Monday, December 14, 2015

Hong Kong - Contracts and Third Party Rights

By Helen Colquhoun, Withers


The Contracts (Rights of Third Parties) Ordinance (Cap.623) ("Ordinance") is due to come into force on 1 January 2016. The aim of the Ordinance is to bring Hong Kong into line with other common law jurisdictions (such as England & Wales, Canada and New Zealand) by reforming the common law doctrine of privity of contract.

Under this common law doctrine, only the parties to a contract have the right to enforce the contract against another party to the contract. A third party, even if granted rights under the contract, cannot bring an action to enforce the terms of the contract.

The Ordinance

The aim of the Ordinance is to reform this doctrine and protect third parties who expect to benefit from a contract, by giving them the ability to enforce the terms directly against the contracting parties. Thus, under the Ordinance a third party will potentially be able to enforce a term under a contract if:

1. the contract expressly provides that the third party may do so; or

2. a term in the contract purports to confer a benefit on the third party, and the contracting parties intend for the term to be enforceable by the third party.

The second limb above clearly gives rise to uncertainty and thus a risk of dispute as to whether or not a benefit is conferred and/or as to what the contracting parties intended. Parties to contracts covered by the Ordinance (as set out below) should therefore clearly and expressly state whether or not a particular term is intended to be enforceable by a third party. Third parties should also be expressly identified in the contract by name, as a member of a class or as answering a particular description.

It is important to note that it is permissible under the Ordinance for parties to an agreement to select which terms are intended to be enforceable by third parties and which are not.

Which contracts does the Ordinance cover?

The Ordinance will apply to contracts entered into on or after 1 January 2016. However, the Ordinance can be contracted out of by the parties (provided this is expressly stated in the contract).

There are also a number of contracts which are automatically excluded from the Ordinance, including negotiable instruments, bills of exchange, covenants relating to land, and promissory notes.

In relation to employment contracts, a partial exemption applies - the Ordinance does not permit third parties to enforce terms against an employee. A third party can, however, enforce a term in an employment contract against an employer. Importantly, other employment related documents (such as settlement agreements, standalone confidentiality agreements and restrictive covenant agreements and independent contractor agreements) do not benefit from this exemption and will all be covered by the Ordinance (and can therefore potentially be enforced by third parties against both employers and employees assuming the conditions set out above are met).

What does this mean for employers?

The Ordinance will be relevant to employers in a number of areas. By way of example:

1. many employees will have access to confidential information across group companies and it may be important for group companies (as 'third parties') to have the ability to enforce any confidentiality obligations which the employee has entered into with the employing entity. To ensure this is permissible under the Ordinance, an employer will need to ensure that a separate confidentiality agreement is entered into with the employee (rather than simply having confidentiality obligations within the employment contract itself). The confidentiality agreement should also include an express clause stating that the obligations can be enforced by group companies. Similar considerations will apply in relation to a group company wishing to have the ability to enforce post-termination restrictions;

2. in a settlement agreement, group companies are likely to want to have the ability to enforce any obligation upon the employee to release claims against them. The settlement agreement should expressly confirm that group companies are permitted to enforce the agreement;

3. an employer may wish to limit the ability of a third party to enforce rights under the employment contract against the employer. For example, employers often extend fringe benefits to both employees and their dependants (such as health insurance and education allowances). Family members will be entitled under the Ordinance to enforce their rights to such benefits against the employer, unless the contract expressly states otherwise;

4. if an employer outsources the provision of benefits to employees to a service provider, the employer will wish to avoid the risk of an employee (as a third party) being able to bring a claim against the employer by virtue of an agreement between the employer and the service provider. Again, such an option will be available to employees unless the agreement between the employer and the service provider expressly excludes the application of the Ordinance.

In many cases, employers will wish to exclude (or at least limit) the operation of the Ordinance. Employers should therefore review their contracts and agreements to see if any terms purport to confer a benefit on third parties and, if so, consider whether they wish to expressly exclude or modify application of the Ordinance in relation to any or all such terms and/or in respect of particular classes of third parties.

Employers should also consider whether there are any scenarios in which they want to ensure that the Ordinance does apply (for example to allow for enforcement of obligations by group companies). In such a scenario, and to minimise the risk of any dispute, employers should ensure that agreements are carefully drafted to ensure: (i) they do not fall within the exemptions to the Ordinance, (ii) they expressly confirm that the Ordinance applies, and (iii) the third parties who are intended to be able to enforce the agreement are clearly identified.