A third party beneficiary is a person who benefits from a contract that is made between two other people. For example, a third party beneficiary is not a party to the contract himself but receives a benefit once the contract is satisfied. In certain situations, a third party beneficiary is afforded the legal rights necessary to enforce the contract and share in the proceeds. To explore this concept, consider the following third party beneficiary definition.
Definition of Third Party Beneficiary
- A person who benefit from a contract made between two other parties.
1605-1615 Latin beneficiārius
What is a Beneficiary
A beneficiary is someone who, as the name would suggest, receives some kind of benefit. For instance, a beneficiary is someone who receives an inheritance after being named in another person’s will. Someone who is listed on an insurance policy as the person who is to receive funds in the event of a payout is also known as a beneficiary.
What is a Third Party Beneficiary
A third party beneficiary is a person who receives a benefit from a contract that he is not a direct party to. There are two primary parties involved in every contract: the promisor and the promisee. However, for certain contracts, a third party may also benefit. That is where the third party beneficiary comes in.
Example of a third party beneficiary
Carlos wants to buy a new car for his daughter, Elise, as a college graduation present. He enters into a purchase contract with ABC Auto Sales, which is supposed to deliver the car to Elise’s home. Carlos gives the dealer $15,000 as a down payment on the car, and signs financing documents on the car. Elise is not a party to the contract between her father and ABC Auto Sales. However, she hears that her dad is giving her a sparkly new car, so she sells her old car to a friend.
On Elise’s birthday, the dealer fails to deliver the car, and when Carlos checks back, he discovers they never ordered the car in the first place. In this example, whether or not Elise can sue the car dealer for specific performance – to force it to deliver the vehicle – depends on whether she knew about the benefit she was to receive from the contract, and whether she relied on that belief.
Because Elise had been told about the car, and believing the gift was forthcoming, she sold her old car, she becomes a third party beneficiary, with the right to enforce the contract against ABC Auto Sales.
Important to note is that the intended beneficiary of a third-party contract does not need to be existent at the time the contract is entered into. This means that a contract can benefit someone who is unborn at the time of satisfaction, or it can secure benefits for a company that is still being formed.
In order for ius quaesitum tertio to be enforceable, it must also be irreversible. This can be accomplished by any of the following criteria:
- The contract is delivered to the third party.
- Evidence is presented that the third party was aware of the provision that was intended to benefit him.
- Hints are made to the third party that he may benefit as a result of the contract.
- The third party is tasked with fulfilling burdensome obligations on the belief that he indeed has ius quaesitum tertio.
A promisee can also sue a promisor for failing to pay a third party beneficiary. This is referred to as the practice of suing for “specific performance” of the contract. The promisee can only sue the promisor if the third party beneficiary has not already done so. Further, if the promisee was in debt to a creditor beneficiary, and the promisor’s failure to perform has resulted in the promisee being held responsible for that debt, then the promisee can sue for what remains of the outstanding debt.
Third Party Beneficiary Clause
A third party beneficiary clause must be present in order for a third party beneficiary to be considered an intended beneficiary. What this means is that, by including a third party beneficiary clause in a contract, the parties to the contract intend for that third party to benefit from the contract in some way. If no third party beneficiary clause is included in the contract, and a third party still benefits, then that third party beneficiary is referred to as an “incidental beneficiary,” rather than an “intended beneficiary.”
Example of a Third Party Beneficiary Clause
Norma has put everything she owns into a trust, and plans to give her home to her son, Michael, and retire to her new condo by the lake. Before she transfers the property title to Michael, she has the home remodeled, and contracts with a pool service to install a hot tub on the deck. All of the work is to be paid out of the monies in the trust.
Norma includes a third party beneficiary clause in the trust which states:
Third-Party Beneficiary. It is hereby specified that Michael, and each of his respective successors and assigns, shall have all the rights of a third-party beneficiary in respect to the improvements to be made to the home as contracted on xxx date, and shall be entitled to rely upon, and directly enforce the provisions of, those contracts.
Michael and his family move into the home, and the pool contractor keeps making excuses for not showing up. While the contract was between Norma and the pool service, Michael has become a third party beneficiary, and can file a lawsuit against the pool service in order to force the contractor to make good on the contract.
A third party beneficiary can either be an intended beneficiary or an incidental beneficiary. An intended beneficiary is someone who receives a benefit directly from the agreement that was made. His name is normally mentioned at some point within the contract, and he is just as entitled to sue for a breach of contract as are the primary parties. An incidental beneficiary is someone who benefits from a contract without being specifically named within it. An incidental beneficiary does not hold any rights to the contract, and simply received a reward from it by chance.
When an intended beneficiary decides to sue, the burden lies with him to prove whether he was indeed an intended beneficiary to the contract. In this case, the promise must have intended to benefit the third party by naming him in the contract. There are two situations in particular that tend to involve intended beneficiaries: a creditor beneficiary and a donee beneficiary.
Third Party Beneficiary Example Involving Drug Manufacturers
An example of a third party beneficiary situation being brought before a court involved a county suing drug manufacturers based on its perception of a breach of contract. In 2010, Santa Clara County, California, the operator of several healthcare facilities sued nine drug manufacturers, claiming they had charged prices that were higher than the prices previously set by statute. This was in violation of the Provider Pricing Agreements the manufacturers had drafted with the Department of Health and Human Services.
In its lawsuit, the county fully acknowledged that it was not a direct party to these allegedly breached contracts, but insisted it was entitled to compensatory damages. The county also argued that it was an intended third party beneficiary of the agreements, and could thus enforce the price caps that were supposed to be imposed on these manufacturers.
The District Court dismissed the county’s complaint, but the County appealed, and the Ninth Circuit reversed the District Court’s decision. The Ninth Circuit agreed that the county could sue the manufacturers as a third party, even if it was not technically entitled to sue under the statute. The Ninth Circuit’s decision was then appealed to the U.S. Supreme Court, and the Court agreed to hear the case.
The Supreme Court did not agree with the Ninth Circuit, and flat-out denied Santa Clara County’s suit in a unanimous decision. The Court found that a third party beneficiary lawsuit could not be filed due to the regulations that had been established by the Public Health Service Act. Because plaintiffs were allowed to enforce statutory requirements only through causes of action as provided by the statute, then, per the Court:
“It would make scant sense to allow them to sue on a form contract implementing the statute, setting out terms identical to those contained in the statute.”
For third party beneficiaries to be able to sue, the Court explained in its decision, the contracts that were drafted would need to show that such suits would be allowed to be brought. In this case, the Court held that the Ninth Circuit had erred by interpreting that intent was granted solely by relying on the references to the statute that the contracts were supposed to reflect.
This decision was an important one. Not only does it eliminate the possibility for redundant and potentially contradictory litigation in the future, but it may also predict the Supreme Court’s willingness to reject third party beneficiary suits filed against federal contractors in the future.
Many government contracts contain provisions similar to those that were argued here. If the decision made in this case extends to similar cases, then third party beneficiaries may only be permitted to file a similar suit if the statute related to that suit gives them permission to do so.
Related Legal Terms and Issues
- Breach of Contract – A violation of contract through failure to perform, or through interference with the performance of the contractual obligations.
- Compensatory Damages – An award of money in compensation for actual economic loss, property damage, or injury, not including punitive damages.
- Contract – An agreement between two or more parties in which a promise is made to do or provide something in return for a valuable benefit.
- Plaintiff – A person who brings a legal action against another person or entity, such as in a civil lawsuit, or criminal proceedings.