Chapter 15: Third-Party Rights and Discharge

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Third-Party Rights and Discharge

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  • Privity of contract is the relationship between the parties to a contract

    • Contracting parties have a legal obligation to perform the duties specified in their contract

  • A party’s duty of performance may be discharged by agreement of the parties, excuse of performance, or operation of law

  • If one party fails to perform as promised, the other party may enforce the contract and sue for breach

  • Third parties do not acquire any rights under other people’s contract unless the person enforcing the contract is a:

    1. Assignee to whom rights are subsequently transferred

    2. Intended third-party beneficiary to whom the contracting parties intended to give rights under the contract at the time of contracting

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Assignment of a Right

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  • Assignment (assignment of a right) is the transfer of contractual rights by obligee to another party

Form of Assignment

  • Obligor: a party who owes a duty of performance under a contract

  • Obligee: a party who is owed a right under a contract

  • Assignor: an obligee who transfers a right

  • Assignee: the party to whom a right is transferred

  • Generally, no formalities are required for a valid assignment of rights

    • Although the assignor often uses the word assign, other words or terms, such as sell, transfer, convey, and give, are sufficient to indicate intent to transfer a contract right

  • Unassignable Rights:

    • Personal service contract

    • Assignment of a future right

    • Contract where an assignment would materially alter the risk

    • Assignment of a legal action

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Third-Party Rights and Discharge

  • Privity of contract is the relationship between the parties to a contract

    • Contracting parties have a legal obligation to perform the duties specified in their contract

  • A party’s duty of performance may be discharged by agreement of the parties, excuse of performance, or operation of law

  • If one party fails to perform as promised, the other party may enforce the contract and sue for breach

  • Third parties do not acquire any rights under other people’s contract unless the person enforcing the contract is a:

    1. Assignee to whom rights are subsequently transferred

    2. Intended third-party beneficiary to whom the contracting parties intended to give rights under the contract at the time of contracting

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Assignment of a Right

  • Assignment (assignment of a right) is the transfer of contractual rights by obligee to another party

Form of Assignment

  • Obligor: a party who owes a duty of performance under a contract

  • Obligee: a party who is owed a right under a contract

  • Assignor: an obligee who transfers a right

  • Assignee: the party to whom a right is transferred

  • Generally, no formalities are required for a valid assignment of rights

    • Although the assignor often uses the word assign, other words or terms, such as sell, transfer, convey, and give, are sufficient to indicate intent to transfer a contract right

  • Unassignable Rights:

    • Personal service contract

    • Assignment of a future right

    • Contract where an assignment would materially alter the risk

    • Assignment of a legal action

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Personal Service Contract [Unassignable Rights]

  • Contracts for the provision of personal services are generally not assignable

  • Example A famous actor signs a contract with a movie studio whereby she agrees to star in a romantic comedy. The movie studio cannot assign the actor’s contract to another movie studio because it is a personal service contract.

  • The parties may agree that a personal service contract may be assigned

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Assignment of a Future Right [Unassignable Rights]

  • Usually, a person cannot assign a future right, a currently nonexistent right that the person expects to have in the future

  • Example Henrietta, an heiress worth millions of dollars, signs a will, leaving all her property to her granddaughter Anastasia. Anastasia has only an expected future right, not a current right, to the money. Anastasia cannot lawfully assign her expected future right to receive her inheritance. The assignment would be invalid.

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Contract Where an Assignment Would Materially Alter the Risk [Unassignable Rights]

  • A contract cannot be assigned if the assignment would materially alter the risk or duties of the obligor

  • Example Consuelo, who has a safe driving record, purchases automobile insurance from an insurance company. Consuelo cannot assign her rights to be insured to another driver because the assignment would materially alter the risk and duties of the insurance company.

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Assignment of a Legal Action [Unassignable Rights]

  • The right to sue another party for a violation of personal rights cannot usually be assigned

  • A legal right that arises out of a breach of contract may be assigned

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Effect of an Assignment of a Right

  • Where there has been a valid assignment of rights, the assignee “stands in the shoes of the assignor”

    • That is, the assignor is entitled to performance from the obligor

    • The unconditional assignment of a contract right extinguishes all the assignor’s rights, including the right to sue the obligor directly for nonperformance

  • An assignee takes no better rights under the contract than the assignor had

  • An obligor can assert any defense he or she had against the assignor or the assignee

  • An obligor can raise the defenses of fraud, duress, undue influence, minority, insanity, illegality of the contract, mutual mistake, or payment by worthless check of the assignor, against enforcement of the contract by the assignee

