Under the common law “doctrine of privity of contract”, a person cannot acquire or enforce rights under a contract unless he or she is party to that contract.
For example, if Party A and Party B enter into a contract whereby Party A agrees to provide goods or services to a third party, the third party company, which is not a party to the contract, as it never signed the original written contract, has no rights at law to claim compensation from Party A, if Party A fails to provide goods or services or provides faulty goods or services and/or if Party B is unable or unwilling to enforce that contract.
This common law doctrine has long been criticized for creating unsatisfactory commercial results.
The traditional approach to address and to avoid this privity of contract doctrine and to actually confer benefits on a third party was always to include collateral contracts/warranties, trust arrangements, agency arrangements or a deed poll in addition to the substantive main contract.
Recognising the need to reform the long established privity of contract rule, the Government passed the Contracts (Rights of Third Parties) Ordinance (Cap.623) (the “Ordinance”) which provides a comprehensive framework in which to enforce third party rights.
The commencement date of the Ordinance is 1 January 2016, and the Ordinance will apply to all contracts entered into on or after its commencement date.
Protection of a third party
Section 4 of the Ordinance, gives a third party the right to enforce the terms of a contract (including a term that excludes or limits liability) if:-
- the contract expressly provides that the third party may do so; or
- the term purports to confer a benefit on the third party.
But exactly who is that third party?
The third party must be expressly identified in the contract by name or as a member of a class or as answering a particular description.
However, the Ordinance also confers benefits on a third party who was not in existence when the contract was entered into, which implies that benefits can also be conferred on “future members” of a class.
Key Features of the Ordinance
1. Applicable Contracts
- The Ordinance applies to all contracts that are entered into after 1 January 2016. However, it does not confer a right on a third party to enforce a term of a contract of employment against an employee, and will not apply to the following other categories of contract:-
- a bill of exchange, a promissory note or any other negotiable instrument;
- a deed of mutual covenant;
- a covenant relating to land;
- a contract of carriage;
- a contract for the carriage of goods by air;
- a letter of credit; and
- a company’s articles having effect as a contract under seal.
2. Alteration of third party’s right, variation and rescission of the contract
- If a third party can enforce a term of a contract under the Ordinance, under certain conditions, then the contracting parties may not, without the third party’s consent:-
- rescind the contract; or
- vary the contract so that the third party’s rights are altered or extinguished.
- The consent from the third party will be necessary if:-
- the third party has assented to the contractual term and the promisor has received notice of the assent; or
- the third party has relied on the contractual term and the promisor is aware of the reliance or the promisor can reasonably be expected to have foreseen that the third party would rely on the contractual term.
3. Protection of the contracting parties
- If the third party brings proceedings to enforce a term of a contract, the promisor may, pursuant to Section 8 of the Ordinance, raise matters by way of defence and set-off:-
- those arise from or in connection with the contract and is relevant to the term in question;
- where an express term of the contract provides for the matter to be available to the promisor, by way of defence or set off to such third party claim; or
- that would have been available to the promisor by way of defence or set-off if the third party had been a party to that contract.
- The promisor may be protected from double liability to the extent the promisor has discharged the obligations to the third party or has paid to the promisee losses or expenses in relation to the term being enforced.
- The third party may assign its enforceable right under a term of the contract to another person in the same way as a contracting party may assign a right under the same contract, unless the contract expressly provides otherwise or such right is personal to the third party and is not assignable.
The Ordinance creates some uncertainty if the contract is silent on whether a contractual term is intended to be enforceable by a third party.
As such, if you do not intend to have the Ordinance apply to your contract, you should expressly opt out from its provisions.
The following is an example of an “opt out” clause:-
“Neither this [Agreement] nor any document issued pursuant to this [Agreement] shall confer any benefits on any third parties.
No third party may enforce any term of this [Agreement] or of any provision contained in any document issued under this [Agreement].
The provisions of the Contracts (Rights of Third Parties) Ordinance (Cap. 623) of the laws of Hong Kong are hereby expressly excluded from this [Agreement] and/or any other documents issued pursuant thereto.”
Alternatively, you can select certain terms of the contract to be enforceable by a third party under the Ordinance, but you can exclude the remaining terms of the contract as follows.
“The provisions of the Contracts (Rights of Third Parties) Ordinance (Cap. 623) of the laws of Hong Kong are hereby expressly excluded from this [Agreement] and/or any other documents issued pursuant thereto, save and except for [the name of that third party] who may enforce [the clause number] of the [Agreement].”
Since the Ordinance will significantly impact on a broad range of contracts entered into on and after 1 January 2016, every Client should consider the following issues when preparing their contract:-
- Will a third party or a class of third parties benefit from the contract?
- Should the Ordinance be applied to or be excluded from the contract?
- If the Ordinance is to be applied:-
- identify the third party or a class of third parties;
- identify which terms of the contract are to be enforceable by the third party;
- specify the circumstances where the contract can or cannot be varied or rescinded by the contracting parties, and whether consent from the third party should be required;
- whether the right of the third party should be assignable to another person;
- whether the third party’s rights and/or remedies for breach by a contracting party should be limited; and
- whether a contracting party’s rights of defence, set-off or counterclaim against the third party should be limited.
- If the Ordinance is to be excluded, the contract should include an “opt-out” clause to contract out the provision of the Ordinance from the contract.
This article is for information purposes only. Its contents do not constitute legal advice and readers should not regard this article as a substitute for detailed advice in individual instances