Third party beneficiary
Encyclopedia
A third party beneficiary, in the law
of contract
s, is a person who may have the right to sue on a contract, despite not having originally been an active party
to the contract. This right, known as a ius quaesitum tertio
, arises where the third party (tertius
or alteri) 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 (promittens, or performing party) or the promisee (stipulans, or anchor party) of the contract, depending on the circumstances under which the relationship was created. A contract made in favor of a third party is known as a third-party contract or contract for the benefit of a third party (stipulatio alteri), and any action to enforce a ius quaesitum tertio is known as a third party action.
Under traditional common law
, the ius quaesitum tertio principle was not recognized, instead relying on the doctrine of privity of contract
, which restricts the rights, obligations, and liabilities arising from a contract to the contracting parties (said to be privy to the contract). However, a number of allowances and exceptions for ius quaesitum tertio were introduced into English law
with the Contracts (Rights of Third Parties) Act 1999
. Other common-law countries are also making reforms in this area, though America is unique in abandoning privity early in the mid-19th century.
In either case, a third-party contract differs from agency in that the promisee acts in his own name and for himself, whereas an agent or representative does not. It is also distinguishable from a promesse de porte-fort under which the third party has a negative obligation to perform and, by expressing his consent, initially substitutes himself for an intended party to a contract and therefore binds himself. Also, as a somewhat distinct rule, the intended beneficiary of a third-party contract does not need to be in existence at the time the contract is concluded. This means a contract may benefit an unborn person (usually a family member) or secure benefits for a legal person, such as a company, still in the process of forming or registering.
interpretation, however, prior to formal acceptance of the benefit, the third-party beneficiary only has a spes, or expectation; in other words, he does not have the right to accept, but rather a mere competency. Acceptance may also be a suspensive condition in certain contracts. Under Scots law
, acceptance is not necessary to be vested in a right of action, but is necessary to be liable. Before acceptance, however, the ius quaesitum tertio is tenuous so that acceptance of a benefit does not create a right, but rather entrenches that right. In either case, the contracting parties may vary or rescind the contract until acceptance or reliance.
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. (This would be illegal if the intent was to scare his enemy, contracts are voided based on criminality.)
There are two common situations in which the intended beneficiary relationship is created:
with the third party's contract rights.
There are three tests used to determine whether the third party beneficiary's rights have vested:
, 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.
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.
Law
Law is a system of rules and guidelines which are enforced through social institutions to govern behavior, wherever possible. It shapes politics, economics and society in numerous ways and serves as a social mediator of relations between people. Contract law regulates everything from buying a bus...
of contract
Contract
A contract is an agreement entered into by two parties or more with the intention of creating a legal obligation, which may have elements in writing. Contracts can be made orally. The remedy for breach of contract can be "damages" or compensation of money. In equity, the remedy can be specific...
s, is a person who may have the right to sue on a contract, despite not having originally been an active party
Party (law)
A party is a person or group of persons that compose a single entity which can be identified as one for the purposes of the law. Parties include: plaintiff , defendant , petitioner , respondent , cross-complainant A party is a person or group of persons that compose a single entity which can be...
to the contract. This right, known as a ius quaesitum tertio
Tertius
Tertius is Latin word for "third", or "concerning the third".-In law:The term is used in contract law to refer to an interested third party not privy to a contract...
, arises where the third party (tertius
Tertius
Tertius is Latin word for "third", or "concerning the third".-In law:The term is used in contract law to refer to an interested third party not privy to a contract...
or alteri) 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 (promittens, or performing party) or the promisee (stipulans, or anchor party) of the contract, depending on the circumstances under which the relationship was created. A contract made in favor of a third party is known as a third-party contract or contract for the benefit of a third party (stipulatio alteri), and any action to enforce a ius quaesitum tertio is known as a third party action.
Under traditional common law
Common law
Common law is law developed by judges through decisions of courts and similar tribunals rather than through legislative statutes or executive branch action...
, the ius quaesitum tertio principle was not recognized, instead relying on the doctrine of privity of contract
Privity of contract
The doctrine of privity in the common law of contract provides that a contract cannot confer rights or impose obligations arising under it on any person or agent except the parties to it....
, which restricts the rights, obligations, and liabilities arising from a contract to the contracting parties (said to be privy to the contract). However, a number of allowances and exceptions for ius quaesitum tertio were introduced into English law
English law
English law is the legal system of England and Wales, and is the basis of common law legal systems used in most Commonwealth countries and the United States except Louisiana...
with the Contracts (Rights of Third Parties) Act 1999
Contracts (Rights of Third Parties) Act 1999
The Contracts Act 1999 was an Act of the Parliament of the United Kingdom that significantly reformed the common law Doctrine of Privity and "thereby [removed] one of the most universally disliked and criticised blots on the legal landscape"...
. Other common-law countries are also making reforms in this area, though America is unique in abandoning privity early in the mid-19th century.
Ius quaesitum tertio
While the law on this subject varies, there is nonetheless a commonly accepted construction of third-party rights in the laws of most countries. A right of action arises only where it appears the object of the contract was to benefit the third party's interests and the third-party beneficiary has either relied on or accepted the benefit. A promisee nominates a third party usually for one of two reasons, either the promisee owes something to the third party and the performance of this new obligation will discharge it, or the promisee will somehow get a material benefit by giving something to the third party. There are also two possible ways to explain the functioning of the contractual relationship; either,- the parties A (promisee) and B (promisor) contract each in his own name but with the intention of creating an opportunity for C (third-party beneficiary) to acquire a benefit, conditional upon acceptance, from B; or
- C immediately acquires a conditional right, from which A is able to release B until the moment of acceptance, when the right of A to release B is extinguished.
