The Contracts (Rights of Third Parties) Ordinance is due to come into force early in 2016. Zoe Chan So Yuen FCS FCIS, Solicitor, examines how companies can make use of the new law in corporate contract management.

Many commercial projects, no matter what their size, have a potentially complex structure of contractual relations involving multiple parties. The payment paths alone can be wide ranging, involving employers, contractors, consultants, contractors, sub-contractors and suppliers. The Contracts (Rights of Third Parties) Ordinance will come into effect in Hong Kong early next year. The new law will allow, but not compel, contracting parties to use a term of the contract to confer benefits on third parties.

The new law, which is modelled on the experiences of other jurisdictions (including the UK, Australia, Canada and Singapore), envisages the new right of third parties as a ‘shield’ rather than as a ‘sword’. This leaves room open for interpretation by the courts and Hong Kong will have to wait for a judicial decision to be upheld to confirm how the ordinance will be interpreted.

On reflection, it seems unlikely that the new law will alter the existing, conventional boundaries establishing the scope of third party rights. For example, rights can already be extended by a contracting party to a third party via the insertion of a collateral warranty. On a positive note, however, the new law may in time reduce the perceived need for collateral warranties, thus saving parties’ legal fees in contract negotiations. It may also help to overcome the difficulties inherent in procuring warranties after a business project is completed. For the early stage of contractual risk management, it will be premature for companies to remove all collateral warranties/limitation clauses from the business agenda.

Privity of contract

As a general rule, a person not party to a contract can neither sue nor be sued upon it. However, there are a number of real or apparent exceptions to the doctrine of privity of contract, including those outlined below.

  1. The beneficiary of a trust can sue a trustee to carry out the contract.
  2. A third party may make a claim under an insurance policy made for their benefit, despite the fact that the third party did not pay the premiums. For example, in some jurisdictions, including Hong Kong, a person injured in a road accident can directly enforce the judgment against the motorist’s insurer if he succeeds in claiming compensation against the insured motorist (that is, the driver or car owner).
  3. Restrictive covenants on land can be imposed upon subsequent purchasers if the covenant benefits neighbouring land.
  4. Although an agent may conduct negotiations and may sign a contract on behalf of a principal, the rights and liabilities under the contract entered into by the agent are in law the rights and liabilities of the principal.

An assignment – for example an assignment to transfer the rights under a contract to a third party – is another exception to the general rule. However, while a party to a contract can assign or transfer to another person (the assignee) the benefit of the contract, he cannot assign the burden of his contractual obligations without the consent of the other party to the contract. A legal assignment must be in writing with notice to the other party and the assignee can have no better rights than the assignor had.

It is not possible to assign:

  • a  right of action, which is a claim for unliquidated damages for breach of contract or tort, or
  • rights which are personal to the original parties to the contract.

Although a party to a contract cannot escape from his contractual obligations by assignments, he may (unless the contract requires personal performance by him) delegate performance to another person. He remains liable if his substitute’s performance is in breach of contract.

Impact of the new law

The Contracts (Rights of Third Parties) Ordinance may benefit Hong Kong companies and contractors in the three ways outlined below.

  1. It will provide a more straightforward route to allow third parties to enforce their rights as an alternative to reliance on collateral warranties or assignments (of interests/debts) which are prevalent in the financial and commercial industries.
  2. It will ensure that classes of third parties are protected even where third-party beneficiaries of contracts cannot be identified, which is often the case when commercial contracts are entered into.
  3. It will avoid time costs and the formalities of the execution of warranties and assignments involving multiple parties and it will reduce the likelihood of future disputes and multi-party proceedings.

Overseas lessons learned

The Contracts (Rights of Third Parties) Act 1999 in the UK confers similar rights to third parties – in practice contracting parties in the UK generally list third party rights in a schedule to the main contract documents.

Similarly in Hong Kong, since it may be difficult to ascertain who any intended beneficiaries actually are under the new law, from a practical point of view, it is advisable to include a specific clause in the agreement identifying the parties (specifically or by category) who can enforce their rights as ‘third party beneficiary’ under the contract. The incorporation of such a specific clause would, however, be subject to any defences available to the contracting parties.

Company secretaries’ role in new contract management

There is no hard and fast rule for how contracting administrators should continue to use collateral warranties in the new legal environment. For example, third parties can be identified in the contract either by name or by description; the contracting parties should remain free to include in the contract an express term providing for variation or termination of the contract. The parties may further identify what statutory third-party rights may be conferred by identifying all potential third parties or classes of parties in a schedule annexed to the main contract.

For the avoidance of doubt, contracting parties can exclude all third-party interests that have not been expressly provided for in a detailed schedule of third-party interests, which can be annexed to the contract. In sum, the contract negotiators should identify third parties’ rights in the schedule of the contract to vet using collateral warranty clause. For example, existing common law exceptions (in rare circumstances) to bypass the rule of privity of contract are expressly reserved.

Conclusion: positive steps forward

Interestingly, overseas legal experience is not to abrogate the common law privity rule. Company secretaries should take notice of a broad-based exception regarding the intention of contracting parties to confer third parties’ rights. It takes time to test the limits of a new law in commercial practice in Hong Kong. Meanwhile, one may leave many uncertain questions to be resolved through various common law techniques. Such common law techniques as trust, agency and collateral contracts will continue to be relevant and useful for company secretaries to administer corporate contractual management. In some other situations for tax planning and other succession issues, third parties may be reluctant to take up third-party rights. Business managers and company secretaries will need to have their standard contract terms and conditions assessed under the new law. Contracts which are entered into after the law is passed will need to either expressly exclude or contain appropriate wording to cover relationships with third parties.

Zoe Chan So Yuen FCS FCIS

SIDEBAR: The new dispute resolution landscape

To get ready for the new Contracts (Rights of Third Parties) Ordinance, company secretaries can administer their standard contracts inserting express exclusions of the operation of the new law or to limit its application. To avoid surprises in third and multi-party actions, the contracting parties may negotiate a model arbitration clause (see below) drafted for that purpose.

A significant exclusion/limitation of this arbitration provision is where a third party wishes to enforce an award other than a Hong Kong domestic arbitration award in Hong Kong. This is because, under the New York Convention which concerns enforcement of foreign arbitral awards, only signatories to the arbitration agreement, that is the contracting parties, may enforce an award. These contractual loopholes have been hotly debated in cases brought before the courts in foreign jurisdictions including Germany
and Spain.

Model clause on arbitration/ alternative dispute resolution in commercial disputes
‘[Subject to the form of the conditions set out in clause [N] of this Agreement], [name of third party] shall be entitled to enforce the benefits conferred on [it/him] by clause [N] of this Agreement [and for that purpose shall be entitled to the benefit of clause [N] of this Agreement [that is, jurisdiction and/or arbitration clauses] but otherwise no party other than the parties to this Agreement [or their respective assigns] or persons becoming party to this Agreement by novation shall have any right to enforce any terms of this Agreement.’