2 June, 2015
On 26 November 2014 the Hong Kong Legislative Council passed the Contract (Rights of Third Parties) Ordinance 2014 (“Ordinance”)
We expect that the Ordinance will come into force this year. When it does, the Ordinance will change the law of privity of contract in Hong Kong so that certain third parties can enforce provisions of contracts to which they are not a party. The Ordinance only applies to contracts that are entered into after the Ordinance comes into force.
The Doctrine Of Privity Of Contract
The rules of privity provide that: (a) a person cannot acquire and enforce rights under a contract if he is not a party to it; and (b) a person who is not a party to a contract cannot be made liable under it. Owing to a perceived unfairness, a number of countries such as England & Wales, New Zealand, Singapore and territories in Australia and Canada have adopted similar legislation to enable interested third parties to enforce provisions of a contract to which they are not a party in certain circumstances.
The Effect Of The Ordinance
The most important provision of the Ordinance is Section 4. This provides that third parties can enforce provisions of a contract if (a) the contract expressly provides that the third party may do so or (b) the term purports to confer a benefit on the third party. This class extends to third parties who were not in existence at the time the Contract was entered into, and extends to all third parties regardless of whether they are based in Hong Kong or elsewhere. This therefore creates potentially a very wide class of third parties who would be entitled to enforce contractual terms. It is has been argued that this is un-workable in situations such as complex construction contracts, however, despite objection, the Ordinance will apply to the construction industry.
This class of third parties is limited in that they must be identifiable either by name, as a member of a class or as answering a particular description. Further, in respect of third parties relying on limb (b) above, this will only apply where it can be said that on a proper construction of the contract, the term was intended to be enforceable by the third party.
Arbitration And Jurisdiction
Third parties will be treated as parties to any arbitration agreements in contracts, and bound by any exclusive jurisdiction provisions when they seek to enforce a term, unless on proper construction of the contract this is not the intention. The Ordinance permits contracting parties to decide whether a third party should be bound by the dispute resolution clause in their contract.
As to whether the Ordinance will have extra-territorial effect, the presumption is that legislation does not have an extra-territorial effect unless provision is made to the contrary. The Ordinance is unclear about whether it has extra-territorial effect. It is likely that given the intention is to affect the position in Hong Kong law, that contracts governed by Hong Kong law will be affected by the Ordinance even if the conduct in question is not in Hong Kong.
Impact On The Construction Industry
The Ordinance will apply to construction contracts and appointments of construction professionals. This will mean that any identified third parties, or third parties which have a benefit under a contract, will be able to enforce terms against contractors and designers. It is not necessary for such third parties to be expressly provided for in the construction contract. They could simply be an identifiable class of people, such as prospective purchasers, tenants or funders of buildings project for example.
This means that arguably a term which required the Contractor to construct a building which was “fit for purpose” would confer a benefit on a future purchaser of that building, and entitle that purchaser to directly sue the Contractor for any defects. Similarly the designer who is required to use “reasonable care and skill” in his design, could face action from a subsequent purchaser for negligence. This significantly increases the risk profile of such projects for contractors and construction professionals alike.
The approach of construction industries faced with equivalent statutory provisions elsewhere has been to routinely exclude the application of such provisions in construction contracts and appointments. For example, when the Contract Rights of Third Parties Act was passed in England and Wales, it was anticipated that there would no longer need to be requirements for wide-scale collateral warranties from contractors and construction professionals in favour of third parties. However, the industry did not embrace the changes bought about by the law. Arguably resistance was partly driven by the insurance industry, concerned that the Act increased the risk profile of projects. We have yet to see what the response of the insurance market will be in Hong Kong. As a result, in the UK, collateral warranties remain the most common mechanism to give third parties contractual rights of recovery in relation to construction projects, and the provisions of the Act are routinely excluded in contracts and appointments. This is also an option frequently selected in the NEC EEC and PSC contracts.
However, exclusion of the Ordinance in public contracts in Hong Kong may simply not be realistic, given that this could be perceived as contrary to the intentions of the legislature. Therefore alternative ways of managing this risk will need to be sought for contracts subject to Hong Kong law such as:
- Where possible, exclude the application of the Ordinance in contracts, or amend contracts to ensure that the application of the Ordinance does not lead to unintended consequences, such as broad third party rights or uncertainty as to the classes or types of individuals who are given third party rights under the contracts
- Liaise with insurers on coverage of third party claims of this nature
- Acknowledging the potential reliance of third parties on services and works provided; consider when it is appropriate to include disclaimers and limitations in Contracts, Appointments and deliverables.
For further information, please contact:
Dean Lewis, Partner, Pinsent Masons
dean.lewis@pinsentmasons.com
Mohammed Talib, Pinsent Masons
mohammed.talib@pinsentmasons.com
