Background
Under the doctrine of privity of contract, a person cannot acquire and enforce rights under a contract to which he is a non-party nor can he be made liable under that contract.  Over the years, this doctrine has received criticism of defeating the contracting parties’ intention to benefit third parties thereby creating injustice.  Following the recommendation of the Law Reform Commission to introduce a legislative reform, the Department of Justice published the Consultation Paper on Contracts (Rights of Third Parties) Bill 2013 (“Bill”) in October 2012 to seek the public’s views.

Right of Third Parties to Enforce Contractual Term
Under the Bill, a third party can enforce a term of the contract to which he is a non-party if the contract expressly provides that he has such a right, or a term purports to confer a benefit on him and the contracting parties intend for the term to be enforceable by him. He can assign such right to another person, unless the contract expressly provides otherwise or the right is not intended to be assignable under the contract. However, such right will not affect the rights of other contracting parties.

In order to enjoy such right, the third party must be expressly identified by name, as a member of a class or as answering a particular description in the contract but he needs not be in existence at the time when the contract is entered into nor is he required to provide any consideration to the promisor (i.e. the contracting party against whom the term is enforceable by the third party) so long as the promisee (i.e. the contracting party by whom the term is enforceable against the promisor) has given consideration to the promisor.  If there are clauses in the contract which provides that such right has to be enforced by arbitration or in a specified jurisdiction, the third party is bound by such clauses, unless the third party is not intended to be so bound on a proper construction of the contract.

Most importantly, such right will be subject to and must be in accordance with any other term of the contract relevant to the term being enforced. Therefore, the third party should check if there are any other conditions in the contract which must be fulfilled before such right could be exercised. 

Application and Exceptions
The Bill will not affect existing contracts but will only affect contracts entered into on or after the operation of the Bill. Also, certain kinds of contracts are excluded from the application of this Bill, including (a) contracts in which third parties already enjoy such right under existing rules reflecting international conventions, such as bills of exchange, promissory notes, negotiable instruments, contracts for the carriage of goods by air and by sea and contracts on a letter of credit; and (b) contracts in which third parties do not have existing right but due to policy reasons are not appropriate for third parties to intervene, namely memorandum and articles of association having effect as a contract and the enforcement of employment contracts against employees.

Rescission and Variation of Contract
What if the contracting parties decide to rescind or vary the contract? Can they do so without the third party’s consent? The Bill states that the contracting parties cannot vary or rescind the contract in a way that alters the third party’s right without the third party’s consent if:

1.          the third party has already by words or conduct agreed to the term giving him such right and communicated his agreement to the promisor; or

2.          the third party has relied on the term and the promisor is either aware of the reliance or he can reasonably be expected to have foreseen that the third party would rely on the term.

Contracting parties are free to contract out this consent requirement. They can either expressly provide in the contract that the contract may be rescinded or varied without the consent of the third party or they can stipulate in the contract that the third party’s consent is only required in specific circumstances. In addition, the court has wide discretion to order such third party’s consent be dispensed with, on condition that compensation is to be paid to the third party, if the other contracting parties agree to such rescission or variation and the court thinks it is just and practicable to do so.

Defences of Promisors
When the third party exercises such right and brings legal proceedings seeking to enforce a contractual term, the promisor is allowed to rely on the followings under the Bill:

1.          defence or set-off arising from or in connection with the contract that is relevant to that contractual term which would have been available to the promisor if the proceedings have been brought by the promisee; or

2.          defence, set-off or counterclaim not arising from the contract which would have been available to the promisor if the third party is a contracting party.

For instance, in the first scenario, the promisor can challenge the existence, validity or enforceability of the contract on the grounds of mistake, misrepresentation or the promisee’s repudiatory breach. In the second scenario, the promisor can raise defences like he had been induced to enter into the contract by the third party’s misrepresentation, or that the third party owed the promisor a debt under a separate contract.

Impact of the Bill
As in other common law jurisdictions, the passing of the Bill will affect the drafting and negotiation of commercial contracts particularly those in the insurance, employment, construction and shipping contexts since those contracts often involve or benefit third parties, such as a nominated third party under a life insurance contract in the insurance context or related companies of an employer in the employment context.

Nevertheless, the impact brought by the enactment of the Bill can be prevented by careful drafting. One possible way is to include a “contract out” clause to exclude the operation of the Bill in part or in its entirety in contracts where it is more likely for the Bill to operate. This is a common practice in other common law jurisdictions with similar legislation.

Conclusion
The doctrine of privity has long been criticized for being artificial and leading to unjust results. Many common law jurisdictions have reformed it by legislation years ago, for example England has passed the Contracts (Rights of Third Parties) Act 1999 more than 10 years ago. The Bill is indeed a long-awaited reform to prevent injustice and give credits to the true intention of contracting parties to benefit third parties, without bringing drastic change in the existing law.   It is expected that the Bill will be introduced to the Legislative Council in the third or fourth quarter this year and may come into force in late 2013 or early 2014.

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