Background
Following up with our previous article, “Key Features of the Contracts Rights of Third Parties Bill” in May 2014, the bill in discussion was passed by the Legislative Council on 26 November 2014 and is expected to come into effect on 1 January 2016.

This article focuses on the key provisions of the Contracts (Rights of Third Parties) Ordinance (the “Ordinance”) which may affect the contracting parties and the rights of third parties, the application of the equivalent legislation in the UK and the implications brought about by the Ordinance.

The Contents of the Ordinance

Rights of Third Parties to Enforce Contractual Term
Section 4 of the Ordinance provides that a third party may enforce a term of a contract where: (i) it is expressly provided by the contract or (ii) when a contract purports to confers a benefit to the third party and the intention for the third party to enforce the contract is not expressly rebutted.  

In relation to the second scenario, it might lead to uncertainty when the wording of the contract is unclear as to whether its terms are intended to be enforced by third parties.  Therefore, when drafting the contract, parties should ensure that their intention is made clearly through the wording chosen to prevent results that are contrary to the original intent.

In order to rely on the Ordinance, the third party must be expressly identified in the contract by name, as a member of a class or as answering a particular description. Such third party does not have to give consideration for the benefits under the contract and does not even need to exist at the time of contract.  

Remedy
The Ordinance seeks to protect the third parties by giving them similar rights as those that are parties to the contract, therefore the remedies available are the same as those that would normally be available to a contracting party in an action for breach of contract, including remedies available under equity.  Accordingly, any laws applicable to the aforementioned remedies would apply, such as test of remoteness and mitigation. However, the Ordinance does not affect remedies available to third party from sources other than the Ordinance.

Rescission and Variation
The Ordinance allows the parties to the contract to rescind or vary the contract without the third party’s consent if the contract expressly provides that the parties have such right (section 7(3) of the Ordinance).   If there is no such express provision, the parties may rescind or vary the contract only when the third party’s rights have not “crystallised”.  The third parties’ rights would have “crystallised” in either of the following situations:

1.         The third party has agreed to the term, and that the promisor has received notice of such agreement (section 6(2)(a) of the Ordinance); or

2.         The third party has relied on the term and the promisor is either aware of the reliance; or can reasonably be expected to have foreseen such reliance (section 6(2)(b) of the Ordinance).

Apart from the above, the parties may apply to the Court for an order to dispense with the third party’s consent requirement (section 7(2) of the Ordinance) if (i) all the contracting parties agree to rescind or vary the contract; and (ii) the Court thinks it as just and practicable to do so.  The Court could also impose any condition as it thinks fit, such as requiring payment of compensation to third party.

Defence and Counter Claims
Although the Ordinance expands the third party rights, it does not diminish the contracting parties’ rights under the contract.  Under section 8 of the Ordinance, the promisor may raise matters that would have been available to himself by way of defence, set-off or counterclaims against such third party had the third party been a contracting party.

Protection of Promisor from Double Liability
Under section 11 of the Ordinance, the promisor is discharged from liability to the extent of any performed obligations to third party.  This means if the promisee has recovered from a sum in respect of the third party’s loss or the promisee’s expense, the Court must reduce any award to third party to an appropriate extent. The promisor is protected and only liable for single liability in respect of the same loss when the promisee and third party are permitted to enforce the same term.

Contracting Party’s Discretion
The Ordinance does not completely replace the doctrine of the Privity of Contract, as contracting parties may choose to opt out the Ordinance by expressly stated in the contract that the Ordinance does NOT apply, or that any particular third party rights are to be excluded in the contract.

Arbitration, Exclusive Jurisdiction, Assignment and Limitation Period
Unless the contracting parties intend to the contrary, a third party is treated as a party to the arbitration agreement in the contract if either of the following situations apply:

1.         The third party’s right to enforce a term of contract is subject to procedural condition to enforce by way of arbitration (sections 12(1) to (3) of the Ordinance); or

2.         The third party is given a procedural right to require disputes with the promisor be submitted to arbitration (sections 12(4) to (6) of the Ordinance).