In either case, a third-party contract differs from agency in that the promisee acts in his own name and for himself, whereas an agent or representative does not. It is also distinguishable from a promesse de porte-fort under which the third party has a negative obligation to perform and, by expressing his consent, initially substitutes himself for an intended party to a contract and therefore binds himself. Also, as a somewhat distinct rule, the intended beneficiary of a third-party contract does not need to be in existence at the time the contract is concluded. This means a contract may benefit an unborn person (usually a family member) or secure benefits for a legal person, such as a company, still in the process of forming or registering.
Object to benefit
For third-party rights to come into existence, certain contractual criteria must be met to show an object to benefit:- a valid contract must exist between two contracting parties and not some other relationship;
- the contracting parties must have intended to confer a benefit, and not a simple interest, to a third party, either expressly or impliedly;
- the third-party beneficiary must be named or referred to, or is a member of a distinct class referred to;
- the intention to benefit must generally be irrevocable, though a life insurance policy is an exception;
- finally, there must be some intimation to the third party of the contract's existence.
Irrevocability
To be enforceable, a ius quaesitum tertio must be irrevocable. This is established by any of the following:- delivery of the contractual document to the third party
- registration for publication
- intimation to the third party
- the third party coming under onerous obligations on the faith of having a ius quaesitum
- by evidence that the third party knew of the provision intended for his or her benefit.
Acceptance
A third-party beneficiary only acquires a right of action to enforce his benefit once he has accepted the benefit provided for in the contract. Under the South AfricanSouth Africa
The Republic of South Africa is a country in southern Africa. Located at the southern tip of Africa, it is divided into nine provinces, with of coastline on the Atlantic and Indian oceans...
interpretation, however, prior to formal acceptance of the benefit, the third-party beneficiary only has a spes, or expectation; in other words, he does not have the right to accept, but rather a mere competency. Acceptance may also be a suspensive condition in certain contracts. Under Scots law
Scots law
Scots law is the legal system of Scotland. It is considered a hybrid or mixed legal system as it traces its roots to a number of different historical sources. With English law and Northern Irish law it forms the legal system of the United Kingdom; it shares with the two other systems some...
, acceptance is not necessary to be vested in a right of action, but is necessary to be liable. Before acceptance, however, the ius quaesitum tertio is tenuous so that acceptance of a benefit does not create a right, but rather entrenches that right. In either case, the contracting parties may vary or rescind the contract until acceptance or reliance.
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 considerationConsideration
Consideration is the central concept in the common law of contracts and is required, in most cases, for a contract to be enforceable. Consideration is the price one pays for another's promise. It can take a number of forms: money, property, a promise, the doing of an act, or even refraining from...
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. (This would be illegal if the intent was to scare his enemy, contracts are voided based on criminality.)
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 debtDebtA debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
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 giftGiftA gift or a present is the transfer of something without the expectation of receiving something in return. Although gift-giving might involve an expectation of reciprocity, a gift is meant to be free. In many human societies, the act of mutually exchanging money, goods, etc. may contribute to...
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 lawCommon lawCommon law is law developed by judges through decisions of courts and similar tribunals rather than through legislative statutes or executive branch action...
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 interferenceTortious interference
Tortious interference, also known as intentional interference with contractual relations, in the common law of tort, occurs when a person intentionally damages the plaintiff's contractual or other business relationships...
with the third party's contract rights.
There are three tests used to determine whether the third party beneficiary's rights have vested:
- if the beneficiary knows of and has detrimentally reliedEstoppelEstoppel in its broadest sense is a legal term referring to a series of legal and equitable doctrines that preclude "a person from denying or asserting anything to the contrary of that which has, in contemplation of law, been established as the truth, either by the acts of judicial or legislative...
on the rights created; - if the beneficiary expressly assented to the contract at the request of one of the parties; or
- 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 capacityCapacity (law)
The capacity of both natural and legal persons determines whether they may make binding amendments to their rights, duties and obligations, such as getting married or merging, entering into contracts, making gifts, or writing a valid will...
, lack of consideration
Consideration
Consideration is the central concept in the common law of contracts and is required, in most cases, for a contract to be enforceable. Consideration is the price one pays for another's promise. It can take a number of forms: money, property, a promise, the doing of an act, or even refraining from...
, the Statute of frauds
Statute of frauds
The statute of frauds refers to the requirement that certain kinds of contracts be memorialized in a signed writing with sufficient content to evidence the contract....
, 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
Frustration of purpose
In the law of contracts, frustration of purpose is a defense to enforcement of the contract. Frustration of purpose occurs when an unforeseen event undermines a party's principal purpose for entering into a contract, and both parties knew of this principal purpose at the time the contract was made...
, 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 performanceSpecific performance
Specific performance is an order of a court which requires a party to perform a specific act, usually what is stated in a contract. It is an alternative to award/ for awarding damages, and is classed as an equitable remedy commonly used in the form of injunctive relief concerning confidential...
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.