The University of Texas at Austin   School of Law

Main menu:

Case:
BGH VersR 1972, 274 MDR 1972, 316
Date:
25 November 1971
Copyright:
Professor B.S. Markesinis

Facts

The plaintiff is the owner of a castle X. where he runs a hostel for the needy. The building has a mineral oil heating system. The oil is stored in two tanks. A mixer tap connects the two tanks. In May 1965 a company B. employed the first defendant, a mineral oil wholesale firm, to supply and install two devices the function of which is to detect leaks in the tanks. It is disputed whether the first defendant also undertook to remove the mixer tap. The plaintiff is economically linked with the company B. B. contracted in its own name but on the account of the plaintiff. The first defendant employed the sub-contractor R. who in turn instructed the second defendant to actually carry out the construction works.

Oil leaked from one of the tanks into the estate’s soil and subsequently into the estate’s lake by the end of August 1965. The leakage was caused by a defective weld. An employee of the second defendant had welded the respective airing pipe. However, the oil in the tank would not have spilled over had the mixer taps not been wrongly adjusted.

In the action before the Court the plaintiff seeks compensation from the defendants as joint and several liable debtors for the loss caused by the leaked oil. The loss has been provisionally estimated to amount to 171,589.88 DM. The Court of First Instance (Landgericht) and the Court of Appeal (Berufungsgericht) allowed the claim. The appeal is rejected.

Reasons

I.

1. The Court of Appeal held that the plaintiff is entitled to a contractual remedy against the first defendant in respect of the loss although he is not a privy to the contract between the company B. and the first defendant. The company B. contracted in its own name but on the account of the plaintiff. Therefore, B. acted as indirect agent on behalf of the plaintiff. In view of these findings, the Court of Appeal applied the concept of recovery of damages in respect of a third party’s loss (Schadensliquidation im Drittinteresse). According to this principle the promisee may authorise the third party to sue the defendant in its own name and claim compensation for the loss that falls on the third party. This line of the reasoning of the Court of Appeal is supported by a series of decisions substantially to the same effect (BGHZ 51, 91, 93 = VersR 69, 155, 156; BGHZ 40, 91, 100 = VersR 63, 1172, 1173 ; BGHZ 25, 250, 258 = VersR 57, 705, 706 with further references). This part of the judgment is not put into question by the defendant’s submissions.

4. According to the Court of Appeal the first defendant’s breach of contract (positive Vertragsverletzung) for which he is liable lies in the fact that the airing pipe was not properly welded. The first defendant is legally answerable for this defect; the defect is at least a contributory cause for the loss. The fact that the mixer tap was not adjusted properly is contrary to the opinion of the defendant irrelevant because the leakage would have been avoided if the airing pipe had been sealed off properly. In that case the leakage would have been noticed on time. This suffices to meet the requirement of causality.

5. The Court of Appeal further assumes correctly that the first defendant is responsible for the fault of the employees of the second defendant according to § 278 BGB and that these employees have acted negligently; they have not taken sufficient care when welding the airing pipe. The first defendant could not convince this Court of the contrary.

II. 1. In the view of the Court of Appeal the liability of the second defendant is founded exclusively on the law of delict (§ 831 BGB).

...

2. A pre-condition for § 831 BGB is physical damage to property, just as it is for § 823 I BGB. However, the second defendant’s contention that the Court of Appeal did not positively establish that he has caused physical damage to property is not correct. Such physical damage was caused by the second defendant.

...

3. In the view of the Court of Appeal the second defendant did not successfully proof that he had carefully selected and supervised his employees; according to § 831 BGB he bears the burden of proof. This finding is not questioned by the second defendant and the reasoning of the Court appears to be correct.

III. The Court of Appeal found that the plaintiff was not contributory negligent.

...

Notes to Cases 19-26

1. Cases 19-24 deal with economic loss caused by negligent statements – typically taking the form of some certification. The law on this subject is complicated for two reasons. First because the potential liability flows from words and it is generally believed that people utter words with less care than they usually put in their actions. Words also ‘travel’ far and thus, it is said, can cause more widespread harm. Neither argument is entirely convincing. The asbestos, silicon breasts, Dalcon Shield or defective heart valves disputes put paid to this assertion in these days of world- wide class actions. Nor is the distinction between words and actions always as easy or as obvious as those who advocate them believe. Thus, are negligent certifications words or documents based on negligent investigations i.e. acts or omissions? More likely, therefore, that the real problem here is, once again, the systems’ dislike for pure economic loss, aggravated on occasion by the above-mentioned characteristics assigned to words. Whatever, the true reason, and often it is an accumulation of reasons that dictates an “attitude”, the three legal systems examined in this books can boast an extremely rich case law which is not free from contradictions. This complexity is further increased if one bears in mind that the problems here discussed find their solutions sometimes in judge-made law and sometimes in statutes (which in Germany also show the signs of EC influences). For a legal rule that can claim its existence to a multiplicity of sources invariably courts interpretative difficulties.

German law can claim two additional interesting features. First, the ‘statutory’ law, perhaps because it was drafted under the influence of powerful pressure groups, shows marked signs of being more ‘protective’ of accountants and auditors. There are no such signs of leniency in the case law which, in its boldness, is provoking academics and testing the codal philosophy to its limits. For the academic lawyer in general, the comparatist in particular, this may well be one of the most striking features of the German position. For, as a Common lawyer with unique insights into German law once observed, it underscores ‘. . . the German willingness, indeed eagerness, to extend tort protection . . . [despite] the Civil Code’s categorical exclusion of tort damages for pure economic loss and the great weight reputedly given by German law to theoretical orthodoxy over pragmatism.’ (Fleming (1989) 105 LQR, 508.) In this trend (rather than in the details of German law) may also lie the greatest lesson for the Common lawyer who, additionally, would not have to go to the same pains to justify similar results if (or when) he decided to adopt a more flexible attitude towards pure economic loss. Finally, many of the ideas, notions, and trends discussed in this section are also evident in two other areas of economic loss. The first is concerned with the consequences of mistakes made by lawyers (and is discussed in the next section); the other deals with damage caused to products (and is considered by the cases reproduced in section 15 and the notes that accompany them).

In the light of these introductory remarks, it is self-evident that an account such as the one that follows is bound to be somewhat crass – certainly to the extent that it attempts to summarise such an enormous volume of decisional law. Here more than elsewhere the reader should thus look at what follows more in search for signposts for further study of the law than as a source of detailed answers. If the material assembled here and the notes that accompnay it also succeed to make the reader ‘think’ that can only be regarded as a welcome bonus.

2. At first sight, German law is cautious and conservative. § 676 BGB provides that ‘A person who gives advice or a recommendation to another is not bound to compensate for any damage arising from following the advice or recommendation, without prejudice to his responsibility arising from contract or delict.’ Since the main tort provision (§ 823 I BGB) excludes, as we have seen, pure economic loss from its list of protected interests, liability in tort can only be based on § 824 BGB or § 826 BGB. The first has minimal importance, while the second also has a limited application. This is despite the fact that in recent times the courts have widened the meaning of intention (in § 826 BGB) to include not only dolus directus but also dolus eventualis (a notion somewhat akin to our concept of reckless behaviour). Thus, in one decision (BGH NJW 1987, 1758–9) the court eased the fault requirement stating that (for the purposes of liability under § 826 BGB) it would suffice to show that the auditor expected his report to be used in connection with credit negotiations and that (if it were incorrect) it would cause harm to the relying creditor. Professor von Bar has, in fact, gone further by arguing that ‘a person who gives information off the cuff must . . . recognise that it could be false; and the very fact that he still goes ahead and gives that information demonstrates that he has reckoned with the possibility of damage to others and has accepted it.’ (‘Liability for Information and Opinions Causing Pure Economic Loss to Third Parties’ in The Growing Convergence (ed. B. S. Markesinis) O.U.P. (1994). See, also, Palandt-Thomas, § 826 no. 8 c.bb.)

3. Because of the above strictures of the tort provisions of the Code the courts have had recourse to the notion of contract with protective effects vis-à-vis third parties with the result that the liability of auditors has been taken significantly further than the wording of § 826 could even possibly justify. The absence in the German law of tort of any liability for negligently inflicted pure economic loss has resulted in a number of substitute legal constructions. One such device is the so-called contract with protective effects for the benefit of third parties, a judicially-created variant of the better-known notion of contract in favour of third parties (see Ch. 2 section A (d)(iii)). This construction makes it possible to treat pure economic losses of third persons, resulting from a faulty performance of contractual (or non-contractual) duties, as actionable harm resulting from a breach of a contractual duty. This contractually-based liability towards third parties for their pure economic loss, though now well acknowledged in principle, remains controversial; and the controversy rages as much over detail as it does over the dogmatic basis of the solution.

In German law (and often but not invariably in the Common law), liability, essentially, depends upon reliance on the report; and whether this was reasonable or not depends on the contract (commissioning the audit report) as well as all other relevant circumstances. Thus, third parties may be able to sue for damages under contracts to which they are not signatories (BGH JZ 1986, 1111); or where their protection under the contract commissioning the report arises not from its wording but from necessary implication (BGH NJW 1987, 1758, 9). In order to adapt and apply the concept of a contract with protective effects towards third parties to the negligent misstatement situation - the so called “expert liability” category of cases - the Federal Court has held that for the protective effects to arise, it is no longer necessary for the requirement of ‘Wohl und Wehe’ (for better or for worse) to be fulfilled. Until roughly 1984, this requirement had served as one of the main control factors of the concept since it limited its scope to situations where the promisee was responsible for the “well being” of the third party. This, for instance, was easily satisfied in the context of family relationships but also in employment settings where the employer’s duties of care towards his employees were involved. But it was not adequate to cover relationships of commercial nature, so it was dropped. (See BGHZ 69, 82, 86; BGH NJW 1984, 355, 356; BGH NJW 1998, 1059.) A further bold step towards, increasing the range of persons included under the “protective umbrella” of the contract was taken when the BGH abandoned the view that third party protection should be denied when there was a real or potential conflict of interests between the commissioning principal of the report and the third party. (BGH NJW 1987, 1758–9). This trend is continued in case 23. The decision deals with the problem whether and to what extent the co-responsibility of the contractual partner of the surveyor should be taken into account in an action by the third party/purchaser of the land. In this instance the site owner, who intended to sell the property, commissioned a report from a surveyor to estimate the value of the house. The surveyor over-valued the house. This was because he negligently relied on the misleading information given to him by the site owner. The third party/purchaser relied on the surveyor’s report and bought the house at an unrealistic price. The court allowed the action of the third party. The actual result of the decision surely appears reasonable (in that sense, Medicus, JZ 1995, 309). In the final analysis, however, the BGH took another step in the direction of an extra-contractual/ tortious liability for certain cases of economic loss. But the court was not willing to adopt the language of a tortious "duty of care" towards certain third persons. Instead, it sought to derive this result from the intention of the parties to the contract of employement of the surveyor which was given protective effect towards the third party/purchaser. The BGH resorted to two fictions to achieve the “desired” result on the basis of contract.

The first was that the site-owner had a real interest in including the buyer in the protective scope of the contract. In fact he had not, since he and the purchaser were on opposite sides of the bargain and, as a result, the survey gave rise to a conflict of interests. (While the site-owner is clearly interested in a favourable valuation, the purchaser/plainttiff is interested in a valuation at the lower end of the scale). It is, therefore, difficult to argue that the site-owner wished to benefit the third party/plaintiff. Such an intention could only be “discovered” only if one could show that had the parties openly discussed the issue they would have agreed that good faith required that the site-owner also contract for the benefit of the purchaser. Such a construction, however, is so un-convincing that, in reality, it shows that it is the law that is imposing upon the surveyor such a duty towards the purchaser and not the will of the parties.

The second fiction is even more striking. It is inherent in the derivative nature of the third party’s cause of action that the promisor/ surveyor can avail himself towards the third party of any defences available to him against the promisee (§ 334 BGB, which corresponds to Contracts (Rights of Third Parties Act) 1999 s. 3(2)). In an action by the site owner the surveyor could have objected that the promiee/site owner who commissioned the report, had acted contrary to good faith in concealing a crucial defect of the property. The BGH held that the promisor could not avail himself of this defence as against the third party/purchaser. The court relied on a device - which is not always available - to solve this problem, namely implied term reasoning. Thus, it assumed that in the contract that created the ‘duty of care’ towards certain third parties, the surveyor tacitly waived his right to avail himself of any defence against the plaintiff/potential purchaser which he, the contractual debtor, had against his contractual partner (the person commissioning the report). This waiver, the BGH stated, was justified by the fact that the expert knew that his performance was intended to form the basis of the financial calculations of the purchaser of the land (who, one might add will – reasonably – rely on the report). It goes without saying that these considerations might also justify imposing liability under the Hedley Byrne principle of reasonable reliance and assumption of responsibility. However, it is more difficult to see how this result, imposing liability, can be derived from applying the concept of a contract in favour of the third party. For not only is this result incompatible with the traditional model of a contract in favour of third parties; it is also doubtful that the surveyor would have accepted such a waiver had it been discussed before entering into the contract. Once again, such analysis indicates that the duty is imposed by law and does not flow from the will of the contracting parties. It also casts new doubt on the whole construction of a contract with protective effects towards the purchaser. (See Ebke JZ 1998, 991, 993 ff. who suggests that “implied term” reasoning is in such cases used to make up for the exclusion of pure economic loss from the list of protected interests in § 823 I BGB).