  • The obligor can also raise any personal defenses (e.g., participation in the assignor’s fraudulent scheme) he or she may have directly against the assignee

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Notice of Assignment

  • When an assignor makes an assignment of a right under a contract, the assignee is under a duty to notify the obligor that

    1. The assignment has been made, AND

    2. Performance must be rendered to the assignee

  • If the assignee fails to provide notice of assignment to the obligor, the obligor may continue to render performance to the assignor, who no longer has a right to it

  • The assignee cannot sue the obligor to recover payment because the obligor has performed the original contract

  • The assignee’s only course of action is to sue the assignor for damages


  • The result changes if the obligor is notified of the assignment but continues to render performance to the assignor

    • In such situations, the assignee can sue the obligor and recover payment

  • The obligor will then have to pay twice: once wrongfully to the assignor and then rightfully to the assignee

  • The obligor’s only recourse is to sue the assignor for damages

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Anti-Assignment Clause

  • An anti-assignment clause prohibits assignment of rights under the contract

  • Used when an obligor does not want to deal with or render performance to an unknown third party

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Approval Clause

  • An approval clause permits the assignment of the contract only upon receipt of an obligor’s approval

  • Where there is an approval clause, many states prohibit the obligor from unreasonably withholding approval

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Successive Assignments of the Same Right

American Rule (New York Rule)

  • The American rule (New York rule) provides that the first assignment in time prevails, regardless of notice

  • Most states follow this rule

English Rule

  • The English rule provides that the first assignee to give notice to the obligor (the person who owes the performance, money, duty, or other thing of value) prevails

Possession of Tangible Token Rule

  • The possession of tangible token rule provides that under either the American or English rule, if the assignor makes successive assignments of a contract right that is represented by a tangible token, such as a stock certificate or a savings account passbook, the first assignee who receives delivery of the tangible token prevails over subsequent assignees

  • The first assignee who receives delivery of the tangible token prevails over subsequent assignees

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Delegation of a Duty

  • Delegation of duty is a transfer of contractual duties by the obligor to another party for performance

  • Delegator: an obligor who transferred his or her duty

  • Delegatee: a party to whom the duty has been transferred

  • Generally, no special words or formalities are required to create a delegation of duties

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Duties that Can and Cannot Be Delegated

Duties that Can Be Delegated

  • Duties performed by qualified employees

    • Example If a client retains a firm of lawyers to represent him or her, the firm can delegate the duties under the contract to any qualified member of the firm.

Duties that Cannot Be Delegated

  • If an obligee has a substantial interest in having an obligor perform the acts required by a contract, these duties cannot be transferred

  • This restriction includes obligations under the following types of contracts:

    1. Personal service contracts calling for the exercise of personal skills, discretion, or expertise

      • Example If a famous singer is hired to give a concert on a college campus, another singer cannot appear in her place.

    2. Contracts whose performance would materially vary if duties were delegated

      • Example If a person hires an experienced surgeon to perform a complex surgery, a recent medical school graduate cannot be substituted to perform the operation.

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Effect of Delegation of Duties

  • The liability of the delegatee is determined by the following rules:

    1. Assumption of Duties: where a valid delegation of duties contains the term assumption or other similar language, there is an assumption of duties by the delegatee

      • Here, the obligee can sue the delegatee and recover damages from the delegatee for nonperformance or negligent performance by the delegatee

    2. Declaration of Duties: where there is a valid delegation of duties but the delegatee has not assumed the duties under a contract

      • Here, the delegatee is not liable to the obligee for nonperformance or negligent performance, and the obligee cannot recover damages from the delegatee

  • In either form of delegation, the delegator remains legally liable for the performance of the contract

  • If the delegatee does not perform properly, the obligee can sue the obligor-delegator for any resulting damages

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Anti-Delegation Clause

  • An anti-delegation clause prohibits the delegation of duties under the contract

  • Anti-delegation clauses are usually enforced

  • Some courts, however, have held that duties that are totally impersonal in nature—such as the payment of money—can be delegated despite such clauses

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Assignment and Delegation

  • An assignment and delegation occurs when there is a transfer of both rights and duties under a contract

  • If the transfer of a contract to a third party contains only language of assignment, the modern view holds that there is corresponding delegation of the duties of the contract

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Third-Party Beneficiaries

  • A third-party beneficiary is a third party who benefits by the performance by others of the others’ contracts

  • Third parties are either intended or incidental beneficiaries

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Intended Beneficiary

  • An intended third-party beneficiary is a third party who is not in privity of a contract but who has rights and can enforce the contract against the promisor

  • Examples The beneficiary may be expressly named in a contract from which he or she is to benefit (“I leave my property to my daughter Yu Yan”) or may be identified by another means (“I leave my property to all my children, equally”).

