2. Other than the essential elements as mentioned on question 1, what are the other important matters that the parties should note when making a contract?
Privity of contract
Under common law, a third party cannot sue or be sued regarding a contract, and only the parties to a contract can rely on the contract terms to take legal action. However, there are some exceptions to this principle, such as:
- If the contract is signed by an agent or representative on behalf of one of the parties, then that agent (who is a third party) may also bear the liability if he or she acted fraudulently or signed the contract without authorisation.
- It is common in insurance contracts to subrogate the insured person's rights to the insurance company. For example, if someone injures you and the insurance company subsequently pays your claim for the injury, then that insurance company (as a third party) can take over your legal rights to claim against the wrongdoer.
The Contracts (Rights of Third Parties) Ordinance (Cap.623 of the Laws of Hong Kong) which came into force on 1 January 2016 has reformed the common law doctrine of privity of contract. It enables a third party to enforce a term of a contract where the contract expressly provides that the third party may do so or the term purports to confer a benefit on the third party. This Ordinance applies to all Hong Kong law-governed contracts entered into on or after 1 January 2016 save for certain types of contracts (such as contracts of employment) which are expressly excluded. If the contracting parties do not want to grant rights to third parties, they should include a clause into the contract to disable the operation of this Ordinance.
Express or implied terms of a contract
Generally speaking, the contracting parties are free to agree on the terms of a contract (unless such terms are illegal). However, some of the terms may not be expressly stated on the contract. These terms, known as "implied terms", are terms that have not been orally mentioned or written down by the parties, but that are still incorporated into the contract according to the law or previous dealings between the parties.
Liquidated damages (compensation)
Liquidated damages are a genuine pre-estimation of the loss or damage that would result if a certain event were to happen during the performance of the contract. A contract term that specifies liquidated damages binds the parties, whereas a "penalty clause" in the contract (i.e. when there is no genuine pre-estimation and the amount of compensation is arbitrary stated) is not binding.
Certain contracts are illegal under the law. Here are some examples: a contract to insure the life of a person in whom the insurance buyer has no insurable interest, contracts to commit a crime, contracts to corrupt public life (to bribe government officials), contracts to defraud the Inland Revenue Department, and contracts to oust the jurisdiction of the courts.
Genuine consent of the parties
There must be no threats of physical danger in the drawing up of a contract (i.e. a party cannot be forced by the other party to enter into a contract). Otherwise the contract may be voidable, in which the party who needs the protection can seek to avoid the contractual liability.
Discharge of contract
With regard to the performance of contractual duties, the law requires the parties to perform all of their obligations under the relevant contract. However, a contract may be discharged by mutual agreement, performance of contractual duties, breach or frustration (the occurrence of certain unforeseen events that make a contract impossible to perform).
(Note: This answer highlights only a few of the important issues. There may be other information that you need to know before signing a contract, in which case a lawyer is in a better position to help you.)
Formalities of a contract
As discussed above, a contract can be made orally or in writing. However, in reality, it is always difficult, if not impossible, to prove the content or even the existence of an oral contract. It is therefore always preferable to prepare and sign a business contract in writing.
In terms of business contract, you may have come across the terms “agreement” and “deed”. So what are the differences between them? When to use an “agreement” and when to use a “deed”?
By way of an “agreement”, the parties of a contract agree to do somethings which the other party desires. As discussed above under the section of “Consideration”, for a contract to be legally binding, each party has to provide and obtain benefit (i.e. the consideration) from the transaction. This sounds very typical in the business world. But what about some atypical cases where a party is prepared to give something to another party without getting any reward?
Now this is where the “deed” comes into place. In the section on “Consideration”, we have briefly mentioned using a “deed” to construe a promise of a gift. Here are some more examples of deeds:
- Deed of Covenant: A covenant means a promise; and in many cases, a promise does not bear any consideration element. For example, a Deed of Covenant is usually used to evidence a donor’s promise to donate a certain sum of money regularly to a charity over a fixed period of time.
- Deed of Trust: By way of a trust, a trustee will be delegated with the responsibility to hold and control property for another person. The trustee may or may not receive any remuneration (i.e. consideration) for this. The document evidencing the trust should therefore be done by way of a “deed”.
- Deed of Guarantee: As discussed above in the section on “Personal Guarantee” and “Bank Guarantee”, it is not difficult to discern that a guarantor typically does not gain any benefit from entering into a guarantee. That is to say, there is no consideration for the guarantor to enter into the guarantee. It is therefore common for a guarantee to be executed in the form of a “deed”.
Further, the deed is often described as a legal instrument in writing which transfers the title of an asset to a new owner. For example an “Agreement for Sale and Purchase” signifies the parties’ readiness to buy and sell; but it does not confirm the actual act of buying and selling. The parties subsequently have to enter into a “Deed of Assignment” to actually transfer the title of the subject asset to the buyer.
You may also be interested in the following differences between an “agreement” and a “deed”:
- An “agreement” can be made either orally or in writing; a “deed” must be made in writing.
- An “agreement” in writing has to be signed by the parties; a “deed” must be signed, sealed and delivered. (Note: The act “signed” is obvious and probably does not require any explanation. The act “sealed” originally involves the use of sealing wax, but in modern days it only requires fixing a small red label onto the document. For delivered, the parties simply has to show an intention to be bound by the deed; in the case of companies, the law presumes that a document, if executed pursuant to certain procedures, is to be presumed to be delivered as a deed upon its execution (section 128 of the Companies Ordinance (Cap.622)).
Contemporary law has also dispensed with some of the above formalities regarding the execution of a deed. The law now only imposes a “face value requirement”. In other words, if a document describes itself as a deed, it is a deed. For example, the words “executed as a deed” in the document would suffice to make it a deed.
It may not be easy for a business person without legal training to decide whether to use an agreement or a deed to establish a contract. We strongly suggested that you should consult a lawyer before entering into any important contract, be it an agreement or a deed.