In the light of the above, it comes as no surprise to discover that some academic commentators have argued in favour of abandoning the contract with protective effects as theoretical basis of the decisions of the court - at least in cases such as the present one. But the BGH remains to be convinced and has yet to give any signs that it is about to change its present stance (see Ch. 2 A(d)(iii)). See e.g. Canaris ‘Die Reichweite der Expertenhaftung gegenüber Dritten’ ZHR 163 (1999) 206 and ‘Schutzwirkungen zugunsten Dritter bei ‘Gegenläufigkeit’ der Interessen’ JZ 1995, 441. Professor Canaris submits that at least in situations like the present the theoretical basis of the liability of the “expert” for negligent misstatements in German law ought to be culpa in contrahendo. Such an analysis would entail a number of advantages such as a better explanation of the independence of the action from the contract between the person who commissioned the statement and the expert. It would also cater for the need to limit liability in relation to third parties by disclaimers etc. One is reminded here of the reasoning in Smith v. Eric S. Bush [1990] 1 AC 831 (recently applied by the Court of Appeal in Merrett v. Babb [2001] 3 WLR 1). Professor Picker on the other hand (e.g. ‘Gutachterhaftung’ in Beuthien et al (ed.) Festschrift für Dieter Medicus (1999) p. 397) rejects the reliance-based culpa in contrahendo model. Instead, he favours a limited and overt exception to the rule that pure economic loss is not recoverable in the law of delict (which would cover this and other similar cases of negligent miss-statements.) Whether this is de lege lata possible in German law is not for us to decide. But the discussion prompted by case 23 certainly indicates that the contractual approach currently prevailing in Germany may also have its shortcomings.

4. Cases 19-24 also highlight one of the main structural differences between German tort law and English law. German law has not developed a limited exception to the general rule that pure economic loss cannot be recovered in the law of delict. As a result, it has, once again, been forced into contractual thinking. As the cases reproduced above show, its contract law has proved flexible enough to accommodate the desire to hold liable those who give advice (or perform other services such as auditing or surveying) even if in a strict sense there is no privity of contract between the parties. This, for instance, could happen when third parties rely on statements by professionals given in the course of their employment by a different person. From a comparative perspective this confirms the insight formulated many years ago by Zweigert and Kötz and which still cannot be bettered. For, in their Introduction to Comparative Law (3rd edn. 1998) p. 44, the authors remarked that: “… when the process of comparison begins, each of the solutions must be freed from the context of its own system.” And they continued: “Here, too, we must follow the principle of functionality: the solutions we find in the different jurisdictions must be cut loose from their contextual context and stripped of their national doctrinal overtones so that they may be seen purely in the light of their function, as an attempt to satisfy a particular need.”

The problem of negligent misstatements has caused major conceptual difficulties in both systems. The preferred option of English courts is, as we have seen, to extend liability in negligence to cover pure economic loss- a type of harm traditionally belonging to the realm of contract law. By contrast, the German predilection for contract appears at first sight to have an axiomatic advantage. On closer re-examination, however, it raises serious doubts whether liability really flows from the intention of the parties (essential if one is to remain faithful to contract theory) or whether it is more accurately imposed by the law. The realisation that the theoretical basis might not, after all, lie on the intention of the parties has finally come to full light, especially in recent cases such as BGHZ 127, 378 (case 23). We must conclude therefore that in this area, if any, a functional approach is capable of providing insights of general interest. As Professor Schlechtriem remarked recently it is not so much the theoretical basis that counts. What really matters is that the specific criteria for imposing liability receive attention and are developed rationally on a case by case basis. (See his ‘Schutzpflichten und geschützte Personen’ in Beuthien and others (edd.) Festschrift für Dieter Medicus (1999) p. 529.) More specifically his view is that the main emphasis should be laid upon the scope and purpose of the duty owed in the individual case. In his opinion, the relevant test is to be found in Lord Hoffmann's speech in South Australia Asset Management Corp. v . York Montague Ltd. [1997] AC 191, 211 where the learned Law Lord argued that the claimant has to show “that the duty was owed to him and that it was a duty in respect of the kind of loss which he has suffered”. Against this background, the comparative study of each other’s systems can provide useful insights to both of them and make the lawyer – student or practitioner - understand better what he is trying to achieve. Another and perhaps more important lesson that can be drawn from comparing liability for negligent misstatements is that in this field of “professional negligence” the traditional compartmentalisation of obligations into contractual and tortious lacks explanatory power. (Cf. Cartwright (1997) 13 Constr LJ 157). These observations will be best understood if read in conjunction with the text in Ch. 2 section 2(d)(iii), above, and the notes to cases 11-13. (For further details about the topics discussed above see in addition to those already referred to: Bamm, ‘Entwicklungstendenzen der Expertenhaftung’ JZ 1991, 373; Ebke, ‘Die Haftung des Wirtschaftsprüfers für fahrlässig verursachte Vermögensschäden Dritter’, WM 1991, 398; Hopt ‘Nichtvertragliche Haftung außerhalb von Schadens- und Bereicherungsausgleich’ AcP 183 (1983) 608; Lang, ‘Die Rechtsprechung des Bundesgerichtshofes zur Dritthaftung der Wirtschaftsprüfer und anderer Sachverständiger’, WM 1988, 1001; Müller, ‘Wirtschaftsprüfer und vereidigte Buchprüfer als Sachverständige und Gutachter’, WPK-Mitt 1991, 3; Schneider ‘Die Reichweite der Expertenhaftung gegenüber Dritten’ ZHR 163 (1999) 246 and Bosch ibid. at p. 274 with further references.)

5. The (German) case law regime just described is, as indicated at the beginning of this section, modified wherever the statutory regime takes precedence. This is the situation in the Caparo type of case where the result reached by the House of Lords is acceptable also to German law. (Cf. von Bar’s comprehensive review of the Caparo case from a comparative perspective ‘Liability for Information and Opinions Causing Pure Economic Loss to Third Parties’ in The Growing Convergence, ed. Markesinis, (1994) 98, 125). Contrast now case 24 on statutory audit under § 323 HGB. Caparo, it will be recalled, dealt with a ‘statutory’ audit, prepared for the company but relied upon (to their detriment) by (a) existing and (b) potential shareholders of the said company. The Court of Appeal allowed the first (but not the second) to recover their losses, but the House of Lords overturned the decision denying both categories of plaintiff all redress against the negligent accountants. The same solution as in Caparo would still follow in German law if the result were to be determined solely by the wording of § 323 of the Commercial Code (HGB) which specifically regulates the legal position of auditors in the case of ‘mandatory audits’ (Pflichtprüfungen viz., the formation audit, the annual audits, and ‘special’ reports) and which limits the auditor’s liability for negligent breach of his duties to the company only. (For an English version of the text see: Business Transactions in Germany, Gen. Ed. Ruester, N.Y., Matthew Bender (1990). For a more detailed account in German see: Ebke, Wirtschaftsprüfer und Dritthaftung (1983), esp. pp. 38–43; 56–60.) Shareholders and potential shareholders are, thus, excluded for the purview of this paragraph. (This has been confirmed in case 24 though see, below, comments on the wider effect of this case which introduced a significant extension of this type of liability for statutory audit and, to that extent, may have caused the two systems to part company). And they are also denied an action under § 823 II BGB because § 323 HGB is not regarded as a protective norm (Schutzgesetz). (This has been well-established for some time. See: Aktiengesetz Kommentar, 13th edn. by Baumbach, Hueck and Schulze (1968) § 168, no. 7; Aktiengesetz Kommentar by Gessler, Hefermehl, Eckhardt and Kropff, vol. III (1973) § 168, no. 31; Kölner Kommentar zum Aktiengesetz by Zoellner, vol. II (1971), § 168, no. 16. These are commentaries on § 168 of the Aktiengesetz which is now to be found as § 323 of the Commercial Code, quoted in the text above. See now Hopt Handelsgesetzbuch Kommentar (30th edn., 2000) § 323 HGB Rn. 8.) This restrictive interpretation is reinforced by § 340b (5) of the Aktiengesetz which deals with the potential liability of auditors in the event of mergers. For in this second instance, liability is expressly extended towards ‘the companies participating in the merger and their shareholders’.

As already indicated in the previous paragraph, § 323 I HGB provides that if the auditor negligently fails to comply with his duties he is liable only to the company in question (and if an associated company sustains loss also to this company). Until this seminal judgment was published this was understood as implying that any other third party was prevented from suing the auditor. It thus came as a surprise that the BGH, in case 24, did not endorse fully this widely held view. While the court there acknowledged that the “legislative intention” which was expressed in this provision was “to limit appropriately the risk of the auditor’s liability”, it also stressed that this provision did not have an “exclusionary” effect. The consequence of such an approach is that the auditor could in principle owe a duty also to persons not expressly mentioned in § 323 HGB. This was the case where the auditor (contractually) undertook to perform his service without prejudicing the interests of a third party, in the instant case a purchaser of the company. It is not entirely clear whether this requires that the auditor issues a statement in addition to the actual audit before his liability widens to include third parties. In the somehwat unusual facts of the case in question, the auditor had confirmed to a second auditor employed by the purchaser that he would stand by the views expressed in the annual report. (The better view would seem to be that this extended liability is engaged only of such an additional statement is made. On this, see Canaris ZHR 163 (1999) 206, 208.) A consequence of this restrictive reading would be that in respect of the statutory audit, itself, no liability would arise in relation to third parties. But that does not affect the striking feature of the decision which is that such an undertaking was said to flow from the intentions of the parties and that it had been conclusively declared. Once again, therefore, one must express serious doubts as to whether the auditor was actually willing to accept liability beyond that which normally flows from § 323 HGB, especially in the light of the pre-existing and restrictive understanding of that provision. (See Ebke, ‘Abschlußprüfer, Bestätigungsvermerk und Drittschutz’, JZ 1998, 991, 993.) The inescapable impression thus is that the duty is imposed by law with consequences which may not have yet been fully fathomed by the (German) courts. For, as Professor Ebke remarked: “If the intention of the parties as expressed in the contract no longer determines the existence and extent of liability and this is allowed to turn on ‘objective interests’ and the third party’s reliance, then the choice of the [contracting] parties and their right to determine the extent of their obligations will take second place. A result-orientated risk allocation that does not flow from the will of the parties will then become predominant.” This is in turn is difficult to reconcile with those decisions in which it was held that § 323 HGB was not a provision which acquires protective effects towards third parties within the framework of § 823 II BGB already referred to, not to mention traditonal contract dogma.

6. In this context, of particular interest is a decision of the BGH in 1985 where one reason given for the enlargement of the auditor’s liability was the existence of mandatory liability insurance according to § 54 of the Accountants’ Regulations (Wirtschaftsprüferordnung, WPO). (See, BGH WM 1985, 450, nos. 6 and 8). Also relevant may be the fact that under the WPO the auditors are allowed to make use of the General Commissioning Terms for Chartered Accountants (Allgemeine Auftragsbedingungen für Wirtschaftsprüfer) which restrict or (in certain circumstances) eliminate their liability. Statutes such as the General Conditions of Business of 1977 (the German equivalent to the (British) Unfair Contract Terms Act of the same year) may also help define the ambit of liability and thus, de facto, limit litigation by reference to the amount of insurance coverage. (See: BGH NJW 1987, 1758, 1760.) One should add that if third parties are entitled to sue auditors, now subject however to the uncertain implications of the decision in case 23 above, they can be opposed by all the defences that may be available to auditors as a result of their contracts with the commissioning company. The contractual nature of this action makes this point obvious, whereas it would be more problematic if the action were tortious in nature.

7. Negligent statement relied upon by third persons have proved as troublesome in the USA as in other systems and, if anything, the case law here is both enormous in its volume and not possible to reconcile. The reasons for the difficulties inherent in this subject are many. First is the belief – not always factually correct – that words travel more than acts and can thus raise the spectrum of truly “indeterminate liability” in terms of time and persons. Secondly, is the fact that the audited client retains a good deal of control over the records upon which the auditor bases his report. Thirdly, and not entirely unrelated to the previous point, is the fact that auditors will rarely be in a position to estimate anywhere near as accurately as will be necessary, the extent of their potential liability. This “informational asymmetry” has been examined more in the USA than in England by academic literature. (See, for instance, Siliciano, “Negligent Accounting and the Limits of Instrumental Tort Reform”, 86 Michigan L.Rev. 1929 (1988). Finally, a few courts in the USA have also argued that its in most cases open to the plaintiff/lender to arrange to become a client of the auditor if he really wishes to be able to rely on his report. (See, Bily v. Arthur Young & Co., 834 P. 2d 745 (1992). Situations of negligent misrepresentations can take an infinite variety of factual forms. These have been systematically analysed by Lorenz, ‘Das Problem der Haftung für primäre Vermögensschäden bei der Erteilung einer unrichtigen Auskunft’, Festschrift K. Larenz (1973) 575. Here suffice it to divide them into two groups.

