Contracts: Third Party Beneficiaries

Sometimes on the MBE, we are forced to deal with another party entering into the contractual relationship, which can complicate the fact patterns. When broken down, however, these concepts are not as difficult as they might first appear. This note will discuss third party beneficiaries. The next note will discuss assignments and delegations.

A: Third Party Beneficiaries

Throughout this note, I'll be using variables to hopefully simplify things. Here:

Let X=the promisor
Let Y-the promisee
Let Z-the 3rd party beneficiary.

The situation we are presented with is one in which X contracted with Y, but the performance, rather than going directly to Y (as would be the case in a contractual situation with only 2 parties), will go directly to Z.

When analyzing a 3rd party beneficiary problem, your first concern should be whether Z is an intended beneficiary or an incidental beneficiary. Only intended beneficiaries have contractual rights. A beneficiary is intended if the beneficiary receives performance directly from the promisor (ie, Z receives performance directly from X); or the beneficiary has some relationship with the promisee (ie, Z has a relationship with Y); or the beneficiary is identified in the contract.

Once you've made that initial determination, assuming you've determined that Z is intended, next you must determine whether Z's rights under the contract have vested. Again, we have three possibilities in regard to how Z's rights might vest. Rights vest when Z manifests assent to a promise in the manner requested by the parties; or Z materially changes position in justifiable reliance on the promise; or Z brings a suit to enforce the promise.

Let's assume now that you've determined that Z is an intended beneficiary, and that Z's rights have vested. Next, it must be determined who can sue whom under the contract.

Can Z sue X?

Yes. A 3rd party beneficiary can sue the promisor. If Z sues X, however, X will be able to assert against Z any defenses that X has against Y from the original contract. So, for example, if X is only 15 years old, then his promise to Y in the original contract is voidable (with a few exceptions), and therefore any promise that Z attempts to enforce against X will be voidable, as well.

Can Z sue Y?

It depends. Remember, we are in a situation in which the promisee has told the promisor that the promisor should perform for the 3rd party beneficiary, rather than the promisee. Whether or not the 3rd party beneficiary will be able to sue the promisee will be based on whether the 3rd party beneficiary is a creditor of the promisee (and therefore owed a debt by the promisee,) or merely a donee (and therefore was receiving a gift from the promisee). If Z was a creditor of Y, then Z will be able to sue Y if X fails to perform. If, however, Z is a donee, then Z will have no rights against Y, if X fails to perform. One exception to the general rule that a donee beneficiary can not sue the promisor on the contract is a situation in which detrimental reliance is found to exist. In such an instance the equitable doctrine of promissory estoppel might prevent Y from denying that he is obligated to perform for Z, even though the original obligation was merely to provide a gift to Z.

Can Y sue X

Yes. Y and X were the original contracting parties, so if analyzing the rights and obligations of the promisee and promisor, revert back to the contractual analysis that would have applied had there been no third party beneficiary.

The next note will discuss assignments and delegations, yet another situation in which a third party enters into the contractual relationship.