are the beneficiaries in a contract.[19] The Contracts (Rights of Third Parties) Act 1999 also modifies the British law states more or less the same thing.[20]

Thus, there are two conflicting positions. But if we look into the situations that might arise in a standard form contract, we may conclude that because of the very notion of unfairness associated with a standard form contract and the idea that the drafter in a standard form contract has a better placed bargaining position than any other party to a contract, it will be unfair to give him the power to exempt himself of liability towards the third party that might arise out of a standard form contract.[21] Further, if we take into account other important situations then we notice that an exemption clause exempts sub-contractors and employees associated with the drafter of standard form contract, then such an exemption clause will be unreasonable for the second party. But in this situation those exemptions can be valid which further the reasonable exemptions as exist between the two main contracting parties, but anything beyond this exemption shall be more or less unjust.[22] It will also make commercial contracts more viable and economical and will bring about clarity in dealing with such situations.[23]

Standard form contract

 

Standard form contracts have a notion of unfairness associated with them. These contracts are not just confined to commercial contracts or contracts between a seller and consumer but contracts with public authorities, multinational corporations, in bank and insurance business are all standard form contracts .[24] These contracts help make modern mass consumer culture possible.[25] But these contracts are associated with the idea of unfairness because of the fact that the non-drafting party does not have a right to negotiate terms and conditions of a standard form contract but to simply accept whatever conditions are being offered to them or to reject them completely.[26] Contractual conditions in a standard form contracts can be incorporated against a non-drafting party via notice, reasonably sufficient notice and exhibited notices etc. Due to their nature, standard form contracts often have an element of unfairness associated with them. This can be divided into procedural unfairness and substantive unfairness. Procedural unfairness is associated with conditions and circumstances under which such contracts are entered into and substantive unfairness is associated with the subject matter of the contract and conditions and liabilities imposed in it.[27]

In common law jurisdictions unfair terms in a contract have been dealt on different levels. It was for the first time included in Canals and Railway Act, 1854[28], according to which an unfair exemption clause in a standard form contract is invalid. In modern day U.K. idea of unfairness in standard form contracts was addressed in the cases of Gillespie Bros & Co. Ltd. v Row Bowlers Transport Ltd.[29] and Lloyds Bank Ltd. v Bundy[30] wherein Lord Denning said that due to unequal bargaining powers clauses of a standard form contract need to be assumed to be unfair. Further he said that this unfair and unreasonable advantage extracted by the better placed party cannot be allowed to be enforced against the weaker party, even if it was adhered to. This issue is now dealt specifically under Unfair Contract Terms Act, 1977[31]. This act regulates contractual terms. Under the law certain terms in a standard form contract are considered to be illegal. These include terms like exemption from liability for death or personal injury and other terms in a contract have to satisfy the terms of reasonableness.[32]

In India a contract can only be void under certain provisions of The Indian Contract Act, 1872[33]. A contract can be rendered void if a person is made to enter into a contract by coercion, undue influence, fraud or misrepresentation under sections 15 to 18 respectively. A contract might also be void because of the lack of consideration or because of illegality of object and consideration in a contract. But there is nothing explicitly in the Indian laws which deals with standard form contracts and elements of undue influence that generally exist in such a contract.[34] For the first time Supreme Court got beyond the provisions of ICA, 1872 in the case of Central Inland Water Transport Corporation Ltd. v Brojo Nath Ganguly[35]. Supreme Court analysed the consequences of unconscionability, distributive justice and unreasonableness and inequality of bargaining power on the rights and obligations of contracting parties in a standard form contract. It concluded that unreasonable clauses in a contract can’t be enforced irrespective of the consent given for the same. Furthermore, consumers are protected from unfair clauses in standard form contract under special laws like The Consumer Protection Act, 1986[36] and 199th law commission report[37] deals specifically with the issue of unfairness in standard form contracts.

We can conclude that most of the statutes tend to associate a notion of unfairness with the terms in a standard form contract. This unfairness exists on two levels, first being procedural and second being substantive. Thus, unfairness[38] on procedural and substantive level might only be considered to be a criteria for validity of any clause in a standard form contract.

