Third Party Beneficiary: Definition and All You Need To Know

Third Party Beneficiary
Third Party Beneficiary

A third-party beneficiary is a person or company who benefits from the terms of a contract entered into by two other parties. A third-party beneficiary may have legal rights that can be enforced if the contract is breached. The intended third-party beneficiary contracts clause will be examined below in this post.

Understanding the Third-Party Beneficiary

Certain requirements must be met for the third party beneficiary to have legal rights to enforce contracts or share in the proceeds. The benefit to the third party, in particular, must be intended rather than accidental.

Life insurance contracts are the most obvious example of a third-party beneficiary. A person enters into a contract with an insurance company requiring the payment of death benefits to a third party. That third party did not sign the contract and may not even be aware of its existence; but he or she is entitled to its benefits.

The Rights of a Third-Party Beneficiary

Most examples are more ambiguous. Assume the owner of a new office building agrees to lease four floors to a large corporation. The landlord then signs a separate contract with a small business owner who wants to open a coffee shop on the ground floor; promising the big company a steady stream of customers. The large corporation then breaches the contract. The coffee shop owner is now bankrupt.

Can the coffee shop owner sue the big company for lost business as a result of its breach of contract with another party? The coffee shop owner, as a third-party beneficiary, may or may not have a case.

The company could argue that the coffee shop owner was an unintended beneficiary rather than an intended beneficiary. That is, the company did not intend to open offices in that building to enrich a coffee shop owner.

Clarifying Third-Party Beneficiary Rights

A third-party beneficiary’s rights are more clear if that person or business is specifically named in the contract. A third-party beneficiary clause is added in such cases to identify an individual or company; that expects to benefit from the agreement. If the third-party beneficiary is aware of the agreement and the intended benefit, this right is strengthened in law.

Assume a parent signed a lease and put down a security deposit on a rental apartment for a child to live in while attending college. When the student arrives in town, he is denied entry to the apartment. To make matters worse, the apartment has been rented to someone else. Both the student and the parent have the right to seek compensation for the landlord’s failure to meet the terms of the contract.

Two Types of Third-Party Beneficiaries

In the Restatement’s terminology, an intended beneficiary is a third person who the contract’s parties intend to benefit; that is, someone who is entitled under contract law to assert a right arising from a contract to which he or she is not a party. There are two kinds of intended recipients.

Creditor Beneficiary

A creditor beneficiary is someone to whom the promisor agrees to pay the promisee’s debt. A father, for example, is required by law to support his child. If the child’s uncle (the promisor) contracts with the father (the promisee) to provide support for the child; the child is a creditor beneficiary and may sue the uncle. Alternatively, suppose the Customer pays Ace Dealer for a new car and Ace delegated delivery to Beta Dealer. Ace is now a debtor because he owes the Customer money for a car.

The customer is a creditor; she owes money for a car. When Beta fulfills his delegated contract with Ace, he is discharging Ace’s debt to the customer. The customer is a creditor beneficiary under the Dealers’ contract and has the right to sue either of them for nondelivery. She could sue Ace because she had a contract with him, and she could sue Beta because once again; she intended to benefit from the Dealers’ agreement’s performance.

Donee Beneficiary

A donee beneficiary is the second type of intended beneficiary. The third person is a donee beneficiary when the promisee is not indebted to the third person but intends for him or her to benefit from the promisor’s performance (and the promise is sometimes called a gift promise). In exchange for a premium, an insurance company (the promisor) promises to its policyholder (the promisee) that it will pay $100,000 to his wife upon his death; this makes the wife a donee beneficiary.

Even though she was not a party to the contract, the wife could sue to enforce it. Alternatively, if Able enters into a contract with Woodsman to cut the trees in Able’s backyard as a Christmas gift to Able’s uphill Neighbor (so that Neighbor will have a view), the Neighbor may sue Woodsman for breach of contract.

Third-Party Beneficiary: Requirements

In contract law, a third-party beneficiary is someone who has the right to sue based on a contract clause despite not being a party to the contract or a signer of the contract.

