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Hong Kong – Privity Of Contract Law Under Review.

27 February, 2013

 

Legal News & Analysis – Asia Pacific – Hong Kong – Dispute Resolution

 

In October 2012, the Department of Justice released a draft Contracts (Rights of Third Parties) Bill 2013 (“the Bill“), for consultation. If the Bill is passed, a third party will, in certain circumstances, be able to enforce the terms of a contact that he is not a party to. The changes could have a significant impact, particularly on insurance and construction contracts (under which benefits are often conferred on third parties), although the Bill does allow the contracting parties to exclude its statutory provisions from their contract.

 

In the likely event of the Bill being passed, industries, particularly the insurance and construction industries, will need to carefully review their contracts and expressly exclude the statutory provisions, where they wish to do so.

 

Hong Kong’s current law – The Doctrine of Privity of Contract

 

Under the doctrine of privity of contract (“the Doctrine”):

 

  1. a person cannot acquire and enforce rights under a contract to which he is not a party; and
  2. a person who is not a party to a contract cannot be made liable under it.

 

Criticisms of the Doctrine of Privity of Contract

 

The second aspect of the rule (at ii above) is generally regarded as sensible, but the first aspect (at i above) has been criticized, as frustrating contracting parties’ intentions to benefit third parties. For example, A and B enter into a contract under which A agrees to pay a sum of money to C, with both parties fully intending that C should take the benefit of A’s promise. If A defaults, C cannot sue A under the existing law because of the Doctrine.

 

Various other jurisdictions, including England, Canada (New Brunswick), Australia (Western Australia, Northern Territory and Queensland), New Zealand and Singapore have reformed the Doctrine by legislation.

 

Contracts (Rights of Third Parties) Bill 2013

 

After considering recommendations of the Law Reform Commission of Hong Kong Sub-Committee (“LRC Sub-Committee), the Department of Justice prepared the Bill, with a view to implementing the recommendations in full. The LRC Sub-Committee recommended that the Doctrine should be reformed (but not completely abolished) and that a clear and straightforward legislative scheme should be enacted whereby, subject to the manifest intentions of the parties to a contract, the parties could confer legally enforceable rights or benefits on a third party under that contract.

 

The Department of Justice has sought the views of professional bodies, business communities and other interested parties on the Bill and a summary of the main provisions (which could be changed after the public consultation) are as follows.

 

Scope of Application

 

The Bill excludes contracts entered into before the Ordinance comes into effect and also the following two categories of contracts:

 

  1. Contracts where third parties already have enforceable rights under existing rules reflecting international conventions. This includes bills of exchange, promissory notes and other negotiable instruments, contracts for the carriage of goods by sea and air, and contracts on a letter of credit.
  2. Contracts where there are policy reasons for a third party not having the right to enforce a contract. This includes a memorandum and articles of a company having effect as a contract under seal under section 23 of the Companies Ordinance (where it is intended that the contract should not confer rights on third parties) and contracts of employment, as against an employee. The latter envisages, for example, a situation where an employer and employee enter into a contract and the employee is seconded to work for a third party. It could be unfair to the employee if the third party could sue on the contract.

 

In its comments on the Bill, the Hong Kong Bar Association has suggested that Deeds of Mutual Covenants, governing the use of multi-storeyed buildings, should also be excluded, since the obligations contained in them are a unique feature of Hong Kong’s conveyancing system, with their own special rules on enforcement by third parties, evolved through case law and underpinned by statute.

 

Which Third Parties have a right to enforce a contractual Term?

 

The Bill provides that a third party who is expressly identified in the contract by name, as a member of a class or as answering a particular description, may enforce a term of the contract, if :

 

  1. the contract expressly provides that he may do so; or
  2. the term purports to confer a benefit on him, unless on a proper construction of the contract, the parties did not intend the term to be enforceable by the third party.

 

The Bill provides that rights may be conferred on a third party who was not in existence when the contract was entered into. It also provides that a third party’s right to enforce a contractual term is to be subject to other relevant terms of the contract.

 

What remedy is available to the third party?

 

The Bill provides that a third party is entitled to any remedy that would have been available to him in any action for breach of contract, had he been a party to the contract.

 

Can the contracting parties rescind or vary the contract?

 

To achieve a balance between the contracting parties’ freedom to alter the contract terms and the interests of the third party who may suffer as a result, the Bill provides a cut off point after which the contracting parties cannot vary or rescind the contract, without the third party’s consent. The cut off point occurs :

 

  1. once the third party has communicated to the promisor (by words or conduct) his assent to the term conferring benefit on him, or
  2. the third party has relied on the term and the promisor
     

     

    1. is aware of that reliance; or
    2. could reasonably be expected to have foreseen that the third party would rely on it.

 

The above is subject to any express term in the contract allowing the contract to be rescinded or varied by a party or parties without the third party’s consent and the third party is aware of that express term or reasonable steps have been taken to bring it to his attention.

 

The Bill provides that the Court may dispense with a third party’s consent to rescind or vary the contract if it thinks it just and practicable to do so and the other party (ies) agrees to this.

 

Defences available to a Promisor

 

The Bill provides for the defences, set-offs and counterclaims available to the Promisor where the third party brings proceedings for the enforcement of a contract term.

 

The Promisee’s Right

 

The Bill contains a provision making it clear that a third party’s right to enforce a term in the contract, does not affect the right of the Promisee to enforce any term of the contract.

 

Protection of Promisor from Double Liability

 

The Bill provides that if a Promisor has performed his obligations to the third party, the Promisor is discharged, to the extent of that performance, from the same obligations owed by the Promisor to the Promisee. It also provides that if the Promisee has recovered from the Promisor a sum in respect of the third party’s loss or the Promisee’s expense in making good to the third party the Promisor’s default, in any subsequent proceedings brought by the third party, the court must reduce any award to the third party to an appropriate extent to take account of that sum.

 

Arbitration and Exclusive Jurisdiction Clauses

 

Parties to a contract may include in it an arbitration clause agreeing to refer any dispute arising from the contract to arbitration and/or a jurisdiction clause specifying the jurisdiction for any action in relation to the contract. The question is whether such claims would also be binding on the third party. The Bill provides that if a third party has the right under the Ordinance to enforce a contractual term and the contract contains an arbitration clause or an exclusive jurisdiction clause, then the third party is to be bound by that clause, as regards any dispute between the third party and the Promisor, relating to the enforcement of the term by the third party, unless on a proper construction of the contract, the third party is not intended to be so bound. The Law Society, in its comments on the Bill, has suggested that the same should also apply to any mediation clause in the contract.

 

Assignment of Third Party Right

 

The Bill allows the third party to assign to another person his rights to enforce a term under the contract, unless there is a clause in the contract prohibiting this or, on a proper construction of the contract, those rights were not intended to be assignable.

 

The Way Forward

 

As stated above, the Department of Justice sought comments by 31 December 2012 and is now in the process of considering such. 

 
 

For further information, please contact:

 

Karen Dicks, Deacons

karen.dicks@deacons.com.hk
 

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