Privity of Contract: The Malaysian Common Law Rule vs Chinese Third-Party Rights

Privity of contract is a core principle of common law, but it is also one of the most debated areas in commercial law. It prevents contracts from conferring rights or obligations on non-parties. While jurisdictions like the United Kingdom and Singapore have enacted laws allowing third parties to enforce contractual benefits, Malaysia has not adopted such reforms. In contrast, the 2020 Chinese Civil Code follows the civil law tradition, allowing contracts to benefit third parties and creating a significant divergence in cross-border contract enforcement.

The Malaysian Stance: The Persistence of Strict Privity

In Malaysia, privity is strictly enforced, following English precedents such as Tweddle v Atkinson and Dunlop Pneumatic Tyre Co Ltd v Selfridge & Co Ltd. Only contracting parties may sue on a contract. Although Section 2(d) of the Contracts Act 1950 allows consideration to move from a third party, Malaysian courts have held that this does not give third parties the right to sue.

The case of Schmidt v Kepong Prospecting Ltd confirms that even if a contract benefits a third party, only formal parties to the agreement can enforce it. This poses challenges in commercial arrangements such as insurance, construction sub-contracts, and trust structures. As a result, Malaysian practitioners often rely on trusts, agency, or assignment of rights to address these issues.

Malaysia has limited statutory exceptions, such as the Insurance Act 1996 and Road Transport Act 1987, which allow third-party claims against insurers. However, these exceptions are narrow and do not generally relax the privity rule. Without a Contracts (Rights of Third Parties) Act, practitioners must draft contracts with precision. To grant a third party the right to sue, they must usually be made a formal party or be included through a separate deed, increasing administrative complexity.

The Chinese Approach: Article 522 and the Intended Beneficiary

The Chinese Civil Code provides a stark contrast through Article 522, which formally recognises the rights of third-party beneficiaries. This reflects the civil law heritage that prioritises the true intent of the parties over the formalistic constraints of privity. Under the Chinese framework, a contract can be structured specifically to perform an obligation to a third party.

Article 522 stipulates that where the parties agree that the debtor shall perform the obligation to a third party, and the debtor fails to do so or the performance does not conform to the agreement, the debtor shall bear the liability for breach of contract to the creditor. Crucially, the second paragraph of Article 522, introduced in the 2020 Code, states that if the law provides or the parties agree that a third party may directly request the debtor to perform the obligation, and the third party does not explicitly refuse within a reasonable period, the third party has the right to request performance.

This marks a significant departure from the Malaysian position. In China, third parties are granted an independent right of action, allowing them to sue for performance or damages. This is especially useful in trade finance or logistics, where a sub-buyer may need legal standing to enforce delivery directly from a supplier.

Furthermore, the Chinese Civil Code distinguishes between third-party performance (where a third party fulfils an obligation) and third-party rights (where a third party receives a benefit). Article 523 covers the former, stating that if a debtor fails to have a third party perform the obligation, the debtor remains liable. This ensures that while benefits can be extended to strangers of the contract, the ultimate responsibility for performance remains anchored to the original contracting parties, maintaining a balance between flexibility and accountability.

Strategic Implications and the Evidentiary Shift

The divergence between these systems creates challenges for cross-border practitioners. Under Malaysian law, a parent company cannot sue on behalf of its subsidiary, nor can a subsidiary sue for a breach of a contract signed only by the parent. Lack of standing is a common defence in Malaysian litigation. To protect all entities, each must be a named party or covered by a collateral warranty.

Under Chinese law, the focus is on the intended beneficiary rather than the signatory. Enforcing or defending a third-party claim requires evidence of the original parties’ intent. If a contract specifies delivery to Company X, Company X may have the right to sue under Article 522. Malaysian practitioners should note that Chinese sub-contractors or affiliates may have greater legal standing than under Malaysian law.

This flexibility in Chinese law introduces risks. A party may be sued by a third party with whom they had no direct dealings. Under Article 522, the debtor can assert the same defences against the third party as against the original creditor. Therefore, maintaining clear records of the contractual relationship is essential to defend against such claims.

Managing the Privity Gap in Cross-Border Trade

When drafting cross-jurisdictional contracts, the choice of law is strategic. If you are providing a benefit to a third party, such as a guarantor or service provider, Malaysian law helps limit potential litigants. Strict privity ensures you are only accountable to the contracting party.

If you aim to protect a broader group of stakeholders, such as end-users or subsidiaries, the Chinese Civil Code provides a more direct solution. You can name third-party beneficiaries and grant them rights to request performance, avoiding the need for complex arrangements required in Malaysia.

Practitioners should be cautious of the incorporation by reference issue. In Malaysia, simply mentioning a third party does not grant them rights. In China, referencing a third party in performance clauses may trigger Article 522. Draft clauses carefully to avoid unintentionally granting third-party rights under Chinese law.

Conclusion: Formality vs Intent

Malaysia’s strict privity reflects a common law preference for commercial certainty and the sanctity of contracts between signatories. While this approach rewards precision, it can produce unfair outcomes when the intent to benefit a third party is blocked by a lack of standing.

The Chinese Civil Code formalises third-party beneficiary rights, prioritising economic reality and the intent behind commercial arrangements. This modern, flexible framework aligns with global trade practices where multi-party involvement is common.

For international trade lawyers, success depends on bridging these two legal philosophies. Whether working within Malaysian privity or the broader rights under Article 522, the objective is to ensure contractual benefits reach their intended recipients without exposing clients to unforeseen liabilities. Understanding these boundaries is essential for protecting commercial interests in Malaysia-China trade.

The article was first published on LinkedIn.