In the first, the defendant makes a statement (usually a report) to the person who asked for it (and, invariably, paid for it) but knows that it will be relied upon by a specified third person. OLG München BB 1956, 866 is such a case and it is discussed along with other similar cases in Lawson and Markesinis, I, 83 ff. In the USA this situation is usually described as being covered by the “privity or near privity rule”. It finds an excellent illustration in Glanzer v. Shepard 233 NY 236, 135 NE 275 (1922). That German law based its solution on contract whereas the American law opted for tort is mostly a matter of ‘emphasis’, as Cardozo J. put it, adding that if necessary he, too, could have based his decision on contract. (For further German decisions see, inter alia, BGH WM 1965, 287; BGH WM 1963, 913.)

Real difficulties appear in the second type of situation where A commissions the (negligently prepared) report from B and then shows it to others who rely on it to their detriment. Case 19 (WM 1979, 548) is such a case and it is here that the problem of ‘indeterminate liability’, so well identified by Cardozo J. in Ultramares Marine v. Touche Niven and Co. 255 NY 170, 174 NE 441 (1931), rears its ugly head. The courts, if they abandon strict adherence to the privity requirement (as they are nowadays inclined to do), are, in such cases, forced to seek a balance between two opposing positions. The first is liability resting on pure foresight (or some equivalent concept). The second is liability based only on a form of direct nexus between the representor and the representee of the kind found in the aforementioned decision of the Court of Appeal of Munich or in the Glanzer decision. (Yet a third option, available to some plaintiffs, is to rely on statutory enactments such as ss. 11 and 12 of the (American) Securities Act of 1932 or s. 18 of the Securities Exchange Act of 1934. But such actions have been of limited use to ordinary investors or creditors besides suffering from the drawback of a short—one year—limitation period. For the protection currently afforded by federal securities law see Kraakman, ‘Gatekeepers: The Anatomy of a Third-Party Enforcement Strategy?’ 2 J. of Law, Econ. and Org. 53 (1986).)

The USA provides, as one would expect, the greatest variety of court-devised techniques to avoid the strictures of the Ultramares rule. Thus some courts, while not overruling Ultramares, appear to be extending the rationale of the Glanzer decision (third party can recover only if he is “the end and aim of the transaction”). See, for example, White v. Guarente 43 NY 2d 356, 372 NE 2d 315 (NY 1977); Credit Alliance Corp. v. Arthur Anderson and Co., 476 NYS 2d 539 (1984); reversed in 483 NE 2d 110, 493 NYS 2d 435 (1985) (holding that a duty of care is owed only to limited class of foreseen users). According to this approach, if A prepares a report for B knowing that C will rely upon it, he will not be liable to him in the absence of some actual and meaningful contact with him so that for instance a mere telephone exchange between A and C will not suffice. (Security Pacific Business Credit, Inc. v. Peat Marwick Main Co., 597 NE 2d 1080.) A New Jersey statute (New Jersey Stat. Ann. 2A: 53A-25) adopts a similar position and spares the accountant of all liability unless he knew the specific plaintiff and the specific transaction for which his report was intended.

A more middling or flexible approach is that advocated by the Restatement (Second) of Torts, para. 552 (1977) which rejects the private requirement and renders accountants liable not only to those persons whom they intended to influence but also towards the persons whom the accountants know that their clients intended to influence. Rusch Factors Inc. v. Levin, 284 F. Supp. 85 (1968) offers an early illustration, the court in that case being influenced by a tentative draft of the Restatement. (Note that the Rusch decision (at p. 93) talks of an ‘actually foreseen and limited class of persons’ [italics supplied]. Whereas the German decision, while agreeing with the idea that the identity of the relying person need not be known to the representor, insists that he must be ‘part of a calculable group of persons’.) Ohio (Hadden View Investment Co. v. Coopers and Lybrand (436 NE 2d 212, 70 Ohio St. 2d 154 (1982)) and New Hampshire (Spherex Inc. v. Alexander Grant and Co., 122 N.H. 898, 451 A. 2d 1308 (1982)) were among the early converts to this rule. For other important decisions see: Raritan River Steel Co. v. Cherry, Bekaert & Holland, 367 SE 2d 609 (1988); Bily v. Arthur Young & Co., 834 P. 2d 745 (1992) (indisputably a leading case); Boykin v. Arthur Andersen & Co., 639 So. 2d 504 (1994); Nycal Corp. v. KPMG Peat Marwick LLP, 426 Mass. 491 688 N.E 2d 1368 (1998). But the interpretative “refinements” attempted by some courts may have also made possible for ‘daring’ practitioners or judges to go beyond the (undboutedly) ambiguous wording of the Restatement. Thus in Marcus Bros. Textiles, Inc. v. Price Waterhouse, LLP, 350 NC 214 (1999) the Supreme Court of North Carolina “clarified” its aforementioned judgment in Raritan and held that actual knowledge by the accountant of those persons who might rely on the accountant’s opinion is not necessary under Restatement 552, general business practices from which such reliance can be inferred being sufficient.

Finally, a number of minority decisions have moved towards the adoption of the most liberal test namely that of pure foreseeability. Thus see: H. Rosenblum Inc. v. Adler 93 NJ 324, 461 A. 2d 138 (1983) (now rejected by the legislator: see statute mentioned above). See, also Citizens State Bank v. Timm, Schmidt and Co. 335 NW 2d 361 (1983); International Mortgage Co. v. John P. Butler Accountancy Corp. 223 Cal. Rptr. 218 (1986); Touche Ross v. Commercial Union Ins., 514 So. 2d 315 (1987) (Mississipi); Citizens State Bank v. Timm, Schmidt & Co., 335 NW 2d 361 (1983) (Wisconsin). Yet even in these States, a variety of limitations help keep matters under control. Wisconsin, for instance, the Supreme Court in its aforementioned decision in Citizens State Bank was eager to stress that liability would not be found where the harm was found to be too remote, disproportionate or financially crushing – a way which suggests judicial reliance been placed more on causative notions rather than on the duty of care (with all the drawbacks that this approach may entail, especially in a jury dependant system.) Additionally, all States insist that “justifiable reliance” is a sine qua non. Thus a North Carolina court held that reliance on the audit, not directly but through a summary of it produced in a Dun & Bradstreet report, was not sufficient. (Raritan, above.)

The literature on the subject is enormous. An excellent review can be found in Guerci, “Liability of Independent Accountant to Investors or Shareholders”, 48 ALR 5th 389 (1997). From the more recent literature see: Sinason, “Gaining a New Balance in Accountants’ Liability to Nonclients for Negligence: Recent Developments and Emerging Trends”, 103 Com. L.J. 15 (1998); Young et al., “Financial Reporting and the Accounting Profession: The Whirlwind Continues”, 1151 PLI/ Corp 95 (1999).

8. English law, too, has vacillated on this topic in a manner which has been as confusing as it is difficult to summarize with any pretence to accuracy. The modern law starts with Candler v. Crane Christmas and Co. [1951] 2 KB 164 which, though denying recovery to the plaintiff, opened the door for future developments through the prophetic dissent of Denning LJ (as he then was). Some fifteen years later heresy was transformed into orthodoxy by the seminal judgment of the House of Lords in Hedley Byrne and Co. Ltd. v. Heller and Partners Ltd. [1964] AC 465 where the rule was settled that there would be liability for careless statements causing pure economic loss provided there was a ‘special relationship’ between the plaintiff and the defendant and there was no disclosure of liability. ‘Special relationship’ has obviously been a key phrase; and it has been subsequently interpreted to include a friend giving advice seriously though not in a professional context (Chaudhry v. Prabhaker [1989] 1 WLR 29). Earlier attempts to narrow the Hedley Byrne rule only to cases where the party making the statement professed to give that kind of advice or held himself out as possessing special skills also proved unsuccessful. See: Mutual Life and Citizens’ Assurance Co. Ltd. v. Evalt [1971] 3 AC 793; Esso Petroleum Co. Ltd. v. Mardon [1976] QB 501.

The 1960s and 1970s found the English courts in an imaginative and expansionist mode. This can be seen in English administrative law, but it is also obvious in the decisions dealing with liability for negligent misstatement. Thus, in Ministry of Housing and Local Government v. Sharp [1970] QB 223 two further extensions were made to the Hedley Byrne principle. (In Hedley Byrne A made a false statement to B who relied on it to his detriment; in Sharp A made the statement to B (who never repeated it to C) but it was C who suffered the loss and was allowed to recover. Secondly, in Hedley Byrne the plaintiff’s loss was actual expenditure whereas in Sharp the harm suffered was failure to recover a sum that had become due). And a potentially more far-reaching extension came in JEB Fasteners Ltd. v. Marks, Bloom and Co. [1981] 3 All ER 289 where liability was not based on the Hedley Byrne rule (which requires the establishment of a ‘special relationship’) but on the more amorphous neighbourhood rule of Donoghue v. Stevenson [1932] AC 562 (which also provided the justification for the legal malpractice rule of Ross v. Caunters [1980] Ch. 297, though in the latter case the economic loss was not caused by a false statement but by a negligent attestation of a will.

More recently, however, this expansionist mood has been checked; and in some cases it has been accompanied by severely restricting dicta found in a long series of decisions expressing disapproval of the liberal tendencies which peaked with the decision of the House of Lords in Junior Books v. Veitchi [1938] AC 520 (a case also involving pure economic loss, though caused by negligent deeds, not words). In the context of negligent misstatements, the leading judgment can be found in Caparo v. Dickman [1970] 2 AC 605 where the House of Lords overruled an interesting and well thought-out judgment of the Court of Appeal by refusing to hold that the auditors of a company owed a duty of care towards the shareholders of the company who suffered losses by purchasing shares in that company by relying on that report. The judgments of at least two Lords (Bridge and Jauncey) suggest that liability can only arise if the statement was both intended to be relied upon for a particular purpose and was, in fact, relied upon, something which, in the opinion of their Lordships, was not satisfied in this case. See, also, Al Saudi Banque v. Clarke Paxley [1990] Ch. 313 (company auditors not liable to a bank who lent to the company on the strength of their report); The Morning Watch [1990] 1 Lloyd’s Rep. 547 (Lloyds Register, reporting on the condition of a vessel at the request of the owner, not liable to potential purchaser who relies on their report). As always, the plethora of dicta, often with relatively minor verbal variations, may one day enable a shift to more liberal positions, analogous to those one finds in some leading German judgments. For the time being, however, the following statements may provide a general indication of the current state of English law. Thus, in Smith v. Eric Bush; Harris v. Wyre Forest District Council [1990] AC 831, 865, Lord Griffiths stressed ‘that in cases where the advice has not been given for the specific purpose of the recipient acting upon it, it should only be in cases when the adviser knows that there is a high degree of probability that some other identifiable person will act upon the advice that a duty of care should be imposed.’ Likewise, in Caparo Industries Plc v. Dickman [1990] 2 AC 605, 621 Lord Bridge argued that in these cases it is essential to prove ‘that the defendant knew that his statement would be communicated to the plaintiff, either as an individual or as a member of an identifiable class, specifically in connection with a particular transaction or transactions of a particular kind (e.g. in a prospectus inviting investment) and that the plaintiff would be very likely to rely on it for the purpose of deciding whether or not to enter upon that transaction or upon a transaction of that kind.’ See, also, Lord Oliver’s remarks at p. 652.

9. As a postscript one might add that inadequate consideration has been given to a point raised by Lord Justice Bingham in the Caparo case ([1989] 1 QB 653, 689 et seq.) namely that the finding of a duty situation in such cases will by no means always lead to liability. For most claims would very likely fail (or would be settled at a very early state in the proceedings) on the grounds that no negligence can be proved or that the causation link between negligent misstatement and the loss has not been established. Banque Financière de la Cité v. Westgate Insurance Ltd. [1991] 2 AC 249 supports this assertion though, given the paucity of case law on this point, this view in the text is only advanced as a tentative one.

