Collateral contract

A collateral contract is a contract where the consideration is the entry into another contract, and co-exists side by side with the main contract. For example, a collateral contract is formed when one party pays the other party a certain sum for entry into another contract. A collateral contract may be between one of the parties and a third party.

A party to an existing contract may attempt to show that a collateral contract exists if their claim for a breach of contract fails because the statement they relied upon was not held to be a term of the main contract. It has been held that for this to be successful, the statement must have been promissory in nature.[1]

It can also be explained as: a subsidiary contract that induces a person to enter into a main contract. For example: if X agrees to buy goods from Y that will, accordingly, be manufactured by Z, and does so on the strength of Z's assurance as to the high quality of the goods, X and Z may be held to have made a collateral contract consisting of Z's promise of quality given in consideration of X's promise to enter into the main contract with Y.

In the case of Barry v Davies, it was held that an Auctioneer and A buyer had formed a collateral contract. (Barry v Davies t/as Heathcote Ball & Co [2001] 1 All ER 944; [2000] 1 WLR 1962).

A theory sustains that is feasible to typify letter of credit as a Collateral Contract for a Third-Party Beneficiary because letters of credit are prompted by the buyer’s necessity and in application of the theory of Jean Domat the cause of a Letter of Credit is that a bank issue a credit in favor of a seller to release the buyer of his obligation to pay directly to the seller with legal tender.There are in fact three different entities participating in the letter of credit transaction the seller, the buyer, and the banker. Therefore, Letter of Credit theoretically fits as a collateral contract accepted by conduct or in other words, an Implied-in-fact contract.[2]

A collateral contract, if forged between the same parties as the main contract, must not contradict the main contract i.e. If the term was agreed upon prior to the completion of the formal contract (but was still included as a term, and could not be executed until completion of the second term), the first term will still be allowed.[3]

Collateral contracts are an exception to the Doctrine of Privity of Contract.[4]

A collateral contract is one where the parties to one contract enter into or promise to enter into another contract. Thus, the two contracts are connected and it maybe enforced even though it forms no constructive part of the original contract.

References

  1. ↑ J J Savage & Sons Pty Ltd v Blakney (1970) 119 CLR 435.
  2. ↑ Letter of Credit, its Relation with Stipulation for the Benefit of a Third Party
  3. ↑ Hoyt's Pty Ltd v Spencer (1919) 27 CLR 133.
  4. ↑ Shanklin Pier Ltd v Detel Products Ltd (1951) 2 KB 854.
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