The long awaited Contracts (Rights of Third Parties) Ordinance (the "Ordinance") came into force on 1 January 2016, nearly 12 years after the initial consultation paper in May 2004. This Ordinance reforms the previous contractual regime characterised by the strict privity of contract doctrine (the "Privity Doctrine") and allows persons who are not party to a contract to enforce rights under a contract as if they were parties to the contract. This brings Hong Kong law in line with countries such as the UK and Singapore, where similar legislation has been enacted. For the most part, third party rights are already recognised in Europe and the United States.
Why the need for reform?
The Privity Doctrine is comprised of the following restrictions:
- a person cannot acquire and enforce rights under a contract to which they are not a party; and
- a person who is not a party to a contract cannot be made liable under it.
The second aspect of the Privity Doctrine is generally considered fair and sensible. However, the first aspect has been subject to heavy criticism, in particular for being an artificial rule that fails to reflect or give effect to modern commercial arrangements. Contracting parties would need to circumvent the Privity Doctrine through complex legal devices e.g. by establishing an agency or trust with the third party or assigning rights under the contract to the third party, which come with their own risks and limitations.
What is the scope of application of the Ordinance?
From 1 January 2016, parties entering into a contract are able to create contractual rights that are legally enforceable by third parties. Alternatively, contracting parties can elect to contract out of the Ordinance and maintain the Privity Doctrine.
The Ordinance does not apply to all types of contracts. Bills of exchange, promissory notes, negotiable instruments, deeds of mutual covenant, any covenant in relation to land, contracts of carriage, letters of credit and a company's articles of association are explicitly excluded from the operation of the Ordinance, either for policy reasons or because third parties already have rights under the law.
In addition, employment contracts cannot confer a right on a third party to enforce a term of against an employee. However, it is possible to allow a third party to enforce a term against an employer.
How can third party rights be enforced under the Ordinance?
Under the Ordinance, a third party can enforce a term of a contract, including a term that excludes or limits liability, in the following circumstances:
- if the contract expressly provides that the third party may do so; or
- if, on the proper construction of the contract, the term purports to confer a benefit on the third party.
The contract must expressly identify the third party by name, as a member of a class or as answering a particular description. However, the third party referred to need not be in existence at the time the contract was entered into.
The reference to a "term" instead of a "contract" means that the Ordinance allows parties to select the terms under the contract which they intend for the third party to enforce, and to differentiate these from the terms which the contracting parties only intend to be enforceable between themselves.
The contract may either expressly state that a term is enforceable by a particular third party, or the contract may "purport" to confer a benefit on its proper construction. The latter permits a degree of ambiguity in the contract, and a court would ultimately need to use its interpretative skills to determine the parties' true intentions. Clearly parties will be better advised to expressly agree to third party rights at the time of negotiating the contract, to avoid future dispute.
A third party who has been granted the right to enforce any contractual term can also assign such right to another party in the same way as a party to the contract may assign a right under the contract, unless this is expressly (or on the proper construction of the contract) forbidden.
Protection for third parties under the Ordinance
To ensure that third party rights are more than mere words on paper, the Ordinance offers protection to third parties. Once a third party right is granted, the contracting parties cannot rescind the contract or vary the terms of the contract in a way that would alter or extinguish the third party's rights if:
- the third party has assented to the terms and the parties to the contract have received notice of such assent; or
- the third party has relied on the terms and the parties to the contract are aware, or can reasonably be expected to be aware, of such reliance.
If the contracting parties wish to vary or rescind the contract without the third party's consent, they can do so by express provision to this effect, as long as the third party is made aware of the existence of such a provision at any time before he or she assents to, or relies upon the relevant terms.
Protection for contracting parties under the Ordinance
If a contracting party is faced with third party proceedings to enforce a term of a contract, the contracting party is entitled to rely on any defence, set-off or counterclaim available under the contract. In other words, the contracting party can treat the third party as a party to the contract, and raise any suitable defence or counterclaim that they would have had in proceedings brought by a counterparty.
Significance of the Ordinance
The Ordinance is likely to benefit businesses across a wide range of sectors, particularly for construction contracts which involve the sub-contracting of projects to third parties and insurance contracts which confer the benefits under an insurance policy upon third parties. These contracts will no longer need to rely on complex legal mechanisms to enable enforcement of third party rights. In properly drafted contracts, the Ordinance will also enable group companies to bring damages claims in the event that losses are suffered by a group entity which was not party to the contract.
On the other hand, if the effect of the legislation is ignored, there is a risk of contracting parties being subject to liability for unintended third party rights. To mitigate against this risk, businesses should revise their contract templates to negate or control the effects of the Ordinance. For example, the contract might exclude all third party interests other than those expressly provided for in the contract. Alternatively, parties can simply contract out of the Ordinance altogether. A solid comprehension of the Ordinance and careful drafting of contracts will help reap the benefits of the Ordinance and at the same time prevent any unforeseen liability of businesses to third parties.