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.
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.
An incidental beneficiary is a party who stands to benefit from the execution of the contract, although that was not the intent of either party. For example, if party A hires party B to rennovate party A’s house, and insists that party B use a particular house painter – party C – because that house painter has an excellent reputation, then the house painter is an incidental beneficiary. Neither party A nor party B is entering into the contract with the particular intent to benefit party C. A simply wants his house properly rennovated; B simply wants to be paid to do the rennovation. If the contract is breached by either party in a way that results in party C never getting hired for the job, party C nonetheless has no rights to recover anything under the contract. Similarly, if party A were to promise to buy party B 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.
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 contract with party B to have a thousand killer bees delivered to the home of Party A’s worst enemy, party C, then C 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 party A owes some debt to party C, and party A agrees to provide some consideration to party B in exchange for party B’s promise to pay party C some part of the amount owed.
The other is the donee beneficiary, which is created where party A wishes to make a gift to party C, and party A agrees to provide some consideration to party B in exchange for party B’s promise to pay party C 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 has expressly assented to the contract at the request of one of the parties
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 can not 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 not sue the promisee, because the promisee’s act is gratuitous. Courts simply will not allow a party who has been promised a gift to sue to compel delivery of the gift. However, if the beneficiary has relied to his detriment on the promisee’s assertion that the promisor would perform, the beneficiary may sue the promisee under a promissory estoppel theory.
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.