Introduction

The Contracts (Rights of Third Parties) Ordinance, Cap 623 (“Ordinance”) came into effect on 1 January 2016. In previous newsletters, we have given overviews of the Ordinance and recommended that companies carefully review their contracts and expressly exclude the statutory provisions, where they wish to do so:

Hong Kong’s Privity of Contract Law Under Review

Contracts (Rights of Third Parties) Ordinance gazetted on 5 December 2014

Contracts (Rights of Third Parties) Ordinance or Contract Out of Rights of Third Parties?

By way of recap, under the common law doctrine of Privity of Contract, a third party (i.e. a party who is not named in and has not signed a contract) cannot acquire or enforce rights under the contract and cannot be made liable under it. The Ordinance reforms the doctrine by providing that a third party may enforce a term of the contract (including a term excluding or limiting liability) if:-

  1. the contract expressly provides that the third party may do so; or
  2. the term purports to confer a benefit on the third party.

The Ordinance will apply not only where a third party is named in a contract, but also where they are expressly identified as a member of a class or as answering a particular description. The Ordinance will not apply, however, if on a proper construction of the contract, the term is not intended to be enforceable by a third party.

Which contracts does the Ordinance apply to?

The Ordinance applies to contracts entered into on or after 1 January 2016, except for certain types of contracts, namely bills of exchange, promissory notes or other negotiable instruments, deeds of mutual covenant, contracts of carriage, letters of credit, contracts of employment (as regards enforcement of a term against employees) and a company’s registered articles.

Contracts of Insurance

Contracts of insurance are covered by the Ordinance and so insurers need to be aware of how the Ordinance affects them. The Ordinance will apply to all insurance contracts entered into on or after 1 January 2016, which will include renewals of insurance contracts on or after that date.

Many types of insurance contracts confer benefits on third parties, for example, life insurance policies under which the insured party nominates a third party to receive a payment upon the insured’s death and public liability policies, where third parties are compensated for injuries or damage to their property. Under the Ordinance, such third parties may be able to directly enforce those benefits against the insurers even though they were not a party to the insurance contracts.

Concerns

A key concern is that third parties may enforce a term of a contract against the insurer, where the policy “purports to confer a benefit” on them. Accordingly, careful drafting of policies is required to ensure that no third party rights are created where none were intended.

Another concern is that where a third party is entitled to enforce a term under the policy and they have assented to or relied on the term in question, the parties to the policy cannot rescind or vary the policy without that third party’s consent. Accordingly, this may affect the insurer and their insured if they wish to alter the terms or add endorsements that affect the rights of the third party.

The parties to the policy can avoid this by careful drafting, by including an express term in the policy stating that they can vary or rescind the policy without the third party’s consent.

Defences available to insurers

The good news for insurers is that under the Ordinance, in the event that a third party tries to enforce a benefit directly against them, they can raise any defence that they could have raised had the action been brought by the insured. For example, if the insured had breached the policy, the insurer would be entitled to rely upon that breach as a defence to the third party’s claim.      

Contracting out of the Ordinance

Insurers may contract out of the Ordinance altogether by including in their insurance policies a clause to the effect that the application of the Ordinance is expressly excluded and that the policy does not confer any rights enforceable by any third parties.

What should insurers do?

It is important for insurers, if they have not already done so, to:-

  • Carefully review their insurance policies to ascertain whether they confer any benefits on third parties, which could be enforced against them under the Ordinance. 
  • Where it is not intended to confer any third party benefits, include a clause in the policy to exclude the application of the Ordinance.  
  • In most cases, insurers will want to exclude the Ordinance, but in any cases where it is intended to confer third party benefits, ensure (by careful drafting) that those third parties are specifically identified (so that no unintended third parties are covered) and that the ambit of benefits to be conferred is no wider than intended. A clause should also be included stating that the contract can be varied or rescinded without the third party’s consent.