15 June, 2015
The commencement date for the Contracts (Rights of Third Parties) Ordinance (the “Ordinance”) has been set for 1 January 2016. Now, in preparation of the commencement of the Ordinance, we set out the implications for drafting contracts under the new regime.
The Ordinance provides an exception to the doctrine of privity of contract and provides a person who is not a party to a contract with a right to enforce the contract terms directly. The conferral of the benefit need not be express, nor need the third party be identified by name. Given the broad application of the Ordinance to contracts entered into from 1 January 2016, those with responsibility for drafting and negotiating contracts should ensure they are familiar with the Ordinance and be prepared for its implementation.
Importance Of Considering The Ordinance In Relation To Every Contract
The Ordinance will apply to all contracts entered into on or after 1 January 2016, with some limited exceptions including (i) letters of credit, bills of exchange, promissory notes and other negotiable instruments; (ii) covenants relating to land; (iii) contracts for the carriage of goods by air and sea; (iv) a company’s articles having effect as a contract; and (v) employment contracts.
The Ordinance gives third parties a right to enforce the terms of a contract where the contract expressly provides for this but also where the contract term purports to confer a benefit on the third party. Given the Ordinance’s broad application and the fact that the concept of purporting to confer a benefit on a third party is so wide you will need to consider the Ordinance carefully in relation to each agreement that you are preparing or negotiating. You must consider whether the provisions of the Ordinance should be excluded or included.
To Include Or Exclude The Ordinance?
Parties to contracts entered into from 1 January 2016 will be at liberty to contract out of the effect of the Ordinance. This has been commonly done in England & Wales since the implementation of the Contracts (Rights of Third Parties) Act 1999 and we expect that a similar approach will be taken in Hong Kong.
Where the Ordinance applies, then it is important that, at the drafting stage, you consider the effect of it, and draft accordingly. Unless you specify to the contrary, all the terms, remedies, limitations and boilerplate provisions in the contract will apply to, or be available to, the third party benefiting under the contract as if he were a party to the agreement. Unless you specify to the contrary, the consent of the third party will be required to any variation of the contract which affects him.
In many cases, you will want to exclude the provisions of the Ordinance. If you do not want any risk of a third party having enforceable rights then, unless you are absolutely sure that there is no possibility of the agreement (or any other agreement to which it is connected or relates) being interpreted as conferring a benefit on a third party (and in any cases of doubt you should err on the side of caution), you should add a clause to the agreement excluding the provisions of the Ordinance.
However, you should always consider in each case whether, rather than completely excluding the Ordinance, you may want to use its provisions in order to confer a directly enforceable right on one or more third parties. If you do decide that the Ordinance may be useful, then again specific provision needs to be included, in order that it can be used in a controlled way. A clause providing for the use of the Ordinance in relation to specified clauses only may be included, together with further provisions dealing with how the other clauses of the agreement are to operate vis à vis those third party rights.
Examples Of Key Areas Where Parties May Wish The Ordinance To Apply
A number of ways of circumventing the privity rule have been developed by the courts and by contract, such as the use of collateral warranties and trust devices in contracts. However, these methods are often complex and subject to a degree of uncertainty under Hong Kong law. Using the Ordinance will enable the creation of a certain, directly enforceable right for a third party where this is what the parties intend and will eliminate the current potential uncertainty under Hong Kong law.
Below is a list, based on our experience in England & Wales, of some key areas where parties may want to apply the Ordinance, to enable third parties to enforce rights directly:
- contracts which contain an indemnity which benefits a third party – for instance indemnities given in connection with a share acquisition, business acquisition or lease agreements where the third party is another company in the same group or its employees;
- confidentiality agreements – where the obligation not to disclose information confers a benefit on the company and its group companies or on other entities;
- restrictive covenants – where the restrictive covenant benefits all of the companies in a group; and
- limits on or release of liability – contracts may include clauses which purport to limit the liability of one of the parties to the contract as well as other companies in the same group and their employees or may (for example in a settlement agreement) include a release from liability of all of the companies in a group.
Checklist For All Contracts
The Ordinance means that in relation to every contract which you are preparing or negotiating from 1 January 2016, you must consider the following questions:
- Is the agreement a “contract” to which the Ordinance applies?
- Is there any possibility that the agreement provides for the enforcement of a term by a third party or purports to confer a benefit on a third party?
- If so should the Ordinance be excluded or included?
- If the Ordinance is to be excluded, add an exclusion clause.
- If the Ordinance is to be included in relation to the whole or any part of the agreement, consider:
- which clauses it should apply to;
- whether the list or class of third parties is sufficiently clear and properly defined;
- whether the third party’s right to consent to a variation or modification of his rights should be excluded (in which case there must be an express provision in the contract to this effect);
- whether the third party’s rights and/or remedies for breach should be specifically limited;
- whether express provision should be made in relation to set off, defences and counter claims as regards the third party;
- how each of the other provisions of the contract should apply in relation to the third party’s rights.
For further information, please contact:
Tommy Tong, Partner, Herbert Smith Freehills
Matt Emsley, Partner, Herbert Smith Freehills
Jason Sung, Partner, Herbert Smith Freehills