Further reading

For further readings on the Common law see Franklin, (3rd edn.) 248 ff. (4th edn.) 347 ff.; Henderson and Pearson, 1129–37; Prosser, Wade, and Schwartz, 1035 ff.; Prosser in 19 Vand. L. Rev. 231 (1966); Craig in 92 LQR 213 (1976). For German law see Haller ‘Haftung für Rat und Auskunft’ Jura 1997, 234; Honsell ‘Die Haftung für Gutachten und Auskunft unter besonderer Berücksichtigung von Drittinteressen’ in Beuthien and others (edd.) Festschrift für Dieter Medicus (1999) p. 211; Lammel, ‘Zur Auskunftshaftung’ AcP 1979, 337; Martiny, ‘Pflichtenorientierter Drittschutz beim Vertrag mit Schutzwirkung für Dritte’, JZ 1996, 19; Musielak, Haftung für Rat, Auskunft und Gutachten (1974); Scheerer, ‘Probleme der Haftung der Kreditinstitute für die Erteilung von Auskünften in Deutschland und Frankreich unter besonderer Berücksichtigung der Haftungsfreizeichnungsklauseln’ Festschrift Bärmann (1975); Strauch ‘Rechtsgrundlagen der Haftung für Rat, Auskunft und Gutachten’ JuS 1992, 897. Rich references to recent American decisions and the policies that lie behind them can be found in Bilek, ‘Accountants’ Liability to the Third Party and Public Policy: A Calabresi Approach’, 39 Southwestern Law Journal 689 (1985). See also: Achampong, ‘Common Law Liability of Accountants for Negligence to Non-Contractual Parties: Recent Developments’ 91 Dickinson L. Rev. 677 (1987); Blaney, ‘The Citadel Falls? Liability for Accountants in Negligence to Third Parties Absent Privity: Credit Alliance Corp. v. Arthur Andersen and Co.’ 59 St John’s L. Rev. 348 (1985); Casazza, ‘Rosenblum Inc. v. Adler: CPA’s Liability at Common Law to Certain Reasonably Foreseeable Third Parties Who Detrimentally Rely on Negligently Audited Financial Statements’ 70 Cornell L. Rev. 335 (1985); Davies, ‘The Liability of Auditors to Third Parties in Negligence’ 14 University of N.S. Wales Law Journal 171 (1991); Chapman, ‘Limited Auditors’ Liability: Economic Analysis and the Theory of Tort Law’ 20 Canadian Business Law Journal 180 (1992); Nicholson, ‘Third Party Reliance on Negligent Advice’ (1991) 40 ICLQ, 551; Gormley, ‘The Foreseen, the Foreseeable, and Beyond: Accountants’ Liability to Nonclients’ 14 Seton Hall L. Rev. 528 (1984); Pace, ‘Negligent Misrepresentation and the Certified Public Accountant: An Overview of Common Law Liability to Third Parties’ 18 Suffolk Univ. L. Rev. 431 (1984); Causey, ‘Accountants’ Liability in an Indeterminate Amount for an Indeterminate Time to an Indeterminate Class’ 57 Miss. LJ 379 (1987); Whittaker, ‘Privity of Contract and the Tort of Negligence’, 16 OJLS 191 (1996).

10. As has been suggested in Ch. 2 A (d) (iii), the different points of departure of German and English law are linked to the understadning of the doctrine of consideration in England (but not the USA). This has led to a “rigid” contract law which, in turn, has encouraged the expansion of tort law in order to meet new legal challenges, less known in the 19th century, such as product liability, liability for negligent statements and the like. In Germany the legal pressures were in the reverse. Strict if not rigidly conceived tort provisions (e.g. § 823 I BGB, § 831 etc) have meant that the pressure to meet the very same challenges had to be apllied to the inherently more pliable law of contract since German tort law could not meet them. (On this see Markesinis (1987) 103 LQR 354; as late as 1993 Fleming arrived at a similar conclusion, (1993) 5 Canterbury LRev 269, 279.) More recent developments require that the above picture be now modified, at any rate as far as English law is concerned. For, despite the fact that as we have seen some academic commentators would favour an extra-contractual approach to the problem of professional negligence, the BGH does not seem to be inclined to abandon the contractual analyses. But in recent years, English law has seen two remarkable developments that have a considerable potential to boost contract law and open new routes of recovery which might diminish the need to resort to the tort of negligence in the field of economic loss.

The first check on the expansion of tort law has come about with the adoption of the Contracts (Rights of Third Parties) Act 1999 (extracts of which are reproduced as Addendum 2) which implemented the long-standing proposals of the Law Commisssion. (See, Law Com No. 242 (1996).) With the new Act, much of the criticised rigidity of the English law of contract has disappeared. This, of course, does not mean that the recognition of contracts for the benefit of a third party will bring about the abolition of the rule that a third party cannot, generally speaking, derive rights from the contract. German law, which has known this insitution for a long time now, proves as much. But it does mean that the 1999 Act adds another and wide-ranging exception to the privity doctrine even if it does not replace it with a different general rule. (See Treitel Law of Contract (10th edn. 1999) p. 600. The doctrine of privity or, to use the German term “relativity of contract”, will thus continue to apply “to prevent strangers from enforcing a contract.” (Flannigan (1987) 103 L.Q.R. 564.) But the effect of importing the concept of a contract for the benefit of a third party into English law will be to allow a third party whom the original parties intended to benefit from their agreement to enforce such an agreement. The question, therefore, arises whether the Act will enable the range of claimants who previously resorted to tort remedies to base henceforth their claims on the new Act rather than to try and dress them up in tort clothing.

Under the Act the third party has a direct remedy in contract against the promisor. At this point, comparative analysis leads one to include a word of caution. Although in Germany contracts for the benefit of a third party have long been recognised, German jurists have been compelled to develop additional techniques and devices to deal with those problems which are also the most difficult ones to slot into the “correct” category. Cases involving negligent misstatements are an example. The central provision of the English Act is its test of enforceability contained in section 1(1). According to this section a contract is for the benefit of a third party if it purports to confer a benefit on an expressly identified (including identifiable by class) third party, section 1 (3). Under the first limb of the test, section 1(1)(a), the parties expressly declare the contract to be one in favour of a third party. The more difficult to apply is, obviously, the second limb, section 1(1)(b). It is interesting to note that the English Act opted for a presumption in favour of such a contract if the contract confers a benefit on a third party, a solution which was rejected by the fathers of the BGB as being too sweeping (see § 328 BGB). (See, Kötz ‘Rights of Third Parties’ in International Encyclopaedia of Comparative Law Vol. VII Chapter 13 (1992), p. 22.) One might be tempted therefore to conclude that the scope of application of the Act is extremely wide. However, on closer analysis one can see that this will not be the case. For the presumption is founded on a specific preconception of a classic contract for the benefit of a third party which is very similar to that presupposed by § 328 BGB. The wording is meant to convey this even if the restriction envisaged by the Commission is not an easy one. The distinction relevant to the second limb is that between “to confer” a benefit and merely being (incidentally) “of” benefit. The first situation triggers the presumption and corresponds to the classic contract for a benefit of a third party. The special feature of it is that the third party is meant to be able to enforce the contract as a whole, section 1(5), including for instance the right to rescind a contract or, where available, to seek specific performance. In the case of negligent misstatements these considerations do not apply. In these cases the promisee is entitled to the remedies under the contract and is meant to be the only party who can do so. It is only where the service is performed negligently and causes damage to a third party that the third party might acquire a right to hold the promisor liable in damages. But this isolated interest in the performance of the contract is not sufficient to bring the negligent misstatement cases under the principles flowing from the classic contract for the benefit of a third party. This insight lies at the heart of the contract with protective effects towards third parties. The BGH, following the teachings of Professor Larenz, (NJW 1959, 1976) did not regard the situations in the cases reproduced above to justify the application of § 328 BGB. These provisions apply only by analogy; and as case 23 shows the analogy does not always point to the right direction either (regarding § 334 BGB which corresponds to s. 3(3)). The Commission expressly sought to exclude White v. Jones (reproduced in part as Addendum to case 27 below and which will be discussed in more detail in the next section, No. 7) from the application of the Bill, where primary performance was not owed to the third party but where the third party was, nonetheless, affected by a defective performance of the contract (Law Com. No. 242 (1996) para. 7.17-7.52). This analysis applies mutatis mutandis to most of the negligent misstatement cases. Another indication that the Commission regarded the second limb as confined to cases where the parties intended to grant the third party “primary enforcement” is contained in para. 7.25, note 22. The commissioners stressed that the intention test did not embrace the wider German concept of a contract with protective effects towards third parties (reference to Markesinis (1987) 103 LQR 354). Ironically enough, as a result of these refinements of the presumption contained in section 1(1)(b), the 1999 Act is limited in a very similar way as the German (classic) contract for the benefit of a third party. However, unlike German law, these provisions cannot be applied analogically to those situations traditionally falling under the contract with protective effects towards third parties. So the tort of negligence, as explained in cases such as White v. Jones and Henderson v. Merrett (extracts of which are reproduced below as Addendum to case 27), will continue to play a crucial role in establishing liability. If the second limb of the enforceability test will be constructed in the way the Commission suggests, comparative law could thus provide invaluable assistance in deciding in which circumstances a contract “confers a benefit” in a third party, i.e. the presumption is raised. (See for “typical fact situations” in which § 328 BGB applies: Kötz International Encyclopaedia of Comparative Law Vol. VII Chapter 13 (1992) pp. 27 ff.; Lorenz ‘Contracts and Third-Party Rights in German and English Law’ in Markesinis (ed.) The Growing Convergence (1994) pp. 65 ff. and Markesinis et al The German Law of Obligations vol. I, pp. 261 ff.) Finally, it should be noted also that there is one clear exception from the principle that the third party is entitled to “primary performance” of the contract. The 1999 Act applies where an exclusion clause is meant to benefit a third party, then the third party can enforce this (and only this) isolated provision of the contract. The fact that this is an exception is also confirmed by the realisation that the parallel situation in German law is regarded as an instance not of the classic contract for the benefit of a third party but as one of the contract with protective effects towards third parties. (See case 57 and also notes to case 27, below).

Further Reading: Adams, Beyleved and Bronwsword, ‘Privity of Contract’, (1997) 60 MLR 238; Burrows, ‘Reforming Privity of Contract’, [1996] LMCQL 467; idem, ‘The Contracts (Rights of Third Parties) Act 1999 and its Implications for Commercial Contracts’, [2000] LMCQL 540; Dean, ‘Removing a Blot on the Landscape’, [2000] JBL 143; Macaulay, ‘Warranting Third Party Rights’, [2000] ConstrLJ 265; Roe, ‘Contractual Intention under Section 1(1)(b) and 1(2) of the Contracts (Rights of Third Parties) Act 1999’, (2000) 63 MLR 887; Tettenborn, ‘Third Party Contracts’, [1996] JBL 602.

11. At this juncture, a brief excursus into a related area is desirable. It deals with the reform in the area of carriage of goods by sea introduced by the Carriage of Goods by Sea Act 1992. (Within its scope of application the 1999 Act does not apply (according to section 6(5)) to these cases, except that a third party may in reliance on section 1 avail himself of an exclusion or limitation of liability in such a contract). One of the problems that the Act tried to address was that in some cases loss and remedy part company. Thus, while one party may have had the interest in the goods (or carried the mercantile risk), the rights under the bill of lading might lie in the hands of another. In The Albazero [1977] AC 774 the House of Lords favoured a contractual solution to the problem allowing, in principle, recovery of damages in a contractual action on behalf of a third party. However, the perceived drawback of this solution was that the third party could not compel the promisee to bring such an action. In the Court of Appeal in The Aliakmon ([1985] QB 350) Robert Goff L.J. was thus persuaded to attempt to create a tort remedy based on the “principle of transferred loss”. This would have enabled the third party to sue the carrier directly even though he did not have a proprietary interest in the goods or possession of them at any material time. In the House of Lords ([1986] AC 785, 817-818), Lord Brandon of Oakbrook refused to follow this line of reasoning mainly because he did not accept that there was, in this respect, a lacuna of English law. The learend judge was also suspicious of the new remedy on doctrinal grounds since, in his eyes, it amounted to a derivative action, which was contrary to its tortious nature. For the special feature of the transferred loss principle was that the liability of the carrier was “contractually flavoured” in so far as the duty owed to the third party was shaped by the underlying duty to the goods owner. This, in turn, was determined by the exclusion and limitation clauses contained in the contract of carriage as contained in or evinced by the bill of lading. In 1992 the problem was remedied by statute, Carriage of Goods by Sea Act 1992. (The main impetus for the Act, however was not the decision in The Aliakmon but difficulties arising from modern forms of carriage, in particular the carriage of goods in bulk. (On this see Reynolds [1986] LMCLQ 97). The transfer of the rights under the bill of lading was no longer dependant upon a transfer of ownership in the goods but turned on the claimant’s capacity as lawful holder of the bill of lading. Thus, Lord Goff’s concerns were addressed and his ingenious theory did not have to be pursued any further. Not for the time being at least.

