On 1 January 2016, the Contracts (Rights of Third Parties) Ordinance (the Ordinance) comes into effect in Hong Kong. The Ordinance will allow a person who is not a party to a contract to enforce any rights and benefits provided to them under that contract.
The doctrine of privity
Under traditional contract law, only the parties to a contract are entitled to enforce their rights and benefits under the contract. Over the years, this doctrine of “privity” has increasingly been seen as too strict.
There are many situations where two parties might enter into a contract wholly or partly for the benefit of another person who is not party to the contract. For example, a person may obtain a health insurance policy which covers his whole family. The policy is clearly intended to provide health benefits to all members of the family, but under traditional contract law, only the person holding the contract could enforce the policy in court. Other common examples include:
- a trade union and an employer entering into a collective bargaining agreement for the benefit of the employees;
- a head contractor and a sub-contractor entering into a contract to carry out work for the benefit of the customer who hired the head contractor; or
- an event organiser and a record company entering into a contract to hire a famous singer to perform at an event.
In each case, under contract law, only the parties to these contracts could take legal action to enforce them.
The effects of the Ordinance on privity
The Ordinance provides that a person who is not a party to a contract may enforce a term under the contract if:
- the contract expressly provides that the third party may enforce the term; or
- the term purports to confer a benefit on the third party, unless it is clear that the parties did not intend that term to be enforceable by the third party.
This makes it very important for contracting parties to be clear in drafting their contracts. Previously, the doctrine of privity has meant that the contracting parties can get away with some ambiguity in a contract regarding who an obligation is owed to or who should receive a benefit under the contract, because courts would tend to assume that it had to be one of the contracting parties. However, once the Ordinance comes into effect, courts may be less willing to make this assumption.
The Ordinance also provides that the contracting parties may not vary or terminate a contract without the consent of any third party who is entitled to enforce rights or benefits under the contract, and that such a third party:
- may assign his rights under that contract to another person, in the same way as an equivalent contractual right could be assigned; and
- is subject to any dispute resolution provisions (such as an exclusive jurisdiction clause) set out in the contract.
In defending any claim made by a third party, the contracting parties may raise any defence they would be entitled to raise in relation to any claim of breach of contract – for example, misrepresentation, duress or undue influence. The Ordinance also protects contracting parties against “double dipping” by providing that they cannot be liable to both a contracting party and a third party for the same loss.
The Ordinance does not apply to some specific types of contract: for example, contracts for carriage of goods, company articles of association and bills of exchange. Most of these excluded contracts are already covered by specific third party rights legislation. There is also a limited exception for employment contracts: third parties can enforce an employment contract against the employer, but not against the employee (otherwise, a customer who received poor service from an employee could sue the employee for breaching their employment contract).
Excluding the effects of the Ordinance
Often, the contracting parties may want to exclude the effects of the Ordinance in whole or part. They may want to exclude all third party rights entirely, or specify which third parties may or may not enforce the contract.
It is important to note that all the third party rights granted under the Ordinance are subject to the express terms of the contract. So it is open to contracting parties entering into a contract after 1 January 2016 to provide in the contract that:
- no third party (or only specified third parties) will have the right to enforce any rights or benefits under the contract;
- third parties may only enforce their rights under specified provisions of the contract;
- any rights or benefits provided to a third party under the contract are personal and not assignable; and/or
- the contracting parties may vary or terminate the contract without the consent of any third party (or with the consent of specified third parties only).
Where the contracting parties wish to allow a specific third party to enforce its rights under the contract, it may be better (if it is practical) to simply make that third party a contracting party. This not only reduces uncertainty by making the third party’s interest more clear and providing the third party with a copy of the contract, but it also allows the other contracting parties to impose obligations on and seek warranties from the third party.
From 1 January 2016, any business entering into a contract should:
- consider whether any third parties potentially have an interest in or rights under the contract;
- consider making any interested third party as a party to the contract;
- check that the drafting of the contract is clear and states who each obligation is owed to and who receives each right or benefit; and
- if appropriate, include a clause in the contract which expressly excludes the operation of the Ordinance.