Contracts/Third-party beneficiary: Difference between revisions

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A third party beneficiary, in the law of contracts, is a person who may have the right to sue on a contract, despite not having originally been a party to the contract. This right arises where the third party is the intended beneficiary of the contract, as opposed to an incidental beneficiary. It vests when the third party relies on or assents to the relationship, and gives the third party the right to sue either the promisor or the promisee of the contract, depending on the circumstances under which the relationship was created.

In English law, the doctrine was not recognised at common law, but a similar concept was introduced with the Contracts (Rights of Third Parties) Act 1999.

Intended vs. incidental beneficiary

In order for a third party beneficiary to have any rights under the contract, he must be an intended beneficiary, as opposed to an incidental beneficiary. The burden is on the third party to plead and prove that he was indeed an intended beneficiary.

Incidental beneficiary

An incidental beneficiary is a party who stands to benefit from the execution of the contract, although that was not the intent of either contracting party. For example, if party A, Andrew, hires party B, Bethany, to renovate his (Andrew's) house, and insists that Bethany use a particular house painter—party C, Charlie—because that house painter has an excellent reputation, then the house painter is an incidental beneficiary. Neither Andrew nor Bethany is entering into the contract with the particular intent to benefit Charlie. Andrew simply wants his house properly renovated; Bethany simply wants to be paid to do the renovation. If the contract is breached by either party in a way that results in Charlie never being hired for the job, Charlie nonetheless has no rights to recover anything under the contract. Similarly, if Andrew were to promise to buy Bethany a Cadillac, and were to later go back on that promise, General Motors would have no grounds upon which to recover for the lost sale.

Intended beneficiary

The distinction that creates an intended beneficiary is that one party - called the promisee - makes an agreement to provide some consideration to a second party - called the promisor - in exchange for the promisor's agreement to provide some product, service, or support to the third party beneficiary named in the contract. The promisee must have an intention to benefit the third party - but this requirement has an unusual meaning under the law. Although there is a presumption that the promisor intends to promote the interests of the third party in this way, if party A, Andrew, contracts with party B, Bethany, to have a thousand killer bees delivered to the home of Andrew's worst enemy, party C, Charlie, then Charlie is still considered to be the intended beneficiary of that contract.

There are two common situations in which the intended beneficiary relationship is created. One is the creditor beneficiary, which is created where Andrew owes some debt to Charlie, and Andrew agrees to provide some consideration to Bethany in exchange for Bethany's promise to pay Charlie some part of the amount owed.

The other is the donee beneficiary, which is created where Andrew wishes to make a gift to Charlie, and Andrew agrees to provide some consideration to Bethany in exchange for Bethany's promise to pay Charlie the amount of the gift. Under old common law principles, the donee beneficiary actually had a greater claim to the benefits this created; however, such distinctions have since been abolished.

Vesting of rights

Once the beneficiary's rights have vested, the original parties to the contract are both bound to perform the contract. Any effort by the promisor or the promisee to rescind or modify the contract at that point are void. Indeed, if the promisee changed his mind and offered to pay the promisor money not to perform, the third party could sue the promisee for tortious interference with the third party's contract rights.

There are three tests used to determine whether the third party beneficiary's rights have vested:

1. if the beneficiary knows of and has detrimentally relied on the rights created;
2. if the beneficiary expressly assented to the contract at the request of one of the parties; or
3. if the beneficiary files a lawsuit to enforce the contract

Breach and defenses

Where a contract for the benefit of a third party is breached by the non-performance of the promisor, the beneficiary can sue the promisor for the breach just as any party to a contract can sue the other. Because the rights of the third party are defined by the contract created between the promisor and the promisee, the promisor may assert against the beneficiary any defenses to the contract that could be asserted against the promisee. These include all of the traditional basis by which the formation of a contract may be challenged: lack of capacity, lack of consideration, the Statute of Frauds, etc.; and all of the traditional bases by which non-performance on the contract may be excused: failure of consideration, impossibility, illegality, frustration of purpose, etc.

Because the promisor can assert any defenses that could be asserted against the promisee, the beneficiary also becomes liable for counterclaims on the contract that the promisor could establish against the promisee. This liability can never exceed the amount that the promisor owes under the contract. In other words, if the promisor is owed money by the promisee, any award to the third party for the promisor's failure to perform can be reduced by the amount thus owed. If the promisor is owed more than the value of the contract, the beneficiary's recovery will be reduced to nothing (but the third party can never be made to assume an actual debt).

A creditor beneficiary can sue both the promisor and the promisee, but the beneficiary cannot recover against both. If the suit is successful against one party to the contract, the other party will be dismissed. Because the creditor beneficiary is receiving the performance of the promisor in order to fulfill the promisee's debt, the failure of the promisor to perform means that the beneficiary can still sue the promisee to recover the preexisting debt. The failure of performance simply means that the debt has never been paid.

A donee beneficiary can sue the promisor directly to enforce the promise. (Seaver v. Ransom, 224 NY 233, 120 NE 639 [1918]). A donee beneficiary is when a contract is made expressly for giving a gift to a third party, the third party is known as the donee beneficiary. The most common donee beneficiary contract is a life insurance policy.

Rights that accrue to the promisee

The promisee can also sue the promisor for failing to pay the third party beneficiary. Under the common law, such suits were barred, but courts have since determined that the promisee can sue for specific performance of the contract, provided that the beneficiary has not already sued the promisor. Furthermore, if the promisee was in debt to a creditor beneficiary, and the failure of the promisor to perform caused the promisee to be held liable for that debt, the promisee can sue to recover the amount of the debt.

See also

• Pay it forward

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