12. The second and perhaps more significant extension of contract occurred in the context of the promisee’s remedies in respect of a third party’s loss. In St. Martins Property Corporation Ltd. v. Sir Robert McAlpine Ltd [1994] 1 AC 85 the principle in The Albazero was transferred to construction law. The essence of this development is an increasingly liberal attitude towards contractual claims by which a promisee is not suing for loss sustained by himself but is seeking to recover damages on behalf of a third party. (This area of the law has, in both systems, expressly been left to the courts; see Ch. 2 A 1.). The key decisions are St. Martins, Darlington BC v. Wiltshier Northern Ltd. [1995] 1 WLR 68 and, most recently, Alfred McAlpine Construction Ltd. v. Panatown Ltd. (extracts of which are reproduced as Addendum 3). In these cases contractual remedies were extended to cover situations where a building employer is not the owner of the development site at the time of the breach of the building contract and, as a result, (arguably) suffers no financial loss. The builder/defendant in these cases based his defence on the “no loss argument”. However, the courts allowed recovery in contract of substantial damages in respect of the site owner’s loss. To hold otherwise, they stressed, would mean allowing a meritorious claim to disappear into a “legal black hole”. The need for a contractual solution, or, more crucially, the very danger of the “black hole”, can be traced to the change of heart by the House of Lords in Murphy towards the builder’s liability in tort. For, prior to that case, third parties to a building contract (for instance third party purchasers) could often avail themselves of the Anns type of remedy and recover pure economic loss in tort. In the seminal case of Panatown this re-orientation towards and rediscovery of contract principles reached a new peak. For not only was the contract route to recovery reinforced; but by a majority their lordships laid the foundation for an even more flexible approach to contractual actions where the performance of a service benefits as a matter of fact a third party. This new approach lays emphasis on the fact that a building employer is entitled to substantial damages because he does not get what he bargained for, whether or not he suffered a financial loss as a result of the breach. (See Lord Griffiths’ speech in St. Martins, Beale (1995) 9 Journal of Contract Law 104 and Coote [1997] CLJ 537) It also brings English contract law closer to the typical features of German contract law. In the present context it is, of course, impossible to appreciate fully the impact of this remarkable decision. (For details of this development see Cartwright (1996) 10 Journal of Contract Law 244; Coote (2001) 117 LQR 81; Treitel (1998) 114 LQR 527 and Wallace (1999) 115 LQR 394). A few remarks, however, may help bring out more clearly our comparative observations and explore some future developments.

There is little doubt that the Panatown line of cases re-opens contractual avenues in the area of construction law. For they enable promisees to recover substantial damages even though they were not the owners of the development site at any material time and, arguably, did not suffer a financial loss as a result of the breach. Whether this remedy is more satisfactorily analysed as a remedy whereby one recovers a third party’s loss (or his own) cannot be decided here. For this depends on a series of intricate points such as the promisee’s accountability to the third party, the relevance of direct third party rights, and so forth. Suffice it, however, to say that a majority in Panatown denied recovery of damages on both grounds where the third party could sue himself, regardless of the theoretical basis of the promisee’s remedy. In the present instance, the building owner could have sued on the basis of a so-called duty of care deed. This result seems somewhat harsh. For that limited, direct right of action was merely meant to fill the gap left by Murphy and provide protection to subsequent purchasers or tenants (cf. Lewis (1997) 13 Constr LJ 305) but arguably not to substitute liability under the building contract itself. (Cf. Lords Millett and Goff dissents). St. Martins also presents an ironical twist. For Lord Clyde saw it as an example of Lord Goff’ theory of “transferred loss” (at p. 529). The latter, however, though the inventor of the theory (in The Aliakmon), and user of it in White v. Jones ([1995] 2 AC 207,267) in relation to the construction cases (St. Martins), abandoned it in Panatown in the belief that he had not used the term with “any great accuracy”. (See, p. 557.) One wonders, however, whether the principle of transferred loss should be discarded without more since it performs a useful function. (See, Unberath (1999) 115 LQR 535.) Moreover, this “retreat” from the principle of transferred loss is all the more regrettable as that principle shows similarities to the German concept of Drittschadensliquidation, at least in so far as its function is concerned. Thus, contrary to Lord Goff’s pessimistic statement that “the concept is not an easy one for a common lawyer to grasp”, it enhances the comparability of the positions adopted in the two jurisdictions. Lord Goff had himself emphasised this extra judicially (The Gradual Convergence (Ed. B. Markesinis) (1994) at pp. 129 f.). His hesitation to base his decision on a concept that allowed recovery of third party loss must however be understood in the light of his overall strategy in the latter case. Lord Goff preferred to explain the promisee’s remedy as being founded on loss suffered by himself rather than the building owner. The employer did not get what he bargained for: a building according to the specifications of the contract. It would be “absurd” if he could not recover substantial damages (measured by the cost of cure) as a result. Thus Lord Goff followed the direction indicated by Lord Griffiths in St. Martins. Seen in this light, his reluctance to adhere to a principle “invented” by him in The Aliakmon for taking care of third party losses, was from this perspective understandable.

13. In any event, the solution favoured by Lord Goff is not far removed from the German approach, as the learned Lord was ready to admit. For he pointed out that the rights of a building employer under §§ 633 - 635 BGB were vested in the customer and that there was no indication that the situation was different if a third party owned the property on which the work was done. Certainly the right to have the defect remedied by the builder, restitution in lieu of termination, price reduction are not dependent upon the building employer having sustained a financial loss as a result of a defective performance. (The position is more difficult to ascertain in relation to the right to recover damages). Thus far then we can indeed observe that the solutions of the two systems coincide. There is only a conceptual difference in that the employer’s right is according to Lord Goff framed in terms of a right to substantial damages measured by the cost of cure while the rights mentioned above are not rights which entitle the promisee to recover damages, especially the right to have the defect cured is a variant of specific performance. The rationale behind this approach has been best described by Professor Treitel in the International Encyclopedia of Comparative Law Vol. VII Chapter 16 (1976) p. 6 as the concept of “enforced performance”. From this point of view Lord Goff’s approach constitutes a remarkable step towards protecting the right to the performance of a contract and a departure from a mere loss focussed theory of contractual remedies. In respect of the right to recover damages for defective performance the position of German law is more difficult to ascertain. It should be noted however that German courts also allow recovery of damages in respect of a third party’s loss (the site owner) in contract. Cases 25 and 26 illustrate this point. Case 25 first of all shows that such claims by a promisee on behalf of a third party are meant to enable the promisee to enforce the contract and therefore are not excluded by a direct right in tort. One might add for the sake of completeness that in carriage of goods (by land) situations German law combines the contract for the benefit of a third party with third party loss recovery and as a consequence allows recovery of damages on behalf of a third party even of the third party has a direct action in contract (§ 421 HGB; cf. Basedow Münchener Kommentar zum HGB vol. 7 (1997) § 429 Rn. 52; Herber NJW 1999, 3297, 3302; Helm Haftung für Schäden an Frachtgütern (1966) 164). Case 26 suggests that even though German law follows the principle accurately described as enforced performance it is sometimes nevertheless necessary to allow recovery of damages in respect of a third party’s loss, for instance in the case at hand as far as consequential loss is concerned. We can note that overall German law is characterised by a great degree of flexibility with regard to the rights of a promisee to enforce the contract but also regarding recovery of third party loss. One caveat must be added. The concept of Drittschadensliquidation is confined to particular types of situations and is not freely available to third party claimants (see cases 13 and 61 which contain useful guidelines as to when it is available). It has for instance not been applied to problems of product liability or the negligent misstatements situations discussed above, for they do not involve a transfer of a loss to a different person than the contracting party but increase the risk of liability: the product or the statement might cause loss to the contracting party but also to a per se indeterminate number of third parties. Therefore, additional controlling factors are necessary which reasonably limit liability and which are not and cannot be provided by the more limited and special principle of transferred loss (see notes 1-5 above).

Finally, it is important to stress that Lord Clyde, as well, drew comparisons with German law. He referred to German law in order to underline that the concept of a contract for the benefit of a third party may provide a satisfactory solution in certain so-called “homely” examples, for instance in the notorious Jackson v. Horizon Holidays Ltd. [1975] 1 WLR 1468 situation. (Cf. Law Com. No. 242 (1996) para. 7.40). Lord Clyde’s comments must be welcomed. For English law, after its over due abolition of the traditional doctrine of privity can benefit from the experience that German law has gained by working on this concept over many decades. (Cf. Steyn’s LJ, strongly expressed dissatisfaction with the traditional doctrine of privity in Darlington BC v. Wiltshier Northern Ltd. [1995] 1 WLR 68, 76).

14. So let us conclude by returning to our starting point, namely to the interrelation between economic loss and contract. These two developments in contemporary English law - the privity reform and the increased availability of contractual remedies where third parties are affected by the defective performance of a contract for the performance of a service - reveal an important reversal. (Especially if compared with the pre- Murphy v. Brentwood District Council [1991] 1 AC 398 state of affairs.) The conservative approach to economic loss in that case has been weighed down by an unforeseen extension of contractual devices. This interrelationship between contract and tort (in the area of economic loss) is reinforced more specifically by the observation that the extension in the area of construction was prompted by the change of approach to economic loss in Murphy, itself. However, one should bear in mind that the thesis of an expanding tort law before Murphy and an expanding contract law after Murphy have to be understood as mere generalisations of a general trend to which well-established exceptions existed and continue to exist. First, as far the period before Murphy is concerned, it is crucial to note that in the area of carriage of goods the “primacy” of contract was not successfully challenged. The attempt by Lord Goff in The Aliakmon to establish a limited exception to the exclusion of economic loss for a case of relational economic loss was not followed by the House of Lords in the light of the already existing flexibility of contractual solutions. Against this background the recent construction cases appear merely as a natural development, as a rediscovery of the already developed flexibility of contractual remedies in the area of shipping law. Secondly, the contractual solutions developed by English law do not seem to be available to litigants in the area of negligent misstatements in as much as the existing tort law approach founded on Hedley Byrne retains its importance. The Contracts (Rights of Third Parties) Act 1999 will, likewise, rarely apply to Hedley Byrne situations. The other contractual device, the rule in The Albazero, will also be of limited assistance, as was suggested in White v. Jones which will be discussed in more detail in the next part. White v. Jones is, itself, typical of the pre-Murphy period in that the tort solution adopted in that case was preceded by an extensive discussion of the inaqdequacy of contractual remedies. There is thus room for further expansion and, more importantly, creative comparative thinking.

Addendum 1

Extracts from Caparo Industries plc v. Dickman House of Lords [1990] 2 AC 605

LORD BRIDGE OF HARWICH [After considering the general approach to the duty of care, his Lordship continued:] The damage which may be caused by the negligently spoken or written word will normally be confined to economic loss sustained by those who rely on the accuracy of the information or advice they receive as a basis for action. The question what, if any, duty is owed by the maker of a statement to exercise due care to ensure its accuracy arises typically in relation to statements made by a person in the exercise of his calling or profession. In advising the client who employs him the professional man owes a duty to exercise that standard of skill and care appropriate to his professional status and will be liable both in contract and in tort for all losses which his client may suffer by reason of any breach of that duty. But the possibility of any duty of care being owed to third parties with whom the professional man was in no contractual relationship was for long denied because of the wrong turning taken by the law in Le Lievre v Gould [1893] 1 QB 491 in overruling Cann v Wilison (1888)39 Ch D 39. In Candler v Crane Christmas &Co [1951] 2 KB 164 Denning J, in his dissenting judgment, made a valiant attempt to correct the error. But it was not until the decision of this House in Hedley Byrne & Co Ltdv Heller &Partners Ltd [1964] AC 465 that the law was once more set on the right path.

[His Lordship reviewed the subsequent authorities and continued:] The salient feature of all these cases is that the defendant giving advice or information was fully aware of the nature of the transaction which the plaintiff had in contemplation, knew that the advice or information would be communicated to him directly or indirectly and knew that it was very likely that the plaintiff would rely on that advice or information in deciding whether or not to engage in the transaction in contemplation. In these circumstances the defendant could clearly be expected, subject always to the effect of any disclaimer of responsibility, specifically to anticipate that the plaintiff would rely on the advice or information given by the defendant for the very purpose for which he did in the event rely on it. So also the plaintiff, subject again to the effect of any disclaimer, would in that situation reasonably suppose that he was entitled to rely on the advice or information communicated to him for the very purpose for which he required it. The situation is entirely different where a statement is put into more or less general circulation and may foreseeably be relied on by strangers to the maker of the statement for any one of a variety of different purposes which the maker of the statement has no specific reason to anticipate. To hold the maker of the statement to be under a duty of care in respect of the accuracy of the statement to all and sundry for any purpose for which they may choose to rely on it is not only to subject him, in the classic words of Cardozo CJ, to ‘liability in an indeterminate amount for an indeterminate time to an indeterminate class’ (see Ultramares Corp. v Touche (1931) 255 NY 170 at 179), it is also to confer on the world at large a quite unwarranted entitlement to appropriate for their own purposes the benefit of the expert knowledge or professional expertise attributed to the maker of the statement. Hence, looking only at the circumstances of these decided cases where a duty of care in respect of negligent statements has been held to exist, I should expect to find that the ‘limit or control mechanism ... imposed on the liability of a wrongdoer towards those who have suffered economic damage in consequence of his negligence’ (see the Candlewood case [1986] AC 1 at 25) rested on the necessity to prove in this category of the tort of negligence, as an essential ingredient of the ‘proximity’ between the plaintiff and the defendant, that the defendant knew that his statement would be communicated to the plaintiff, either as an individual or as a member of an identifiable class, specifically in connection with a particular transaction or transactions of a particular kind (e.g. in a prospectus inviting investment) and that
the plaintiff would be very likely to rely on it for the purpose of deciding whether or not to enter on that transaction or on a transaction of that kind....

[His Lordship reviewed other authorities, and then considered the position of auditors in relation to the shareholders of a public limited company arising from the provisions of the Companies Act 1985.]

