The Secretary of Justice has recently asked for comments on the Contracts (Rights of Third Parties) Bill. This Bill proposes to amend the doctrine of privity of contract in Hong Kong. If it becomes law a third party will be able to enforce certain rights conferred on it under a contract despite not being a party to that contract.

How important are these proposals? Will the proposed law impact insurers? Should insurers be taking any action now? Submissions on the proposals are due by 31 December 2012. What submissions should the insurance industry be making?

A simple example demonstrates the position now and the position after enactment of the proposals if they were to come into force.

Now:

An employer enters into an insurance policy with an insurer for reimbursement of its employees’ medical expenses. An employee makes a claim for medical costs reimbursement but then leaves employment. The insurer declines the claim for good reason and the employer accepts that determination. The employee has no right to claim or pursue recovery against the insurer as the employee is not a party to the policy.

After:

If the policy is found to intend to confer rights on employees as third parties, the employee may have the right to claim directly against the insurer (subject to the mechanics of the proposed scheme). Importantly, once the employee relies on the policy, the insurer and employer may need the employee’s consent to amend the policy. For this reason if insurance contracts are included it is likely that insurers will need to take advantage of one of the terms of the proposed scheme which is that the contracting parties may exclude third party rights if they choose to do so.

Law Reform Commission (LRC) consultation and recommendations

When the LRC considered the privity of contract issue back in 2005 and carried out a previous consultation the Hong Kong Federation of Insurers proposed, for a variety of reasons, that any scheme recognising third party rights in contract should not apply to insurance contracts. However, when the LRC recommended that the law be changed so that if parties to a contract conferred a benefit on third parties (subject to the contracting parties’ intention expressed in the contract), that right could be legally enforceable through a legislative scheme - insurance contracts were not to be exempted.

The scheme now proposed by the Bill will apply to most contracts including insurance contracts although there will be limited exemptions for contracts where third parties already have an enforceable right under certain rules reflecting international conventions.

How are third party rights recognised and protected under the scheme?

The scheme applies only to contracts entered into after the effective date of the Bill. A third party will have a right to enforce a contract term where the contract expressly provides or where on a proper construction of the contract a term purports to confer a benefit on a third party. Third parties must be expressly identified by name, or be a member of a class or answer to a particular description. The scheme also permits third parties not in existence at the date of contract to be conferred with contractual rights. To avoid certain amendments of agreements entered into before the scheme’s commencement from unintentionally falling within the scheme, some amendment of the application provisions of the scheme may be helpful.

Where a third party has made a claim the party who has made the contractual promise (promisor) retains the defences under the contract the promisor would have had in relation to a contractual party exercising the same right. To avoid the possibility of double payment, the scheme recognises the extent to which the promisor has performed the relevant obligation or paid a sum in respect of the third party loss to the other party to the contract. The scheme also provides that the enforcement of third party rights may be conditional upon doing so by arbitration or in a specified jurisdiction.

The rights conferred on a third party are generally those that would have been available had they been a party to the contract including the ability to assign those rights. However, the contracting parties can avoid conferring rights on third parties and can also prevent them from assigning any rights they are given by clear contractual provisions to the contrary.

Crystallising third party rights

The scheme contains important provisions preventing the rescission and variation of contracts where the third party rights conferred have "crystallised", unless the consent of the third party has been obtained. Rights crystallise either when the third party agrees to the provision, or the third party relies on the provision and the promisor knows or ought reasonably have foreseen the reliance. Whilst the scheme provides that a contract may permit rescission and variation without a third party’s agreement, the third party must be made aware of the term or reasonable steps must be taken to notify the third party of that provision before the rights crystallise.

Other third party rights not affected

Certain laws in Hong Kong already confer rights on third parties. In the context of insurance, these include:

  • The Employees' Compensation Ordinance
  • The Motor Vehicles Insurance (Third Party Risks) Ordinance
  • The Third Parties (Rights Against Insurers) Ordinance
  • The Married Persons Status Ordinance

Even though the proposed scheme does not affect the rights conferred on third parties by these laws, it may be helpful for it to clarify that credit for payments made under these laws will be given.

Action items

A detailed review of all contracts (including insurance and reinsurance policies) will be required to prepare for the introduction of the new scheme. Some of the matters that will need to be considered include:

  • Drafting provisions excluding the application of the scheme and ensuring:
    • These apply properly
    • In the context of insurance policies that these provisions do not defeat the rights required to be conferred under certain statutory cover (e.g. motor and employees' compensation)
    • Reinsurance "cut through" clauses operate as required
  • The cover intended for third parties in order to:
    • Carefully craft the rights to variation and rescission provisions where there are beneficiaries (including how these provisions are to brought to the attention of the third parties)
    • Consider provisions excluding third parties that are not in existence at the date of contract (as they may otherwise be covered)
    • Prepare provisions, to the extent possible, that avoid double indemnities or topping up claims
    • Prepare provisions that deal with how (if at all) third parties may assign their rights under the scheme or to exclude that right
    • Revisit all limitation provisions, set offs, defences and the like to ensure they also apply to the third party
    • Ensure arbitration and exclusive jurisdiction clauses apply to third parties
    • Ensure relevant time limits in contracts are preserved as against third parties

In the context of industry bodies such as the Motor Insurers Bureau and the Employees’ Compensation Insurer Insolvency Bureau, consideration will need to be given as to how, if at all, third party rights may be conferred.

Next steps

The consultation period ends on 31 December 2012.