When two or more people or entities make a contract that benefits a person who is not a party to the contract, that person is considered a “third-party beneficiary.” A third-party beneficiary may have certain rights that can be enforced in the event one of the parties does not perform as promised in the contract. This is true even though the third-party beneficiary is not a party to the contract.
One classic third-party beneficiary example is a standard life insurance policy. A person buys a life insurance policy from an insurance company. The company promises to pay a death benefit to a third party in exchange for payment of premiums by the person who purchases the policy.
Often one spouse buys a policy that pays a death benefit to the other spouse, who is the third-party beneficiary. The third party does not sign the contract. The third-party may not even know that the contract exists, and yet they are entitled to the benefit of the contract.
What Is Privity of Contract?
Privity of contract is a contract law doctrine that provides that only the parties to a contract are bound by it, and no third-party can sue to enforce a contract or be sued by a party to the contract if there is a breach. Lack of privity of contract exists when parties have no contractual relationship to one another at all, thereby eliminating any obligations, liabilities, and access to certain rights.
When Is a Third Party Beneficiary Able to Enforce a Contract?
Determining whether or not the third party beneficiary can sue depends on whether the party is an intended beneficiary or an incidental beneficiary of the third-party beneficiary contract as follows:
- Intended Beneficiary: If it is clear that the intent of the contracting parties directly and predominantly benefits a third-party, that third party is an intended beneficiary and may be able to bring suit. An example of this would be the life insurance policy in which the third-party beneficiary is named in the policy as the one who should receive the death benefit;
- Or a different kind of contract may have an express third-party beneficiary clause in it;
- Incidental Beneficiary: If a third party benefits if a contract is performed as promised by the parties but not because the contracting parties intended it, the third party is an incidental beneficiary and has no right to seek enforcement of the contract if one of the parties should fail to perform.
In many cases, it is not entirely clear whether a third-party beneficiary is intended or incidental. Suppose the owner of an office building signs a contract with a large company to lease 5 floors of space. The landlord then signs a separate contract with the owner of a sandwich shop who wants to open a sandwich shop on the ground floor.
The shop owner hopes to sell sandwiches to the employees of the large company that occupies 5 floors above. If the large company then reneges on the deal and does not take up occupancy of the 5 floors, the sandwich shop owner is going to have a hard time surviving.
The rights of a third-party beneficiary are more likely to win enforcement in court if the benefit was intentional and the third party was aware of it. In this example, the lease of the large company is not clearly a third-party beneficiary contract.
The issue is whether the sandwich shop owner is an intended beneficiary who can demand compensation for the loss of business from the large company based on its breach of the lease agreement with the building owner. If the shop owner is an intended beneficiary, they might have some rights in this case. If the shop owner is only an incidental beneficiary, they would not have any rights in this situation.
Of course, to escape liability, the company would argue that the shop owner was only an incidental beneficiary, and not an intended beneficiary, of the company’s lease with the owner. The company would argue that it had no plan to take occupancy of the building in order to enrich a sandwich shop on the ground floor. Any benefit that would accrue to the shop would have been incidental only.
On the other hand, circumstances might possibly favor the sandwich shop owner. The landlord/owner might have used the presence of the sandwich shop to lure the large company into the lease, pointing out that it would serve as a great convenience to the employees of the company. In addition, the presence of the company on 5 floors in the building would clearly benefit the shop.
If there is good evidence that the mutual benefit of the leases of the company and the shop was an issue in the negotiation of the lease, the shop might have an argument.
Does the Intent to Benefit Have to Be Written in the Contract?
The intent to benefit a third party does not necessarily have to be expressed in writing in a contract in order to be respected by a court. The intent to benefit the third party can be implied based on the language and nature of the contract. The intent does need to be clearly expressed, however.
Of course, the status of a third-party beneficiary is more certain if the person or business is specifically identified in the contract. Their rights are stronger in the view of the law if the third-party beneficiary is identified in the contract and the beneficiary knows about the agreement and the intended benefit.
For example, say a parent signs a lease and pays a security deposit in order to rent an apartment for their child to live in while they go to college. When the child arrives in town, however, the child cannot gain access to the apartment. It turns out that the landlord has rented the apartment to another tenant for a higher rent. The student and the parent both have the right to sue for breach of the lease agreement and the landlord’s failure to perform their obligation under the lease.
Or a father may want to buy a new car for his son as a 21st birthday gift. He enters into a purchase agreement with XYZ Auto Dealership, which promises to deliver the car on the day of the son’s birthday. Father pays the dealer $10,000 as a down payment and then agrees to a financing deal for the rest of the purchase price. The son is not a party to the contract between his father and XYZ Auto Dealership. However, upon hearing that his father is going to present him with a spanking new car on his 21st birthday, he sells his old clunker to a friend.
On the son’s birthday, the dealer fails to deliver the car, and when the father contacts XYZ to find out what went wrong, he learns that XYZ could not deliver because of delivery issues and the car will not be available for another 2 months.
In this example, whether or not the son can sue XYZ for specific performance – to force it to deliver the vehicle before 2 months have passed – depends on whether XYZ knew about the benefit the son was to receive from the contract and whether the son relied on that belief.
Or it is possible in this example that the son is a third-party beneficiary with a right to sue XYZ for an award of money damages because of its failure to perform as promised.
Do I Need a Lawyer for Third-Party Beneficiary Issues?
Contracts are a complicated area of law. LegalMatch.com can connect you with an experienced contract lawyer experienced in contract law who can help you determine if someone is a third-party beneficiary and, if so, whether that person is intended or incidental.
Or, if you are drafting a contract and you want to protect privity of contract, your lawyer can draft a contract that clearly expresses an intention not to benefit any third parties. If you are a third party and believe you should be able to enforce a contract, your lawyer can advise you as well and help protect your rights.