No doubt these provisions establish a relationship between the auditors and the shareholders of a company on which the shareholder is entitled to rely for the protection of his interest. But the crucial question concerns the extent of the shareholder’s interest which the auditor has a duty to protect. The shareholders of a company have a collective interest in the company’s proper management and in so far as a negligent failure of the auditor to report accurately on the state of the company’s finances deprives the shareholders of the opportunity to exercise their client powers in general meeting to call the directors to book and to ensure that errors in of skill management are corrected, the shareholders ought to be entitled to a remedy. But in practice no problem arises in this regard since the interest of the shareholders in the duty. proper management of the company’s affairs is indistinguishable from the interest of the company itself and any loss suffered by the shareholders, e.g. by the negligent ruse of failure of the auditor to discover and expose a misappropriation of funds by a director of the company, will be recouped by a claim against the auditor in the name of the All ER company, not by individual shareholders.

I find it difficult to visualise a situation arising in the real world in which the individual shareholder could claim to have sustained a loss in respect of his existing shareholding referable to the negligence of the auditor which could not be recouped by the company. But on this part of the case your Lordships were much pressed with the argument that such a loss might occur by a negligent undervaluation of the company’s assets in the auditor’s report relied on by the individual shareholder in knew deciding to sell his shares at an undervalue. The argument then runs thus. The shareholder, qua shareholder, is entitled to rely on the auditor’s report as the basis of his investment decision to sell his existing shareholding. If he sells at an undervalue he is entitled to recover the loss from the auditor. There can be no distinction in law effect between the shareholder’s investment decision to sell the shares he has or to buy would additional shares. It follows, therefore, that the scope of the duty of care owed to se for him by the auditor extends to cover any loss sustained consequent on the purchase of additional shares in reliance on the auditor’s negligent report.

I believe this argument to be fallacious. Assuming without deciding that a claim by a shareholder to recover a loss suffered by selling his shares at an undervalue attributable to an undervaluation of the company’s assets in the auditor’s report could be sustained at all, it would not be by reason of any reliance by the shareholder on the of the auditor’s report in deciding to sell: the loss would be referable to the depreciatory effect of the report on the market value of the shares before ever the decision of the sundry shareholder to sell was taken. A claim to recoup a loss alleged to flow from the purchase urn, in of overvalued shares, on the other hand, can only be sustained on the basis of the for an purchaser’s reliance on the report. The specious equation of ‘investment decisions’ to sell or to buy as giving rise to parallel claims thus appears to me to be untenable. Moreover, the loss in the case of the sale would be of a loss of part of the value of the shareholder’s existing holding, which, assuming a duty of care owed to individual shareholders, it might sensibly lie within the scope of the auditor’s duty to protect. A loss, on the other hand, resulting from the purchase of additional shares would result from a wholly independent transaction having no connection with the existing shareholding.

I believe it is this last distinction which is of critical importance and which prove demonstrates the unsoundness of the conclusion reached by the majority of the Court of Appeal. It is never sufficient to ask simply whether A owes B a duty of care. It is always necessary to determine the scope of the duty by reference to the kind of damage from which A must take care to save B harmless:

‘The question is always whether the defendant was under a duty to avoid or prevent that damage, but the actual nature of the damage suffered is relevant to the existence and extent of any duty to avoid or prevent it.’
See Sutherland Shire Council v Heyman (1985) 60 ALR 1 at 48 per Brennan J.

Assuming for the purpose of the argument that the relationship between the auditor of a company and individual shareholders is of sufficient proximity to give rise to a duty of care, I do not understand how the scope of that duty can possibly extend beyond the protection of any individual shareholder from losses in the value of the shares which he holds. As a purchaser of additional shares in reliance on the auditor’s report, he stands in no different position from any other investing member of the public to whom the auditor owes no duty.

I would allow the appeal and dismiss the cross-appeal.

LORD OLIVER OF AYLMERTON: [After considering the general approach to the duty of care, his Lordship said:] What can be deduced from the Hedley Byrne case ... is that the necessary relationship between the maker of a statement or giver of advice (the adviser) and the recipient who acts in reliance on it (the advisee) may typically be held to exist where (1) the advice is required for a purpose, whether particularly specified or generally described, which is made known, either actually or inferentially, to the adviser at the time when the advice is given, (2) the adviser knows, either actually or inferentially, that his advice will be communicated to the advisee, either specifically or as a member of an ascertainable class, in order that it should be used by the advisee for that purpose, (3) it is known, either actually or inferentially, that the advice so communicated is likely to be acted on by the advisee for that purpose without independent inquiry and (4) it is so acted on by the advisee to his detriment. That is not, of course, to suggest that these conditions are either conclusive or exclusive, but merely that the actual decision in the case does not warrant any broader propositions....

My Lords, no decision of this House has gone further than Smith v Eric S Bush, but your Lordships are asked by Caparo to widen the area of responsibility even beyond the limits to which it was extended by the Court of Appeal in this case and to find a relationship of proximity between the adviser and third parties to whose attention the advice may come in circumstances in which the reliance said to have given rise to the loss is strictly unrelated either to the intended recipient or to the purpose for which the advice was required. My Lords, I discern no pressing reason of policy which would require such an extension and there seems to me to be powerful reasons against it. As Lord Reid observed in the course of his speech in the Hedley Byrne case [1964] AC 465 at 483, words can be broadcast with or without the consent or foresight of the speaker or writer; and in his speech in the same case Lord Pearce drew attention to the necessity for the imposition of some discernible limits to liability in such cases....

In seeking to ascertain whether there should be imposed on the adviser a duty to avoid the occurrence of the kind of damage which the advisee claims to have suffered it is not, I think, sufficient to ask simply whether there existed a ‘closeness’ between them in the sense that the advisee had a legal entitlement to receive the information on the basis of which he has acted or in the sense that the information was intended to serve his interest or to protect him. One must, I think, go further and ask, in what capacity was his interest to be served and from what was he intended to be protected? A company’s annual accounts are capable of being utilised for a number of purposes and if one thinks about it it is entirely foreseeable that they may be so employed. But many of such purposes have absolutely no connection with the recipient’s status or capacity, whether as a shareholder, voting or non-voting, or as a debenture-holder. Before it can be concluded that the duty is imposed to protect the recipient against harm which he suffers by reason of the particular use that he chooses to make of the information which he receives, one must, I think, first ascertain the purpose for which the information is required to be given. Indeed, the paradigmatic Donoghue v Stevenson case of a manufactured article requires, as an essential ingredient of liability, that the article has been used by the consumer in the manner in which it was intended to be used (see Grant v Australian Knitting Mills Ltd [1936] AC 85 at 104, and Junior Books Ltd v Veitchi Co Ltd [1983] 1 AC 520 at 549, 552). I entirely follow that if the conclusion is reached that the very purpose of providing the information is to serve as the basis for making investment decisions or giving investment advice, it is not difficult then to conclude also that the duty imposed on the adviser extends to protecting the recipient against loss occasioned by an unfortunate investment decision which is based on carelessly inaccurate information....

.1 do not believe and I see no grounds for believing that, in enacting the statutory provisions, Parliament had in mind the provision of information for the assistance of purchasers of shares or debentures in the market, whether they be already the holders of shares or other securities or persons having no previous proprietary interest in the company. It is unnecessary to decide the point on this appeal, but I can see more force in the contention that one purpose of providing the statutory information might be to enable the recipient to exercise whatever rights he has in relation to his proprietary interest by virtue of which he receives it, by way, for instance of disposing of that interest. I can, however, see no ground for supposing that the legislature was intending to foster a market for the existing holders of shares or debentures by providing information for the purpose of enabling them to acquire such securities from other holders who might be minded to sell....

In my judgment, accordingly, the purpose for which the auditors’ certificate is made and published is that of providing those entitled to receive the report with information to enable them to exercise in conjunction those powers which their respective proprietary interests confer on them and not for the purposes of individual speculation with a view to profit. The same considerations as limit the existence of a duty of care also, in my judgment, limit the scope of the duty and I agree with O’Connor U that the duty of care is one owed to the shareholders as a body and not to individual shareholders.

To widen the scope of the duty to include loss caused to an individual by reliance on the accounts for a purpose for which they were not supplied and were not intended would be to extend it beyond the limits which are so far deducible from the decisions of this House. It is not, as I think, an extension which either logic requires or policy dictates and I, for my part, am not prepared to follow the majority of the Court of Appeal in making it. In relation to the purchase of shares of other shareholders in a company, whether in the open market or as a result of an offer made to all or a majority of the existing shareholders, I can see no sensible distinction, so far as a duty of care is concerned, between a potential purchaser who is, vis-à-vis the company, a total outsider and one who is already the holder of one or more shares. I accordingly agree with what has already fallen from my noble and learned friend Lord Bridge, and I, too, would allow the appeal and dismiss the cross-appeal.

Addendum 2

Extracts from the Contracts (Rights of Third Parties) Act 1999

1. - (1) Subject to the provisions of this Act, a person who is not a party to a contract (a "third party") may in his own right enforce a term of the contract if-
(a) the contract expressly provides that he may, or
(b) subject to subsection (2), the term purports to confer a benefit on him.

(2) Subsection (1)(b) does not apply if on a proper construction of the contract it appears that the parties did not intend the term to be enforceable by the third party.

(3) The third party must be expressly identified in the contract by name, as a member of a class or as answering a particular description but need not be in existence when the contract is entered into.

(4) This section does not confer a right on a third party to enforce a term of a contract otherwise than subject to and in accordance with any other relevant terms of the contract.

(5) For the purpose of exercising his right to enforce a term of the contract, there shall be available to the third party any remedy that would have been available to him in an action for breach of contract if he had been a party to the contract (and the rules relating to damages, injunctions, specific performance and other relief shall apply accordingly).

(6) Where a term of a contract excludes or limits liability in relation to any matter references in this Act to the third party enforcing the term shall be construed as references to his availing himself of the exclusion or limitation.

(7) In this Act, in relation to a term of a contract which is enforceable by a third party-
"the promisor" means the party to the contract against whom the term is enforceable by the third party,and
"the promisee" means the party to the contract by whom the term is enforceable against the promisor.

2. - (1) Subject to the provisions of this section, where a third party has a right under section 1 to enforce a term of the contract, the parties to the contract may not, by agreement, rescind the contract, or vary it in such a way as to extinguish or alter his entitlement under that right, without his consent if-
(a) the third party has communicated his assent to the term to the promisor,
(b) the promisor is aware that the third party has relied on the term, or
(c) the promisor can reasonably be expected to have foreseen that the third party would rely on the term and the third party has in fact relied on it. ...

3. - (1) Subsections (2) to (5) apply where, in reliance on section 1, proceedings for the enforcement of a term of a contract are brought by a third party.
(2) The promisor shall have available to him by way of defence or set-off any matter that-
(a) arises from or in connection with the contract and is relevant to the term, and
(b) would have been available to him by way of defence or set-off if the proceedings had been brought by the promisee.
(3) The promisor shall also have available to him by way of defence or set-off any matter if-
(a) an express term of the contract provides for it to be available to him in proceedings brought by the third party, and
(b) it would have been available to him by way of defence or set-off if the proceedings had been brought by the promisee.
(4) The promisor shall also have available to him-
(a) by way of defence or set-off any matter, and
(b) by way of counterclaim any matter not arising from the contract,
that would have been available to him by way of defence or set-off or, as the case may be, by way of counterclaim against the third party if the third party had been a party to the contract.
(5) Subsections (2) and (4) are subject to any express term of the contract as to the matters that are not to be available to the promisor by way of defence, set-off or counterclaim.
(6) Where in any proceedings brought against him a third party seeks in reliance on section 1 to enforce a term of a contract (including, in particular, a term purporting to exclude or limit liability), he may not do so if he could not have done so (whether by reason of any particular circumstances relating to him or otherwise) had he been a party to the contract.

4. Section 1 does not affect any right of the promisee to enforce any term of the contract.

5. Where under section 1 a term of a contract is enforceable by a third party, and the promisee has recovered from the promisor a sum in respect of-
(a) the third party's loss in respect of the term, or
(b) the expense to the promisee of making good to the third party the default of the promisor,
then, in any proceedings brought in reliance on that section by the third party, the court or arbitral tribunal shall reduce any award to the third party to such extent as it thinks appropriate to take account of the sum recovered by the promisee.

...

7. - (1) Section 1 does not affect any right or remedy of a third party that exists or is available apart from this Act. ...