The situations that arise in the case of an exemption clause pertaining to a third party in a standard form contract, should be judged on the grounds of unfairness. If it is unfair, then it should not be allowed to be enforced, but if it is reasonable under those circumstances then it can be enforced. However, in most of the cases it is in a sense unreasonable and hence should be unenforceable.[39] Further, when in the situations wherein employees and sub-contractors enjoy extension of exemption clause, then such an extension should be judged on the basis of reasonableness and only those exemptions should be allowed which are very basic to the fundamental objective of such a clause and not in general to any other objective which might be very remotely associated with the contract.[40] Thus, because inherently all the exemption clauses in a standard form contract are in a sense unfair because of being decided unilaterally and not being bargained for by both the parties. Certain exceptions might be allowed depending upon the situation.

 

Recommended law for dealing with exemption clause affecting a third party in a standard form contract

 

It should be a presumption on the part of law that all exemption clauses in a standard form contract that affect the position of a third party are non-enforceable because of them being designed unilaterally by one of the parties. It should be presumed that any party that drafts conditions of a contract shall make the best out of its position and try to secure its position even further by the said contract. Even the presumption of unfairness should be supported by the very idea that the third party can enforce its right against the party that drafts standard form contract, despite the presence of exemption clause. This right to enforce right despite the presence of an exemption clause is again based on the idea of fairness and inequality of bargaining power. Thus, we may have the following clauses:

  1. Any third party that is a stake holder in a contract and hence can be a potential beneficiary out of the terms of the contracts can enforce a contract and claim benefit despite the presence of any exemption clause in a standard form contract.
  2. Any clause exempting any third party from liability in a standard form contract shall not be enforceable.
  3. Any clause in a standard form contract that exempts the drafting party from any liability arising out of the contract towards the third party to the contract shall be considered to be void and hence unenforceable.
  4. Any clause in a standard form contract that exempts any third party from any liability arising out of the contract shall be considered to be void and hence unenforceable.
  5. A clause in a contract is unfair and unjust if it is so detrimental to the position of an agreeing party that under no ordinary conditions would a reasonable party have agreed to it.

Exceptions to the above are as follows:

  1. If a third party claims benefits from a contract under clause 1 then it shall also have to fulfil any liabilities pertaining to it in the said standard form contract.
  2. Clauses that are direct extension of some justifiable exemption being given to the drafting party in a standard form contract and applicable to some third party shall hold good.
  3. If any exemption clause could be proved to be fair, or existent in trade traditionally in the standard form contract shall not be void under clause 3 and 4.
  4. Onus of proving a clause considered to be not void under section c shall depend on the party claiming benefit out of the clause.

Hence, we can conclude that the said clauses can well deal with two possible condition taken into account in this paper.

 

Conclusion

Researcher has taken into account multiple possible situations that may arise in case of an exemption clause in a standard form contract and its impact upon the third party. Then researcher derived doctrine of privity and its impact on third party in a standard form contract, with the help of different common law developments in the United Kingdom and India. In this section researcher concluded that the recent developments in the doctrine of privity must give rights to the third party to enforce those contracts in which it has some stakes. In the second part researcher deals with the concept of standard form contracts and the notion of unfairness associated with them. Here also researcher relies on development of common law in United Kingdom and India and derives the idea of Unfairness associated with standard form contracts. Researcher concludes in this section that because standard form contract is not bargained for, and parties to the contract are not always placed on equal footings, hence clauses in these contracts should always be considered to be unfair per se. Researcher further uses these ideas to draft a possible law that is specifically designed to deal with the situations arising out of impact of exemption clause in a standard form contract.

The law recommended for assumes any exemption clause in a standard form contract pertaining to the third party void. It also gives third part the right to enforce any contract in which that third party has a vested interest. By installing these two mechanisms, the said law seeks to protect rights of all the parties that have stakes in a standard form contract and also seeks to provide a level playing field for all the parties to the contract. Thus, the law does eliminate notions of unfairness and inequality of bargaining powers associated with a standard form contract and also gives mechanisms to the third party to best protect its rights. Another important feature of the law is that it does not simply prevent enforcement of exemption clause, but proposes a mechanism under which if an exemption clause can be proved to be reasonable by the party seeking enforcement of such a clause, then such clause can be enforced.

