Background
The Contracts (Rights of Third Parties) Bill (the “Bill”) was gazetted on 28 February 2014 and introduced into the Legislative Council for the first reading and commencement of second reading debate on 26 March 2014. It is expected that the Bill will pass and come into force sooner this year. As a sequel to our newsletter entitled “Proposed Third Parties’ Statutory Right to Enforce Contractual Terms” published in June 2013, this newsletter will recap the key features of the new regime and discuss the implication to contracting parties in future.

Common law doctrine of privity
Under the common law doctrine of privity of contract in Hong Kong, when contracting parties enters into a contract which confers benefit on a third party, who is not a party to the contract, the third party cannot acquire and enforce any right under that contract and he can only rely on one of the contracting parties to enforce his right. In many occasions, injustice may result from the strict application of this doctrine as it is contrary to the contracting parties’ intention.

Key features under new regime

Protection of the third party
The Bill proposes a new framework in which a third party may enforce his rights under a contract if (1) the contract has an express term which allows the third party to enforce his rights or (2) the contract purports to confer a benefit on the third party and the contracting parties intend for the term to be enforceable by that third party. Remedies available to the third party are the same as those available to the contracting party who brings an action for breach of contract, including damages, injunctions and specific performance etc.

Further, the third party is protected from variation or rescission of the contract by the contracting parties when he has assented to or relied on a term that confers him the rights. The contracting parties cannot rescind or vary the term without the third party’s consent, unless express terms of the contract provide the contrary and the third party is aware of or the contracting parties have taken reasonable steps to make the third party aware of such express terms prior to the third party’s assent or reliance. However, the court has wide discretion to dispense with third party’s consent if the contracting parties agree to rescission or variation and the court thinks that it is just and practicable to do so.

Moreover, the third party can assign his rights to enforce a term under the contract to another person, unless express terms of the contract provide otherwise or such right is not intended to be assignable.

On the other hand, third parties should note that the Bill specifies limitation periods for commencement of third party actions against a promisor, either 6 years or 12 years depending on the nature of the contract entered into between the contracting parties.

Protection of the contracting parties
A promisor is discharged from obligation owed to a promisee to the extent of any wholly or partly performed obligation to the third party. On the other hand, the Court must reduce any award to the third party to an appropriate extent if the promisee has already recovered from the promisor a sum in respect of the third party’s loss or the promisee’s expense of making good to the third party the default of the promisor.

Whilst the Bill expressly stipulates defences available to a promisor against a third party, contracting parties can choose to opt out the statutory regime by expressly excluding the application of the new ordinance in the contract. In the same vein, they can expressly provide that the contract may be rescinded or varied without the third party’s consent. 

Exceptions to the proposed Bill
The Bill applies to all contracts entered into after operation of the Bill subject to two exceptions. The first one is that the Bill does not affect the third party who already has right in those contracts according to the rules under international conventions such as bills of exchange, promissory notes, negotiable instruments, contracts for the carriage of goods by air and sea and contracts on a letter of credit. The second exception is pertained to contracts under which the third party has no right to intervene due to policy reasons such as contracts in a company’s memorandum and article of association and employment contracts.

Implications of the proposed Bill
Under the new regime of third party’s contractual rights, in the course of negotiation and drafting of the contract, contracting parties should first consider whether they intend for any benefit under the contract to be conferred on any third party.

If the contracting parties do not intend to confer any benefit on any third party, they are at liberty to exclude the application of the new ordinance by expressly stating the same in the contract. In this way, the doctrine of privity of contract can be preserved in their contract even under the new regime. Without doing so, a third party may still be able to enforce his rights as if he is a party to the contract if any contractual terms appear to be intended to confer him certain benefit.

On the contrary, if the contracting parties intend to confer benefit on any third party, they should promptly identify the potential third parties who are intended to be benefited under the contract. They should expressly specify the third parties who are intended to be conferred such benefit and, more importantly, excluding those third parties who are not so as to avoid any ambiguity.

To effectively confer benefit on an intended third party, the third party must be expressly identified by name, member of a class or a particular description. Such a third party may not necessarily exist at the time when the contract is entered into, such as an unborn baby or a company to be incorporated.

Moreover, the contracting parties should be wary that they may not be able to rescind or vary the contract which affects third party entitlements if the third party has assented to or relied on the term. To better protect their own interests, the contracting parties can exclude this restriction to rescind or vary the contract by expressly removing the requirement of third party consent in the contract, or expressly state in the contract that only under certain limited scope of circumstances will a third party’s consent be required for rescission or variation of the contract.  

Further, if the contracting parties do not intend for any benefit conferred on specified third parties under the contract to be assignable in future, they should include a term to this effect in order to make sure that such third party’s rights under the contract is personal and not assignable.

Lastly, if contracting parties intend to resolve dispute with the third party by arbitration and/or in a specified jurisdiction, they should expressly stipulate the same in the contract so that the third party is bound by such arbitration and/or exclusive jurisdiction clause.

Conclusion
The Bill is a long-awaited reform to the doctrine of privity to bring contract law in Hong Kong more in line with other common law jurisdictions. The new ordinance will be applicable to a wide range of commercial contracts, especially those which routinely benefits third parties such as construction contracts and insurance contracts. Upon commencement of the new ordinance, contracting parties should pay extra attention as to whether they intend to confer benefit on third parties and incorporate necessary terms into the contract so as to manifest their intention and protect their own interests.

Nevertheless, with the freedom to opt out of the effect of the Bill, from the experience in England and Wales, it is foreseen that the contracting parties can still preserve the current doctrine of privity in their contracts and the new ordinance may possibly not tremendously affect the positions of the contracting parties if the contracts are carefully drafted to opt out the new regime.

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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.