Addendum 3

Extracts from Alfred McAlpine Construction Ltd v. Panatown Ltd. [2001] 1 AC 518

[Panatown employed McAlpine to build a building on land owned by UIPL. The work was defective. Panatown did not suffer any financial loss itself. UIPL owned the defective building, which required a significant expenditure for its repair, and was unable for a considerable period to put the building to a profitable use. Panatown sought to recover, by way of an arbitration, from McAlpine the loss which UIPL had suffered. The appeal thus concerned the circumstances in which the employer in a contract of services may claim from the contractor on the ground of breach of contract damages in respect of a loss which has been suffered by a third party. However, in addition to the contract with the employer, the building contractor, McAlpine, also entered into a duty of care deed (DCD) with the site-owner, UIPL. By that deed the owner acquired a direct remedy against the contractor in respect of any failure by the contractor to exercise reasonable skill in relation to any matter within the scope of the contractor’s responsibilities under the contract. The arbitrator rejected the building contractor’s objection that the employer, having suffered no loss, was not entitled to recover substantial damages under the contract. The judge reversed that ruling and the Court of Appeal restored the arbitrator’s decision. The House of Lords allowed McAlpine’s appeal by a majority (Lord Goff of Chieveley and Lord Millett dissenting). There were mainly two routes of recovery. Under the so-called narrow ground Panatown would recover substantial damages on behalf of the building owner. This route was somewhat problematic since in previous cases it had been suggested that if the third party can sue himself the narrow ground ceases to apply and in the present instance the building owner could have proceeded directly on the basis of the DCD. The alternative route, the so called “broader ground” would allow Panatown to recover as building employer substantial damages because it did not get what it bargained for regardless whether Panatown suffered any financial loss as a result of the defective performance, this principle had however never been unequivocally established by the House of Lords. The DCD appeared much less relevant according to this latter approach. The House of Lords was divided in several respects. Lord Clyde rejected the broad ground, Lords Goff and Millett did not apply the narrow ground, while Lord Jauncey of Tullichettle and Lord Browne-Wilkinson rested their decision on both grounds but somewhat surprisingly came to the conclusion that the availability of a direct action under the DCD also excluded the application of the broader ground.]

LORD CLYDE:

...The proposition which I refer to as The Albazero exception, as described by Lord Diplock (at p. 844), was:

"that the consignor may recover substantial damages against the shipowner if there is privity of contract between him and the carrier for the carriage of goods; although, if the goods are not his property or at his risk, he will be accountable to the true owner for the proceeds of his judgment."

If by a special contract the goods were the property or at the risk of the consignor then the loss would be his. That indeed was recognised in Dunlop. The second part of the passage which I have quoted however advances beyond such a position. What is there propounded is, as was noticed by my noble and learned friend Lord Goff of Chieveley in White v. Jones [1995] 2 A.C. 207, 267, a case of transferred loss. This is not a situation where the loss is that of the promissee. It is a loss suffered by the third party but transferred to the promissee who is then accountable to the third party. Thus the loss becomes that of the employer instead of and in place of the third party, a point emphasised by Hannes Unberath in his recent article in (1999) 115 L.Q.R 535. The promissee is deemed to have suffered the loss so that it is he and not the third party who is able to pursue the remedy in damages.

The justification for the exception to the general rule that one can only sue for damages for a loss which he has himself suffered was explained by Lord Diplock in The Albazero [1977] A.C. 774, 847. His Lordship noted that the scope and utility of what he referred to as the rule in Dunlop v. Lambert 6 Cl. & F. 600 in its application to carriage by sea under a bill of lading had been much reduced by the passing of the Bills of Lading Act 1855 and the subsequent development of the law, but that the rule extended to all forms of carriage, including carriage by sea where there was no bill of lading:

"and there may still be occasional cases in which the rule would provide a remedy where no other would be available to a person sustaining loss which under a rational legal system ought to be compensated by the person who has caused it."

The justification for The Albazero exception is thus the necessity of avoiding the disappearance of a substantial claim into what was described by Lord Stewart in J. Dykes Ltd. v. Littlewoods Mail Order Stores Ltd. 1982 S.C. (H.L.) 157, 166 as a legal black hole, an expression subsequently taken up by Lord Keith of Kinkel in this House at p. 177. ...

The Albazero exception will plainly not apply where the parties contemplate that the carrier will enter into separate contracts of carriage with the later owners of the goods, identical to the contract with the consignor. Even more clearly, as Lord Diplock explained at p. 848, will the exception be excluded if other contracts of carriage are made in terms different from those in the original contract. In The Albazero the separate contracts which were mentioned were contracts of carriage. That is understandable in the context of carriage by sea involving a charterparty and bills of lading, but the counterpart in a building contract to a right of suit under a bill of lading should be the provision of a direct entitlement in a third party to sue the contractor in the event of a failure in the contractor's performance. In the context of a building contract one does not require to look for a second building contract to exclude the exception. It would be sufficient to find the provision of a right to sue. Thus as my noble and learned friend Lord Browne-Wilkinson observed in the St. Martins case [1994] 1 A.C. 85, 115:

"If, pursuant to the terms of the original building contract, the contractors have undertaken liability to the ultimate purchasers to remedy defects appearing after they acquired the property, it is manifest the case will not fall within the rationale of Dunlop v Lambert 6 Cl. & F. 600. If the ultimate purchaser is given a direct cause of action against the contractor (as is the consignee or endorsee under a bill of lading) the case falls outside the rationale of the rule."

In the St. Martins case the employer started off as the owner of the property and subsequently conveyed it to another company. In the present case the employer never was the owner. But that has not featured as a critical consideration in the present appeal and I do not see that that factor affects the application of the exception. ... I have no difficulty in holding in the present case that the exception cannot apply. As part of the contractual arrangements entered into between Panatown and McAlpine there was a clear contemplation that separate contracts would be entered into by McAlpine, the contracts of the deed of duty of care and the collateral warranties. The duty of care deed and the collateral warranties were of course not in themselves building contracts. But they did form an integral part of the package of arrangements which the employer and the contractor agreed upon and in that respect should be viewed as reflecting the intentions of all the parties engaged in the arrangements that the third party should have a direct cause of action to the exclusion of any substantial claim by the employer, and accordingly that the exception should not apply. ...
I turn accordingly to what was referred to in the argument as the broader ground. But the label requires more careful definition. The approach under The Albazero exception has been one of recognising an entitlement to sue by the innocent party to a contract which has been breached, where the innocent party is treated as suing on behalf of or for the benefit of some other person or persons, not parties to the contract, who have sustained loss as a result of the breach. In such a case the innocent party to the contract is bound to account to the person suffering the loss for the damages which the former has recovered for the benefit of the latter. But the so-called broader ground involves a significantly different approach. What it proposes is that the innocent party to the contract should recover damages for himself as a compensation for what is seen to be his own loss. In this context no question of accounting to anyone else arises. ...

The loss of an expectation which is here referred to seems to me to be coming very close to a way of describing a breach of contract. A breach of contract may cause a loss, but is not in itself a loss in any meaningful sense. When one refers to a loss in the context of a breach of contract, one is in my view referring to the incidence of some personal or patrimonial damage. A loss of expectation might be a loss in the proper sense if damages were awarded for the distress or inconvenience caused by the disappointment. Professor Coote ("Contract Damages, Ruxley, and the Performance Interest" (1997) C.L.J. 537) draws a distinction between benefits in law, that is bargained-for contractual rights, and benefits in fact, that is the enjoyment of the fruits of performance. Certainly the former may constitute an asset with a commercial value. But while frustration may destroy the rights altogether so that the contract is no longer enforceable, a failure in the obligation to perform does not destroy the asset. On the contrary it remains as the necessary legal basis for a remedy. A failure in performance of a contractual obligation does not entail a loss of the bargained-for contractual rights. Those rights remain so as to enable performance of the contract to be enforced, as by an order for specific performance. ...

At the heart of the problem is the doctrine of privity of contract which excludes the ready development of a solution along the lines of a jus quaesitum tertio. It might well be thought that such a solution would be more direct and simple. In the context of the domestic and familial situations, such as the husband instructing the repairs to the roof of his wife's house, or the holiday which results in disappointment to all the members of the family, the jus quaesitum tertio may provide a satisfactory means of redress, enabling compensation to be paid to the people who have suffered the loss. Such an approach is available in Germany see W. Lorenz "Contract Beneficiaries in German Law" in The Gradual Convergence: Foreign Ideas, Foreign Influences, and English Law on the Eve of the 21st Century ed. Markesinis (1994), pp. 65, 78, 79. It may also be available in Scotland (Carmichael v. Carmichael's Executrix 1920 S.C. (H.L.) 195). But we were not asked to adopt it in the present case and so radical a step cannot easily be achieved without legislative action. Since Parliament has recently made some inroad into the principle of privity but has stopped short of admitting a solution to a situation such as the present, it would plainly be inappropriate to enlarge the statutory provision by judicial innovation. The alternative has to be the adoption of what Lord Diplock in Swain v. The Law Society [1983] 1 A.C. 598, 611 described as a juristic subterfuge "to mitigate the effect of the lacuna resulting from the non-recognition of a jus quaesitum tertio." The solution, achieved by the operation of law, may carry with it some element of artificiality and may not be supportable on any clear or single principle. If the entitlement to sue is not to be permitted to the party who has suffered the loss, the law has to treat the person who is entitles to sue as doing so on behalf of the third party. As Lord Wilberforce observed in Woodar Investment Development Ltd. v. Wimpey Construction U.K. Ltd. [1980] 1 W.L.R. 277, 283, "there are many situations of daily life which do not fit neatly into conceptual analysis, but which require some flexibility in the law of contract."

It seems to me that a more realistic and practical solution is to permit the contracting party to recover damages for the loss which he and a third party has suffered, being duly accountable to them in respect of their actual loss, than to construct a theoretical loss in law on the part of the contracting party, for which he may be under no duty to account to anyone since it is to be seen as his own loss. The solution is required where the law will not tolerate a loss caused by a breach of contract to go uncompensated through an absence of privity between the party suffering the loss and the party causing it. In such a case, to avoid the legal black hole, the law will deem the innocent party to be claiming on behalf of himself and any others who have suffered loss. It does not matter that he is not the owner of the property affected, nor that he has not himself suffered any economic loss. He sues for all the loss which has been sustained and is accountable to the others to the extent of their particular losses. While it may be that there is no necessary right in the third party to compel the innocent employer to sue the contractor, in the many cases of the domestic or familial situation that consideration should not be a realistic problem. In the commercial field, in relation to the interests of such persons as remoter future proprietors who are not related to the original employer, it may be that a solution by way of collateral warranty would still be required. If there is an anxiety lest the exception would permit an employer to receive excessive damages, that should be set at rest by the recognition of the basic requirement for reasonableness which underlies the quantification of an award of damages. ...

LORD GOFF OF CHIEVELEY:

... There are, as I understand the case, essentially two questions which your Lordships have to consider: (1) whether Panatown is entitled to recover substantial damages from McAlpine in respect of the assumed breaches by McAlpine of the building contract, notwithstanding that at all material times Panatown had no proprietary interest in the site of the development; and (2) if so, whether the existence of the direct right of action by the owners of the site, UIPL, against McAlpine under the DCD precluded Panatown from recovering substantial damages from McAlpine.

I turn therefore to the first question. Here Panatown presented its case primarily on the basis of Lord Griffiths' broader ground in the St. Martin's case [1994] 1 A.C. 85; though in the alternative it was prepared, if necessary, to fall back on the rule in Dunlop v. Lambert, 6 Cl. & F. 600 as adopted by the majority of the Appellate Committee in the St. Martin's case. It was, however, submitted on behalf of McAlpine that it was not open to Panatown to invoke the broader ground. Its submission was that the prospect of imminent legislative reform of the privity rule, in the form of the Contract (Rights of Third Parties) Bill already before Parliament, both removed the need for, and rendered illegitimate, any further judicial activism in the field which was subject of the appeal; and that the present case therefore fell to be decided solely on the basis of the exception to the "privity/loss rules" as laid down in the The Albazero [1977] A.C. 774, and explained and applied by Lord Browne-Wilkinson in the St. Martin's case. There is, I believe, little doubt that the choice by the parties of their respective grounds was largely dictated by the possible impact of the DCD upon Panatown's claim to substantial damages under the building contract. On McAlpine's approach, it was open to it to argue that, by reason of the exception identified by Lord Diplock in The Albazero, the existence of the DCD precluded any claim by Panatown to substantial damages for breach of the building contract; whereas, by invoking Lord Griffiths' broader ground, Panatown could at least avoid that trap, though a claim on the broader ground presented its own difficulties.

Two questions therefore arise at the threshold of the argument in this case: (1) Which is the preferable approach to the appeal? And (2) What is the impact, if any, of the imminence of statutory reform of the old privity rule? I shall now consider the first of these two questions, which is a fundamental question which lies at the heart of the case. The second question I shall postpone to a later stage.

(A) As we all know, from an early time the common law adopted a rule of privity of contract, by virtue of which only a party to the contract could enforce the contract. The rule, seen in the abstract, is rational and very understandable in a law of contract which includes the doctrine of consideration; but it has given rise to great problems in practice - because, both in commerce and in the domestic context, parties do enter into contracts which are intended to confer enforceable rights on third parties, and a rule of law which precludes a right of enforcement by a third party can therefore fail to give effect to the intention of the contracting parties and to the reasonable expectations of the third party. The existence of these problems led first of all to the recognition of a number of exceptions to the rule and ultimately, only last year, to its abolition by the Contracts (Rights of Third Parties) Act 1999.