Hence, the best way for all the stake holding parties in a standard form contract to protect their rights and have obligations toward others is to simply have all exemption clauses pertaining to a third party as void and if based on the notion of fairness, as can be concluded from clause 5 of the above given clauses, a certain clause can be proved fair by the party seeking to enforce it, then such a contract can be enforced.

[1] Sec. 146, Motor Vehicle act, 1988.

[2] J. Beatson el at, Anson’s Law of Contracts, 655 (29th edn., 2010).

[3] Id., at 657.

[4] Morris v C. W. Martin & Sons Ltd., [1966] 1 QB 716 (Queen’s Bench).

[5] Beatson, supra note 2, at 568.

[6] A. Singh, Contract and Specific Relief, 56 (2010).

[7] Id., at 71.

[8] The Contracts (Rights of Third Parties) Act 1999.

[9] Beatson, supra note 2, at 615.

[10] The Indian Contract Act, 1872.

[11] Beatson, supra note 2, at 568.

[12] Price v Easton, (1833) 4 B & Ad 433 (The Court of Appeals of Jersey).

[13] Tweddle v Atkinson, (1861) I B & S 393 (Queen’s Bench).

[14] Dunlop Pneumatic Tyre Co. Ltd. v Selfridge & Co. Ltd, [1915] AC 847, 853 (Court of Appeals).

[15] Beswick v Beswick, [1968] AC 105 (Court of Appeals).

[16] Beatson, supra note 2, at 620.

[17] Jamna Das v Pandit Ram Autar Pande, (1912) 14 BOMLR 1 (Allahabad High Court).

[18] Krishna Lal Sadha v Promila Bala Dasi, (1921) 3 BOMLR (Bombay High Court).

[19] Beatson, supra note 2, at 623.

[20] F. Pollock and D. Mulla, The Indian Contract and Specific Relief Acts VOL. 1, 341 (14th edn., 2014).

[21] Beatson, supra note 2, at 614.

[22] If there is a contract between A and B that says that A will transfer certain goods of B and shall be exempted of any liability that might arise in such transportation due to a road accident. Now suppose that C is an employee of A, who drives transport truck for A and while transporting there happens to be a road accident, then C should also enjoy the immunity. However if damage is caused due to the negligence of D another sub-contractor hired by A for loading and offloading goods in the truck, then there must not be an extension of the exemption clause.

[23] Beatson, supra note 2, at 568.

[24] Beatson, supra note 2, at 172.

[25] 199th report of the Law Commission of India, Unfair (Procedural & Substantive) Terms in Contract, 54 (2006).

[26] B. A. Garner, Black’s Law dictionary, 38 (7th edn., 2010).

[27] 199th report of the Law Commission of India, Unfair (Procedural & Substantive) Terms in Contract, 121 (2006).

[28] Canals and Railway Act, 1854.

[29] Gillespie Bros & Co. Ltd. v Row Bowlers Transport Ltd., [1973] QB 400 (queen’s Bench).

[30] Lloyds Bank Ltd. v Bundy, [1974] EWCA Civ 8, (Court of Appeal).

[31] Unfair Contract Terms Act, 1977.

[32] 199th report of the Law Commission of India, Unfair (Procedural & Substantive) Terms in Contract, 199 (2006).

[33]  The Indian Contract Act, 1872.

[34] 199th report of the Law Commission of India, Unfair (Procedural & Substantive) Terms in Contract, 199 (2006).

[35] Central Inland Water Transport Corporation Ltd. v Brojo Nath Ganguly, 1986 AIR 1571(The Supreme Court of India).

[36] The Consumer Protection Act, 1986.

[37] 199th report of the Law Commission of India, Unfair (Procedural & Substantive) Terms in Contract, (2006).

[38] Unfairness of a clause in the standard form contract may be defined to be a certain clause in a contract that is so inherently detrimental to the position of party accepting that clause under the contract, that such a clause could have never been accepted under ordinary circumstances.

[39] 199th report of the Law Commission of India, Unfair (Procedural & Substantive) Terms in Contract, 121 (2006).

[40] 199th report of the Law Commission of India, Unfair (Procedural & Substantive) Terms in Contract, 123 (2006).

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