  • Intended third-party beneficiaries are sometimes classified as either (1) donee or (2) creditor beneficiaries

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Case 15.1 Third-Party Beneficiary

  • Case

    • Cline v. Homuth

    • Ct. of Appeal of California, 235 Cal.App.4th 699 (2015)

  • Facts

    • Plaintiff’s grandson was responsible for a car wreck while under Plaintiff’s supervision

    • Defendant executed a release that released the driver “and any other person . . . responsible in any manner or degree”

  • Issue

    • Was Plaintiff an intended beneficiary of the release signed by Defendant?

  • Decision

    • The court of appeal found that Homuth was an intended beneficiary of the release and affirmed the trial court’s grant of summary judgment in her favor

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Type 1: Donee Beneficiary [Intended]

  • A donee beneficiary contract is a contract intended to confer a benefit or gift on an intended third party

    1. The promisee is the contracting party who directs that the benefit be conferred on another

    2. The promisor is the contracting party who agrees to confer performance for the benefit of the third person

    3. The donee beneficiary is the third person on whom the benefit is to be conferred

  • If the promisor fails to perform the contract, the donee beneficiary can sue the promisor directly

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Type 2: Creditor Beneficiary [Intended]

  • A creditor beneficiary contract usually arises in the following situation:

    1. A debtor (promisor) borrows money from a creditor (promisee) to purchase some item

    2. The debtor signs an agreement to pay the creditor the amount of the loan plus interest

    3. The debtor sells the item to another party before the loan is paid

    4. The new buyer (new promisor) promises the original debtor (new promisee) that he or she will pay the remainder of the loan amount to the original creditor

  • A creditor beneficiary is an original creditor who becomes a beneficiary under the debtor’s new contract with another party

  • If the new debtor (promisor) fails to perform according to the second contract, the creditor beneficiary may either (1) enforce the original contract against the original debtor-promisor or (2) enforce the new contract against the new debtor-promisor

  • However, the creditor can collect only once

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Incidental Beneficiary

  • An incidental beneficiary is a third party who is unintentionally benefited by other people’s contracts

    • An incidental beneficiary has no rights to enforce or sue under other people’s contracts

  • Generally, the public and taxpayers are only incidental beneficiaries to contracts entered into by the government on their behalf

    • As such, they acquire no right to enforce government contracts or to sue parties who breach these contracts

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Case 15.2 Third-Party Beneficiary

  • Case

    • Does Ⅰ-Ⅺ, Workers in China, Bangladesh, Indonesia,

      Swaziland, and Nicaragua v. Wal-Mart Stores, Inc.

    • U.S. Ct. of Appeals for the 9th Cir., 572 F.3d. 677 (2009)

  • Facts

    • Defendant requires its suppliers to adhere to various standards

    • Plaintiffs, foreign workers, alleged that their employers violated these standards

  • Issue

    • Are the Plaintiffs intended third-party beneficiaries under Defendant’s contracts with its foreign suppliers?

  • Decision

    • The U.S. court of appeals held that the plaintiff foreign workers were not intended third-party beneficiaries to Walmart’s contracts with its foreign suppliers

    • The U.S. court of appeals affirmed the dismissal of the plaintiffs’ case

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Covenants

  • A covenant is an unconditional promise to perform

  • Nonperformance of covenant is breach of contract that gives the other party the right to sue

  • Example Seed Company borrows $500,000 from Rural Bank and signs a promissory note to repay the $500,000 plus 10 percent interest in one year. This promise is a covenant. That is, it is an unconditional promise to perform.

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Conditions

  • A conditional (qualified) promise is a situation in which a promisor’s duty to perform or not perform a contract arises only if a condition does or does not occur

  • A condition is a qualified or conditional promise that becomes a covenant if met

    • Generally, contract language such as if, on condition that, provided that, when, after, and as soon as indicates a condition

  • A single contract may contain numerous conditions that trigger or excuse performance

  • There are three primary types of conditions:

    1. Conditions Precedent

    2. Conditions Subsequent

    3. Concurrent Conditions

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1. Condition Precedent [Condition]

  • A condition precedent is a condition that requires the occurrence of an event before a party is obligated to perform a duty under a contract

  • The happening (or nonhappening) of the event triggers the contract or duty of performance

    • If the event does not occur, no duty to perform the contract arises because there is a failure of condition

  • Example An accounting firm offers​ Dylan, a student in​ college, a job.​ However, the contract contains a provision that Dylan must maintain a 3.0​ GPA, or the offer will be rescinded.