Unless intended otherwise by the contractual parties, the third party right has to be enforced in a specified jurisdiction according to any exclusive jurisdiction clause in the contract (section 13 of the Ordinance).

Pursuant to section 14(1) of the Ordinance, the third party may assign its rights, unless the contract expressly provides otherwise (section 14(2)(a) of the Ordinance) or the right is personal to the third party and is not assignable (section 14(2)(b) of the Ordinance).

In respect of the limitation period, a claim of third party’s rights under a simple contract is 6 years (section 16(1) of the Ordinance and section 4(1) of the Limitation Ordinance); and a claim under an action upon a specialty (e.g. under a Deed) is 12 years (section 16(2) of the Ordinance and section 4(3) of the Limitation Ordinance).

Insights from the UK Cases – Presumption of Enforceability
Since the Ordinance has yet to come into effect in Hong Kong, it has not been tested in local cases.  However, its effects could be glimpsed from observing how the equivalent Contracts (Rights of Third Parties) Act in the UK applied in the precedents.

In Hurley Palmer Flatt Ltd v Barclays Bank Plc [2014] EWHC 3042 (TCC), the third party of a construction contract claimed against the promisor for defects in construction and wished to refer the disputes to adjudication. However, the promisor argued that the third party had no rights to do so. The Court decided that the wording of the contract only conferred the third party’s rights to enforce the terms of contract, but not the right to refer disputes to adjudication.  

Therefore, if the contracting parties wish to confer benefits to the third party, it is important for them to ensure that the wording of the contract specified all those rights. This is because only those rights that are expressly stated and those that can be implied are effectively conferred to the third party.

In a tenancy dispute of Prudential Assurance Co Ltd v. Ayres [2007] EWHC 775 (Ch), the landlord sought to recover rent from the previous tenants of premises (in their capacity as guarantors of the partnership to which an underlease had been assigned).  The landlord had granted an underlease to the tenant who wished to assign the underlease to the partnership. The landlord agreed to the assignment by tenant to the partnership.  In the licence to assign the tenant covenanted with and guaranteed to the landlord that if the partnership failed to pay rent then the tenant would pay.

Through a separate supplemental deed between the landlord and the partnership to which the tenant was not a party, it was agreed that “Liability of the tenant … shall be limited to the partnership … and such liability shall not extend to the personal assets of individual partners …”. However, the partnership subsequently became insolvent leaving rent unpaid and the landlord claimed against the tenant.  The tenant defended by claiming to enforce its third party rights under the deed and the tenant’s liability was limited to the amount of the partnership’s assets.  

The Court of Chancery decided that the third party was able to rely on its rights, even though there was no express provision for the rights, since the third party’s rights were not rebutted, it was assumed to be intended.  It was however found to be inconsistent with the intention of the contracting parties, and was ultimately reversed in the Court of Appeal ([2008] EWCA Civ 52 (CA)).  This case highlighted the importance to expressly exclude third party rights whilst they are not intended, so to prevent situations where the result would be contrary to the intentions of the parties.

In the shipping case Dolphin Maritime & Aviation Services Ltd v. Sveriges Angfartygs Assurans Forening [2009] EWHC 716, the third party was used as an agent to collect money owed between contracting parties, but they settled the sum directly without having the third party to withhold the same.  The Court held that the wording of the contract does not confer any benefits to the third party, and therefore the third party was not entitled to the rights given by the 1999 Act, as it was not intended by the wording.

These cases demonstrate the importance of clear drafting to ensure that the contracts will be interpreted as intended by the parties.  If a party wishes to confer rights upon the third party, it should do so expressly.

Conclusion
The Ordinance appears to strike a fine balance between third party rights and the rights of contracting parties.  It attempts to better carry out the intentions of the parties by giving them the choice in whether they wish to confer rights to the third party and, if so which rights are to be conferred.  So long as the parties are careful in their drafting of the relevant clauses to clearly state their intentions, the Ordinance will be a significant improvement on the law of contracts, and allows Hong Kong to catch up with other common law jurisdictions’ developments in this area.

For enquiries, please contact our Litigation & Dispute Resolution Department:

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Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.