Third-party beneficiaries are classified into two types: “intentional or intended” beneficiaries and “incidental” beneficiaries.

An intentional beneficiary is a non-party to a contract who directly benefits from the agreement.” This means that contracts only create rights, obligations, and liabilities for the parties who negotiated and signed the contract. The contract must refer to or name the third-party beneficiary, and the intent to provide a benefit to this third party must be irrevocable. A contract’s intended third-party beneficiary is explicitly promised certain benefits, but they are not a party to the contract itself.

A person or legal entity that is not a party to a contract but becomes an unintended third-party beneficiary of the contract is known as an incidental beneficiary. An incidental beneficiary is a third party who benefits from a contract between two other parties even though the third party’s benefit is not intended. This type of third-party beneficiary has no legal rights under the contract.

Categories of Intended Third-Party Beneficiaries

A donee or a creditor is a third-party beneficiary. A donee beneficiary receives a contract as a gift, not in exchange for a service provided by him/her/it. Assume you enter into a contract with Ed, a painter, stating that Ed will paint Uncle Pete’s house. Uncle Pete is not a party to the contract, but he is a third-party beneficiary who will profit from your agreement with Ed.

A creditor beneficiary is someone to whom the promisee owes an obligation. Assume you paid Ed to paint the house in the previous example. So, Ed is painting to compensate for his contractual obligation. As a result, Uncle Peter is an intended third-party creditor beneficiary.

Contract Rights of an Intended Third-Party Beneficiary

Contract rights can be enforced by both donee and creditor beneficiaries, but both must be intended beneficiaries. A classic example of an intended beneficiary under the life insurance contract is the named beneficiary on a life insurance policy (the person who will receive the death benefit upon the death of the insured).

In general, an intended beneficiary is one of the following:

  • As stated in the contract
  • Receives performance directly from the promisor or circumstances show that the promisee will provide the beneficiary with the benefit of the contract

Third-Party Beneficiary Examples

Terry agrees to purchase a car and present it to Ellen as a gift. Terry instructs Tom, the car dealer, to order the vehicle. Furthermore, Terry refuses to honor the contract by paying for the car when it arrives. Tom can then sue for damages because the contract breach has caused him financial harm, even though he is not a party to the contract.

When a person buys an insurance policy, a contract is formed. The contract is made between the insurance company and the person purchasing the policy. However, a third party stands to benefit from insurance payments. This is the third-party beneficiary clause, which applies if the person who purchased the policy dies. The beneficiary has the legal right to receive benefits and can sue if the contract is broken.

Grandpa makes a deal with a car dealer to purchase a Jaguar for his grandson as a graduation present. If the dealer accepts a down payment and then fails to complete the sale, the grandson has the right to sue the dealer as a third-party beneficiary. He intended to sue for the specific performance of the agreement.

Conclusion

Third-party beneficiary contracts can be complicated, so if you have any questions or concerns about one, it’s best to consult with a contract law expert. You want to protect your rights as much as possible, so having someone explain everything to you can be very beneficial.

Frequently Asked Questions

What is the difference between a third-party beneficiary and an incidental beneficiary?

An incidental beneficiary is a third party who benefits from a contract between two other parties, but the third party is not intended to benefit. As a result, the third party has no legal rights under the contract.

What factors indicate that a third-party beneficiary is an intended beneficiary?

What indicators show that a third-party beneficiary is an intended beneficiary? A beneficiary is considered an intended beneficiary if a reasonable person in the beneficiary’s position would believe that the promisee intended to confer the right to sue to enforce the contract on the beneficiary.

What is a third-party beneficiary clause?

A third-party beneficiary clause specifies whether a non-contractual party has any rights to enforce the terms of the contract. Beneficiaries are sometimes named, and sometimes they are chosen at random.

When would a 3rd party beneficiary have legal rights to enforce a contract?

To enforce a contract, a third-party beneficiary’s rights under the agreement must have vested, which means that the right has come into existence. The beneficiary’s position changes materially as a result of justifiable reliance on the contract’s promise.

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