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To Benefit or Not to Benefit Third Parties... That is the Question...

7 October 2015
Mayer Brown JSM Article

Whether 'tis nobler in the mind to ensure that non-contracting parties (i.e., third parties) can enforce a benefit bestowed upon them in a contract, or leave them to find other alternative ways to secure their remedies as they endure the slings and arrows of corporate life... I trust that Shakespeare’s fans will forgive the adaptation of Hamlet's famous speech as the drama unfolds with Hong Kong's new law on how to benefit third parties.

Hong Kong is introducing legislation called the Contracts (Rights of Third Parties) Ordinance which comes into force on 1 January 2016. The legislation is similar to the one introduced in England in 1999 and in Singapore in 2002.

As many readers will appreciate, there has been a well known legal principle of "privity of contract" which has been alive and well for centuries. This allows only the contracting parties to enforce their rights under the contract. If you are not a contracting party, then you have no contractual right to sue under such a contract.

This is a very logical rule, but it can lead to "unfair' results". In real life, there are of course situations when the contracting parties A and B do set out in a contract a benefit for a third party. For example, A and B enter into a contract referring to a party C (e.g., a broker) who is due to receive a certain benefit (in the broker's case, a commission). If the contracting parties don't pay the broker, then it is currently not possible for the broker to sue in contract to recover its commission.

In a more consumer type situation, let's look at a scenario of Mr and Mrs Chan who purchase a flat from a developer. The flat has certain defects. Can Mr and Mrs Chan sue the building contractor in contract? Not under the current legal position. Of course, there may be other ways in which third parties can be conferred a benefit under a contract. To get around the privity of contract rule, lawyers have come up with alternative devices for conferring contractual benefits, such as deed polls, agency, trust, or collateral contracts. But assuming such devices were not written into the contracts for the broker or Mr and Mrs Chan, then they would most likely only be able to sue in tort.

The law recognises these difficulties and so Hong Kong, following a number of other common law jurisdictions, is now seeking to provide statutory mechanisms to benefit such third parties. The Government is particularly keen to find benefits for "consumers" - the Mr and Mrs Chans of the world who might otherwise miss out.

The new Ordinance will only apply to contracts entered into, on or after, 1 January 2016. So if you enter into a contract in October 2015 (during HICAP), even if it comes into effect after 1 January 2016, the new Ordinance will not apply. However, if you enter into a supplemental agreement after 1 January 2016, then the supplemental agreement will be subject to the new Ordinance. Consideration should then be given as to whether you want to apply the benefits of the new Ordinance to your contract (as amended) or to exclude it.

Here lies the key issue. Contracting parties have a choice. To benefit or not to benefit those third parties - that really is the question. Contracting parties, for example, can choose to exclude the application of the Ordinance. By contrast, they can choose expressly to benefit certain third parties (and not others) and to benefit such third parties with certain rights (and not others).

If you choose to benefit third parties, then you also need to consider certain other issues which the new Ordinance seeks to address. These include the following related rights/issues:

  1. Can the third party prevent the contract from being amended or rescinded without its consent? Yes - in certain circumstances. Equally, the contracting parties may restrict or exclude this right;
  2. Can the third party assign its rights to another party? Yes, although the contracting parties may restrict this right and/or impose certain procedures (e.g., to give notice of such an assignment to the contracting parties);
  3. Can the third party enforce its rights by means of arbitration proceedings if arbitration is the stated means for resolving any contractual obligations? Yes, and in fact the Ordinance and certain reported cases confirm that where such third party rights exist, then the third party is obliged to use arbitration proceedings to resolve the dispute/seek enforcement of its rights. Interestingly, the Ordinance doesn't apply so expressly to alternative resolution procedures such as expert determination or "adjudication proceedings" (statutory adjudication of construction disputes is on the horizon in Hong Kong). It is important therefore to be clear on your intentions in this regard.

Similarly, if the contract includes an "exclusive jurisdiction" clause (i.e., requiring the dispute to be resolved in a particular jurisdiction), then this will also apply to the third party (unless the contract purports not to apply to the third party).

Contracts should therefore be clear on how these topics are to be addressed in relation to the third party. Further, if third parties are intended to benefit, then these third parties should be identified clearly by name. This could be as specific as to name specific individuals (e.g., "Mr and Mrs Chan") or a class or description (e.g., all purchasers of apartments from ABC Developer Co) or a group (e.g., all companies within the "XYZ Group") in which case the definition of the XYZ Group would then need to make it clear which entities would be included/excluded in this context. Please note, in this latter example, that the rights may apply, for example, to companies which don't even exist at the time the contract is executed. Equally, the contract can also prevent this.

As you can see, the Ordinance still allows the contracting parties to make many choices.

Curiously, however, the Ordinance differs from its English counterpart in a few respects. One particular area is where the Ordinance lists out certain situations where it will NOT apply. In addition to the usual areas similarly covered by the English legislation, the Hong Kong Ordinance will not apply to "deeds of mutual covenants" nor to "covenants relating to land". These exceptions were included as a result of lobbying from Hong Kong's Bar Association, largely because it was felt unnecessary to interfere in existing arrangements which have adopted other means by which third parties can benefit and enforce a right. For example, the Conveyancing and Property Ordinance (Cap. 219) provides certain rights to third parties (e.g., S. 41 and S. 26) in respect of covenants relating to land. What is less clear is what is meant by "covenants relating to land". Do these covenants have to be under seal? Probably "not". Do these covenants have to "touch and concern the land"? Probably "yes". The lack of a clear definition will raise certain concerns (unless clarified by statute or through case law).

DMCs, on the other hand, contain both "burdens" and "benefits" upon third parties. DMCs typically apply to all the owners of an apartment block and their applicable shares in common areas in a particular development. As you can see from the name of the Ordinance, this new Ordinance is intended to confer "rights" but not "burdens" on third parties. This is another reason why DMCs are also excluded from the Ordinance, to ensure both rights and burdens are still enforceable against all owners.

There are other details in the legislation which make it clear that a third party may seek to rely on exclusion clauses in a contract, or for a contracting party to rely on certain defences provided in a contract. Further, there are provisions included to prevent a third party from recovering double the amount (e.g., on its own account and when a claim is made by a contracting party seeking to enforce the benefits which accrue to the third party). We will not cover these topics in this article.

Practically speaking, there are situations in the corporate world where contracting parties may want to ensure third parties benefit, not least as many transactions are often, in substance, transactions between groups of companies as opposed to single entities, even though the contract is often entered into between single entities. These may include confidentiality agreements, sale and purchase agreements and perhaps even hotel management agreements. However, experience from other jurisdictions shows a strong reluctance to change the habits of many lifetimes.

Even 16 years after the equivalent legislation was passed in England, the vast majority of contracts seek expressly to exclude the application of the legislation. Will Hong Kong follow suit? Quite likely, unless the Government actively adopts approaches in certain contracts (e.g., Construction Contracts) to promote the granting of benefits to third parties.

So to benefit or not to benefit third parties? That is the question. If you do, please draft the relevant provisions with great care – ay, there's the rub!

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