  • Some contracts reserve the right to a party to pay for services provided by the other only if the services meet the first party’s “satisfaction”

    • The courts have developed two tests: (1) the personal satisfaction test and (2) the reasonable person test to determine whether this special form of condition precedent has been met

Test 1: Personal Satisfaction Test

  • The personal satisfaction test is a subjective test that applies to contracts involving personal taste and comfort

  • Ex: contracts for interior decorating, tailoring clothes

  • The only requirement is that the person given the right to reject the contract acts in good faith

Test 2: Reasonable Person Test

  • The reasonable person test is an objective test that applies to commercial contracts and contracts involving mechanical fitness and most commercial contracts

  • Most contracts that require the work to meet the satisfaction of a third person (e.g., engineer, architect) are judged by this standard

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2. Condition Subsequent [Condition]

  • A condition subsequent is a condition in which the occurrence or nonoccurrence of a specific event automatically excuses the performance of an existing contractual duty to perform

    • That is, failure to meet the condition subsequent relieves the other party from obligation under the contract

  • Example An accounting firm offers​ Dylan, a college​ student, a job.​ However, the contract contains a provision that Dylan must pass the CPA exam within one year of his hire date or the employment contract may be terminated.

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3. Concurrent Conditions [Condition]

  • A concurrent condition is a condition that exists when the parties to a contract must render performance simultaneously

    • Each party’s absolute duty to perform is conditioned on the other party’s absolute duty to perform

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Express vs. Implied Condition

  • An express condition exists if parties expressly agree to terms

    • “Time is of the essence” is a condition used in contracts that designates that the performance of the contract by a stated time is an express condition and that there is a breach of contract if the contracting party does not perform by the stated date

  • An implied-in-fact condition is a condition that can be implied from the circumstances surrounding the contract and conduct of the parties

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Discharge of Performance

  • A party’s duty to perform under a contract may be discharged by (1) mutual agreement of the parties or by (2) impossibility of performance

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Type 1: Discharge by Agreement [Discharge of Performance]

  • Discharge by agreement is the discharge of contractual duties under a contract by mutual assent of the parties

    • There are different methods for discharging a contract by mutual agreement

(1) Mutual Rescission

  • Mutual rescission is mutual termination of a contract that occurs when the parties to a contract enter into a second contract that expressly terminates the first one

  • Unilateral rescission is an attempt by one party to a contract to terminate the contract without the other party’s consent

    • Not effective and constitutes a breach of that contract

(2) Substituted Contract

  • A substituted contract is a contract that contracting parties enter into that revokes and discharges an existing contract and is a substitute for the first contract

  • If one of the parties fails to perform his or her duties under a substituted contract, the nonbreaching party can sue to enforce its terms against the breaching party

  • The prior contract cannot be enforced against the breaching party because it has been discharged

(3) Novation

  • Novation is an agreement that substitutes a new party for one of the original contracting parties and relieves the exiting party of liability on the contract

  • The new substituted party is obligated to perform a contract

  • All three parties must agree to the substitution

  • In a novation, the exiting party is relieved of liability on the contract

(4) Accord and Satisfaction

  • Accord and satisfaction is the settlement of a contract dispute

    • The agreement whereby the parties agree to accept something different in satisfaction of the original contract is called an accord

    • The performance of an accord is called a satisfaction

  • An accord does not discharge the original contract, it only suspends it until the accord is performed

  • Satisfaction of the accord discharges both the original contract and the accord

  • If an accord is not satisfied when it is due, the aggrieved party may enforce either the accord or the original contract

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Type 2: Impossibility of Performance [Discharge of Performance]

  • Objective impossibility is nonperformance that is excused if a contract becomes impossible to perform

    • The impossibility must be an impossibility (“it cannot be done”) rather than a subjective impossibility (“I cannot do it”)

  • Examples:

    • Death or incapacity of promisor prior to performance of personal service contract

    • Destruction of subject matter

    • Supervening illegality

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Force Majeure Clause

  • The force majeure clause is a clause in a contract in which the parties specify certain events that will excuse nonperformance

  • Example A force majeure clause usually excuses nonperformance caused by natural disasters such as floods, tornadoes, and earthquakes. Modern clauses also often excuse performance due to labor strikes, shortages of raw materials, and the like.

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Statute of Limitations

  • A statute of limitations is a statute that establishes the period during which a plaintiff must bring a lawsuit against a defendant

    • If the lawsuit is not brought within this period, the injured party loses the right to sue

  • The usual period for bringing a lawsuit for breach of contract is one to five years