(B) "There is, or is widely thought to be, a general rule that, where A commits a commits a breach of his contract with B, then B can recover damages only in respect of his own loss and not in respect of loss suffered by a third party, C." I adopt the words of Professor Treitel in (1998) 114 L.Q.R. 527, because, as I have already indicated, I share his scepticism about the existence of this "rule." Plainly it is right that a contracting party should not use the remedy of damages to recover what has been described by Oliver J. (as he then was) in a notable judgment (in Radford v. De Froberville [1977] 1 W.L.R. 1262, 1270 as "an uncovenanted profit," or indeed to impose on the other contracting party an uncovenanted burden. But if the supposed rule exists, it could deprive a contracting party of any effective remedy in the case of a contract which is intended to confer a benefit on a third party but not to confer on the third party an enforceable right. It is not surprising therefore to discover increasing concern on the part of scholars specialising in the law of contract that the supposed rule, if rigidly applied, can have the effect of depriving parties of the fulfilment of their reasonable contractual expectations, and to read of doubts on their part whether any such rule exists.

It is, I believe, important to keep these two problems distinct in our minds when addressing the basic question which arises in the present case. With this distinction in mind, let us look first of all at the rule in Dunlop v. Lambert 6 Cl. & F. 600. As Lord Diplock himself explained, this rule should be seen in context of commercial contracts concerning goods, and in particular of contracts for the carriage of goods by sea. It is a commonplace of such contracts that the goods may be shipped pursuant to a contract of sale, under which the property in the goods may pass to the consignee while the goods are in transit. However, the rule of privity of contract requires that, if the contract of carriage is (as it usually is) made between the consignor and the carrier, it can be enforced only by the consignor and not by the consignee. This creates manifest problems where the goods are lost or damaged in transit after the property in them has passed to the consignee. The rule in Dunlop v. Lambert provided a practical solution to these problems by giving the consignor the right to recover damages for such loss or damage for the benefit of the consignee, to whom he was accountable. The shortcoming of this rule must, I imagine, have been that it left the initiative with the seller, rather than with the consignee who was the person who had suffered the loss of or damage to the goods. It is not surprising, therefore, that Parliament intervened only fifteen years later, in 1855, to pass the Bills of Lading Act of that year, under section 1 of which a person to whom the property in the goods had passed upon or by reason of the consignment to him of the goods or the indorsement to him of the bill of lading acquired a direct right of action against the shipowner on the terms of the bill of lading. (The Act of 1855 has recently been repealed and replaced by the Carriage of Goods by Sea Act 1992.) The more effective remedy given by statute must have meant that the useful life of the rule in Dunlop v. Lambert was relatively short. For present purposes, however, the important point is that the function of the rule was to escape the undesirable consequences of the privity rule in a particular context, though it had the incidental effect that, if there is a rule that a party can only recover damages for breach of contract in respect of his own loss, then the rule in Dunlop v. Lambert constitutes an exception to that rule.

Let me turn next to consider in this context Lord Griffiths' broad ground in the St. Martin's case. It is at once plain that Lord Griffiths was not concerned with a problem of privity of contract; on the contrary, he was concerned that a contracting party who contracts for a benefit to be conferred on a third party should himself have an effective remedy. He was moreover addressing not a special problem which arises in a particular context, such as carriage of goods by sea, but a general problem which arises in many different contexts in ordinary life, notably in the domestic context where parties may frequently contract for benefits to be conferred on others, though it may well arise in other contexts, such as charitable giving or even, as the present case shows, a commercial transaction. His problem was not, therefore, privity of contract; it was the rule, or supposed rule, that a party can only recover damages in respect of his own loss.

The purpose of this analysis is to demonstrate that, in my opinion, the invocation of the rule in Dunlop v. Lambert 6 Cl. & F. 600 in the present context is, I believe, inapposite. This is because we are not here addressing a problem of privity of contract. The problem is not that UIPL had no enforceable rights against McAlpine arising under the building contract: it was the evident intention that UIPL should not have such rights, its rights against McAlpine being restricted to different rights under a separate contract, the DCD. That the rule in Dunlop v. Lambert is inapposite in the present context is illustrated in particular by the irrelevance, in this context, of any contemplation that the property of the contracting party should be transferred to a third party - a feature which was regarded by Lord Diplock as a prerequisite of the application of the rule in Dunlop v. Lambert, and was fortuitously present in the St. Martin's case [1994] 1 A.C. 85. An indication that any such prerequisite is irrelevant in the present context may be derived from the fact that, in the next case in which the St. Martin's case was applied, Darlington Borough Council v. Wiltshier Northern Limited [1995] 1 W.L.R. 68, there was no such feature and yet its absence was ignored by the Court of Appeal, no doubt because they felt that it did not matter. The same applies to the judgment of the Court of Appeal in the present case. In truth, what we are concerned with here is the effectiveness of the rights conferred on Panatown under the building contract itself. ...

It follows, in my opinion, that the principal argument advanced on behalf of McAlpine is inconsistent with authority and established principle. This conclusion may involve a fuller recognition of the importance of the protection of a contracting party's interest in the performance of his contract than has occurred in the past. But not only is it justified by authority, but the principle on which it is based is supported by a number of distinguished writers, notably Professor Brian Coote and Mr. Duncan Wallace Q.C.

However, as I have already recorded, it was the submission of McAlpine that your Lordships should regard any such development in the law as a matter for legislation, presumably after a reference to the Law Commission. This submission was made on the basis that the Lord Chancellor had introduced into Parliament a Bill - the Contract (Rights of Third Parties) Bill, based on a Report by the Law Commission, designed to bring about a radical reform of the privity rule, and that the prospect of this imminent legislation rendered illegitimate any further judicial activism in the field which was the subject of the present appeal. That Bill is now on the statute book: see the Contracts (Rights of Third Parties) Act 1999.

I am unable to accept this submission. As I have previously explained, this case is not concerned with privity of contract. There is no question of a third party here seeking to enforce a jus quaesitus tertio - i.e., of UIPL enforcing a right arising under the contract between McAlpine and Panatown. On the contrary, the reason why Panatown contracted as employer under the building contract with McAlpine was so that UIPL, although the owner of the site, should not do so. Even if the new Act had been in force at the material time, it would not have given UIPL any right to enforce the building contract, or any provision of it, against McAlpine. ...

Furthermore, as I have just indicated, full recognition of the importance of the performance interest will open the way to principled solution of other well-known problems in the law of contract, notably those relating to package holidays which are booked by one person for the benefit not only of himself but of others, normally members of his family (as to which see Jackson v. Horizon Holidays Ltd. [1975] 1 W.L.R. 1468), and other cases of a similar kind referred to by Lord Wilberforce in his opinion in the Woodar Investment case at p. 283 - cases of an everyday kind which are calling out for a sensible solution on a principled basis. Even if it is not thought, as I think, that the solution which I prefer is in accordance with existing principle, nevertheless it is surely within the scope of the type of development of the common law which, especially in the law of obligations, is habitually undertaken by appellate judges as part of their ordinary judicial function. That such developments in the law may be better left to the judges, rather than be the subject of legislation, is now recognised by the Law Commission itself, because legislation within a developing part of the common law can lead to ossification and a rigid segregation of legal principle which disfigures the law and impedes future development of legal principle on a coherent basis. It comes as no surprise therefore that, in its Report on "Privity of Contract: Contracts for the Benefit of Third Parties, (1996) (Law Com. No. 242) para. 5.15, the Law Commission declined to make specific recommendations in relation to the promisee's remedies in a contract for the benefit of a third party (here referring to The Albazero [1977] A.C. 774 and Linden Gardens Trust Ltd. v. Lenesta Sludge Disposals Ltd. (the St. Martin's case) [1994] 1 A.C. 85 as cases in which "the courts have gone a considerable way towards developing rules which in many appropriate cases do allow the promisee to recover damages on behalf of the third party"), and stated that the Commission "certainly … would not wish to forestall further judicial development of this area of the law of damages." This certainly does not sound like a warning to judicial trespassers to keep out of forbidden territory; see also para. 11. 22, concerned with the problem of double liability - which I shall have to consider at a later stage.

The present case provides, in my opinion, a classic example of a case which falls properly within the judicial province. I, for my part, have therefore no doubt that it is desirable, indeed essential, that the problem in the present case should be the subject of judicial solution by providing proper recognition of the plaintiff's interest in the performance of the contractual obligations which are owed to him. I cannot see why the proposed statutory reform of the old doctrine of privity of contract should inhibit the ordinary judicial function, and so prevent your Lordships' House from doing justice between the parties in the present case. As I have said, the principal function of this submission of McAlpine appears to have been to restrict the argument of Panatown to the narrower ground in Dunlop v. Lambert 6 Cl. & F. 600 and by so doing to enable McAlpine to argue that, on that basis, the cause of action by Panatown under the building contract was excluded by the separate contractual right afforded to the building owner, UIPL, under the DCD. That is a matter which I will have to address when I come to consider the second issue in the case. ...

Your Lordships were assisted by a presentation by Mr. Jeremy Nicholson, junior counsel for Panatown, on the applicable German law, for which I was grateful. This was founded upon advice received from Hannes Unberath, recently a graduate student at Worcester College, Oxford, and the author of an interesting case note on the present case in the Law Quarterly Review: see (1999) 115 L.Q.R. 535. His thesis is that, in Germany, the present case would be decided in favour of Panatown on the basis of a principle called Drittschadenliquidation, which has been loosely translated into English as "transferred loss" - an expression which I have myself adopted from time to time, though not I fear with any great accuracy. Indeed the concept is not an easy one for a common lawyer to grasp; and, with all respect to Unberath, I do not feel sufficiently secure to adopt it as part of my reasoning in this opinion. Even so, I find it comforting (though not surprising) to be told that in German law the same conclusion would be reached as I have myself reached on the facts of the present case. I have however also been struck by the provisions of paras. 633 and 635 of the BGB, falling within the Seventh Title entitled Contract for Work. I note (from Ian Forrester's translation of 1975) that the remedies under these two paragraphs (for defective work and for non-fulfilment) are vested in "the customer," and that there is no indication that the situation might be different if the property on which the work is to be done is vested in a person other than the customer. ...

LORD MILLETT

... In the St. Martins case [1994] 1 A.C. 85, 96-98 Lord Griffiths refused to accept the proposition that in the case of a contract for work, labour and the supply of materials the recovery of more than nominal damages should depend on the plaintiff having a proprietary interest in the subject matter of the contract at the date of breach. He observed that in every day life contracts for work and labour are constantly placed by persons who have no proprietary interest in the subject matter of the contract. He instanced the common case where the matrimonial home is owned by the wife, the couple's other assets belong to the husband and he is the sole earner. The house requires a new roof and the husband places a contract with a local builder to carry out the work. The husband contracts as principal and not as agent for his wife because only he can pay for the work. The builder fails to repair the roof properly and the husband has to call in and pay another builder to complete the work. Lord Griffiths considered that it would be absurd to say that the husband has suffered no loss because he does not own the property. He suggested that the husband has suffered loss because he did not receive the bargain for which he contracted with the first builder and the measure of damages is the cost of securing performance of that bargain by having the repairs done properly by the second builder. ...

To my mind the most significant feature of the academic literature is that no one has suggested that the adoption of the broad ground would have any adverse consequences on commercial arrangements. Nor, despite every incentive to do so, has McAlpine been able to suggest a situation in which it would cause difficulties or defeat the commercial expectations of the parties. In my view it would help to rationalise the law and provide a sound basis for decisions like Ruxley Electronics and Construction Ltd. v. Forsyth [1996] A.C. 344 and Jackson v. Horizon Holidays Ltd. [1975] 1 W.L.R. 1468. If it is adopted, it will be for future consideration whether it would provide the better solution in cases such as St. Martin also. ...

It must be wrong to adopt a Procrustean approach which leaves parties without a remedy for breach of contract because their arrangements do not fit neatly into some pre-cast contractual formula. When such arrangements have been freely entered into and are of an everyday character or are commercially advantageous to the parties, it is surely time to re-examine the position.

This is the product of the narrow accountants' balance sheet quantification of loss which measures the loss suffered by the promisee by the diminution in his overall financial position resulting from the breach. One of the consequences of this approach is to produce an artificial distinction between a contract for the supply of goods to a third party and a contract for the supply of services to a third party. A man who buys a car for his wife is entitled to substantial damages if an inferior car is supplied, on the assumption (not necessarily true) that the property in the car is intended to vest momentarily in him before being transferred to his wife, whereas a man who orders his wife's car to be repaired is entitled to nominal damages only if the work is imperfectly carried out. This is surely indefensible; the reality of the matter is that in both cases the man is willing to undertake a contractual liability in order to be able to provide a benefit to his wife.

The idea that a contracting party is entitled to damages measured by the value of his own defeated interest in having the contract performed was not new in 1994. A strong case for its adoption in the case of consumer contracts was made in an important article "The Consumer Surplus" [1979] 95 L.Q.R. 581, in which the authors explained that this would make a significant difference only in a minority of cases. As I shall show, the language of defeated expectation has been employed in the context of building contracts, at least in ordinary two-party cases like Ruxley, since the 19th century. ...

8. Economic loss (legal malpractice)

Back to top

This page last updated Thursday, 01-Dec-2005 11:04:42 CST. Copyright 2007. All rights reserved.