Impact of the Contracts (Rights of Third Parties) Bill on the insurance industry in Hong Kong
'Privity of contract' is a well-established common law doctrine establishing that a person cannot acquire or enforce rights under a contract to which he is not a party. The strict application of the doctrine may, however, give rise to absurdity or even unfairness. By way of example, A promises B to pay a sum of money to C. If A fails to pay as agreed, under the privity of contract doctrine, C cannot enforce the contract between A and B. While B can sue A, it may be difficult for B to prove loss as the contract is to confer benefit to C and not B. Legislators in Hong Kong are considering the Contracts (Rights of Third Parties) Bill (the Bill), which is intended to address such possible absurdity. The Bill has gone through its first reading and the date for second reading has yet to be fixed.
Applicability of 'privity of contract' in employees' compensation insurance context
In a situation where a subcontractor takes out an insurance policy with an insurer to cover his and the principal contractor's liability to employees' compensation, if an employee of the subcontractor is injured due to the negligence of the principal contractor's employee and the principal contractor pays the compensation to the injured employee, can the principal contractor (who is not a party to the insurance policy) seek indemnity from the insurer?
The authority suggests that the common law principle of privity of contract applies. In B+B Construction Ltd v Sun Alliance and London Insurance Plc  2 HKC 295, the plaintiff, as principal contractor, subcontracted its construction work to Pak Kee Transportation Co Ltd (Pak Kee). Under the sub-contract Pak Kee was obliged to provide employees' compensation insurance. Pak Kee had taken out an insurance policy with Sun Alliance and London Insurance plc under which Pak Kee 'and his contractors' were the insured. The policy expressly excluded liability to 'employees of contractors to the insured' (the Exception). An employee of Pak Kee was subsequently injured during the course of employment, which was due to the negligence of an employee of the principal contractor. The principal contractor was held liable for damages and brought an action against the insurer for an indemnity.
The Court of First Instance granted a summary judgment against the insurer. The insurer successfully appealed to the Court of Appeal on the ground that the plaintiff's claim fell within the Exception and thus was wholly outside the scope of Pak Kee's employees' compensation policy. The insurer did not rely on the argument that the principal contractor was not a party to the contract, and therefore could not enforce the rights under the contract. The Court of Appeal proceeded on the basis that the principal contractor's claim, if otherwise good, was enforceable in the usual way. Having said that, the Court of Appeal, set out that the law in Hong Kong remained as magisterially stated in Dunlop Pneumatic Tyre Co td v Selfridge & Co Ltd  AC 847 and that only a person who is a party to a contract can sue on it, affirming the privity of contract principle. The case continued up to the Court of Final Appeal which upheld the decision of the Court of Appeal.
Under the proposed regime set out in the Bill, a third party may enforce a term 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 unless on a proper construction of the contract, the term is not intended to be enforceable by the third party. The contracting parties, however, can expressly agree that their contract does not give rise to any third party rights to enforce it.
Taking the B+B Construction Ltd case as an example, under the Bill, unless the application of which is expressly excluded, the principal contractor may, if challenged, argue that the policy purports to confer a benefit on it.
Existing regime in the insurance industry
Notwithstanding the 'privity of contract' doctrine, under the Third Parties (Rights against Insurers) Ordinance (Cap 273), a third party may have a direct cause of action against the insurer in certain 'specified circumstances'. This would include a situation whereby an insured under a liability policy becomes bankrupt or makes a composition or arrangement with his creditors, in which case the insured's rights against the insurer shall be transferred to and vested in the third party to whom the insured is primarily liable.
The Bill is intended to have a more extensive application than the Third Parties (Rights against Insurers) Ordinance. The full impact of the Bill on the insurance industry in Hong Kong, however, remains to be seen given the existing regime allows third parties to claim against insurers in specified circumstances. In other circumstances, for instance, in the case of a life insurance policy which anticipates payment to a third party nominated by the insured, a trust is usually expressly created in favour of the third party who could then assert its rights under the policy.
Having said that, if the Bill is passed, we can expect an increase in claims by third parties seeking to enforce policies. When drafting policy terms, insurers should set out clearly who will be entitled to enforce the policy. If the insurer wishes to exclude any rights that a third party may have against the insurer, this should also be set out clearly in the policy terms.
It is worthwhile for insurers to review policy wording to ensure that it clearly reflects the intent as to whether or not a third party can enforce the terms of the relevant policy. This could help avoid an argument from a third party claiming a benefit under the policy.