25 June 2015
The Government recently announced that the Contracts (Rights of Third Parties) Ordinance (the "Ordinance") will come into force on 1 January 2016. As explained in our earlier Legal Updates, the Ordinance reforms the current law of contract regarding third parties.
Privity of contract dictates that only parties to a contract can enforce it. This is logical, but can lead to unsatisfactory results - it applies even where the intention is to benefit a third party. There is also a related rule that, generally, a person can only recover damages for his own (and not a third party's) loss.
Lawyers often use devices such as deed polls, agency and trust arrangements and collateral contracts to confer contractual benefits (although not necessarily rights of direct enforcement) on third parties.
These may be inconvenient (e.g., additional documents) or uncertain (e.g., not fully tested by the courts). Indeed, most common law jurisdictions now have third party contractual rights legislation. The Ordinance is substantially modelled on England & Wales' Contracts (Rights of Third Parties) Act 1999 (the "Act").
The New Law
The Ordinance enables someone who is not a party to a contract to have rights under it. The clearest way is to include an express statement in the contract identifying the third party (by name, as a member of a class or as answering a particular description) (s.4(1)(a) and s.4(2)).
The Ordinance also enables a third party to enforce the terms of a contract if a contract term simply purports to confer a benefit on a identifiable third party (s.4(1)(b), s.4(2)).
Where a third party has rights, then the parties to the contract may not rescind the contract or vary it to extinguish or alter the third party's entitlement without consent.
The danger for a draftsperson can be to confer a benefit on a third party unwittingly. Therefore, English law contracts generally exclude the Act and retain the privity of contract rule (with the usual alternative contractual devices).
We anticipate that Hong Kong will take a similar approach.
For that reason, it is worth pausing to consider some areas where market practice in England has evolved so as not to exclude the Act as a whole. The following examples are in the context of an M&A transaction. M&A transactions are often, in substance, transactions between two groups of companies as opposed to single entities, even though the agreement is often entered into between single entities.
A seller will often agree not to compete. If the seller fails to honour its commitment, then the buyer's group members may suffer a loss. It is common for English law contracts to use rights under the Act to allow group companies to enforce restrictive covenants directly.
What if a seller's warranties given in respect of the target company prove inaccurate? The buyer may have transferred the target company elsewhere within its group. It is common for warranties to be expressed also for the benefit of other group companies who may own the shares in the target at the relevant time.
Claims Against the Target Company
In the situation described above, a seller might then try to sue the target company or its employees as a result of alleged inaccurate information. A common provision is to require the seller to waive all such claims against the target company and its employees. It has become reasonably common to invoke the Act to give the target company and its employees the benefit of the waiver, as they would otherwise not have privity of contract.
Each scenario illustrates an example where market practice in England has evolved generally to exclude the Act, but to adopt it for the purposes of a few identified clauses. Other practice areas (such as construction) have developed their own bespoke practices regarding the Act.
Generally, we consider that for most commercial situations, it will be appropriate to exclude the Ordinance. However, before inserting a blanket exclusion, it is worth considering the limitations of privity of contract, which the Ordinance can help to overcome.