Chapter 17 - Third Party Rights

Privity of contract

Relationship between promisor and promisee of a contract.

A third party

one who is not a direct party to a particular contract

There are exceptions to the rule of privity of contract:

Transfer the rights or duties arising from the contract to another person.

• assignment (of rights)

• delegation (of duties)

In a bilateral contract

the two parties have corresponding rights and duties.

One party has a right to require the other to perform some task…

the other has a duty to perform the task.

Assignment

The act of transferring to another all or part of one’s rights under a contract.

Delegation

The transfer of a contractual duty to a third party.

• The party delegating the duty (the delegator) to the third party (the delegatee) is still obliged to perform on the contract should the delegatee fail to perform.

Assignor

Party assigning rights to third party.

Assignee

Party receiving rights.

Obligor

Person who is obligated to perform the duty

Obligee

Person to whom a duty or obligation is owed.

Assignor

Party assigning rights to third party.

Assignee

Party receiving rights.

Obligor

Person who is obligated to perform the duty

Obligee

Person to whom a duty or obligation is owed.

The Effect of an Assignment

When rights under a contract are assigned unconditionally, the assignee obtains only those rights that the assignor originally had.

The Effect of an Assignment

• The rights of the assignor are extinguished.

• The third party (the assignee) has a right to demand performance from the original party.

• The assignee’s rights are subject to the defenses that the obligor has against the assignor.

• The assignee obtains only those rights that the assignor originally had. “stands in their shoes”

Rights That Cannot Be Assigned

As a general rule, all rights can be assigned.

Assignments (Execeptions)

• The assignment is prohibited by statute. (worker compensation future benefits)

• The contract is personal. (Artist to paint a portrait)

• The assignment significantly changes the risk or duties of the obligor. (Assign insurance contract to another)

• The contract prohibits assignment.

The general rule that a contract can prohibit assignment has several exceptions:

• A contract cannot prevent an assignment of the right to receive funds.

  • This exception exists to encourage the free flow of funds and credit in modern business settings

• The assignment of rights in real estate often cannot be prohibited because such a prohibition is contrary to public policy in most states.

  • Prohibitions of this kind are called restraints against alienation—the voluntary transfer of property from one person to another (as opposed to a transfer by operation of law).

• The assignment of negotiable instruments (such as checks and promissory notes) cannot be prohibited.

  • In a contract for the sale of goods, the right to receive damages for breach of contract or payment of an account owed may be assigned even though the sales contract prohibits such an assignment.

Notice of Assignment

• Once a valid assignment of rights has been made, the assignee should notify the obligor of the assignment.

  • Giving notice is not legally necessary to establish the validity of the agreement.

    • An assignment is effective immediately, whether or not notice is given.

If the assignor assigns the same right to two different persons, the question arises as to which one has priority—that is, which one has the right to the performance by the obligor.

First in Time (Most States)

First to Provide Notice

Potential for Discharge by Performance to the Wrong Party

The obligor can discharge their obligation by performance to the assignor (the obligee) until the obligor has notice of an assignment.

Delegation

A party can transfer duties through delegation.

Delegator

Delegatee

One to whom contract duties are delegated by another.

Normally, a delegation of duties does not…

relieve the delegator of the obligation to perform in the event that the delegatee fails to do so.

No special form is required to create a valid delegation of duties.

As long as the delegator expresses an intention to make the delegation, it is effective.

Duties That Cannot Be Delegated

• When special trust has been placed in the obligor or when performance depends on the personal skill or talents of the obligor

• When performance by a third party will vary materially from that expected by the obligee

• When the contract expressly prohibits delegation

If a delegation of duties is enforceable, the obligee must accept performance from the delegatee. (Effect of a Delegation)

• The obligee can legally refuse performance from the delegatee only if the duty is one that cannot be delegated.

• A valid delegation of duties does not relieve the delegator of obligations under the contract.

• Although there are exceptions, generally the obligee can sue both the delegatee and the delegator for nonperformance.

When a contract provides for an “assignment of all rights,” this wording may create…

both an assignment of rights and a delegation of duties

• Typically, this occurs when general words are used.

  • Examples: “I assign the contract” or “I assign all my rights under the contract”

A court normally will construe such words as implying both an assignment of rights and a delegation of any duties of performance.

Thus, the assignor remains liable if the assignee fails to perform the contractual obligations.

Another exception to the doctrine of privity of contract arises…

when the contract is intended to benefit a third party.

Third party beneficiary

One for whose benefit a promise is made in a contract but who is not a party to the contract.

Intended beneficiary

A third party for whose benefit a contract is formed.

• An intended beneficiary can sue the promisor if such a contract is breached.

What happens in a bilateral contract?

both parties to the contract make promises that can be enforced.

• The court has to determine which party made the promise that benefits the third party.

  • That person is the promisor.

In effect, allowing a third party to sue the promisor…

directly circumvents the “middle person” (the promisee).

• This reduces the burden on the courts.

• Otherwise, the third party would sue the promisee, who would then sue the promisor.

The law traditionally recognized two types of intended third party beneficiaries:

• Creditor beneficiaries

• Donee beneficiaries

Creditor beneficiaries

benefits from a contract in which one party (the promisor) promises another party (the promisee) to fulfill a duty that the promisee owes to a third party (the creditor beneficiary).

Donee beneficiaries

• When a contract is made for the express purpose of giving a gift to a third party, the third party (the donee beneficiary) can sue the promisor directly to enforce the promise.

• The most common donee beneficiary contract is a life insurance contract.

The Modern View

adopted by the Restatement (Second) of Contracts does not draw clear lines between the types of intended beneficiaries.

Today, courts frequently distinguish only between: (The Modern View)

• Intended beneficiaries (who can sue to enforce contracts made for their benefit)

• Incidental beneficiaries (who cannot sue)

An intended third party beneficiary…

cannot enforce a contract against the original parties until the rights of the third party have vested, which means the rights have taken effect and cannot be taken away.

• Until these rights have vested, the original parties to the contract—the promisor and the promisee—can modify or rescind the contract without the consent of the third party.

Most courts hold that the rights vest when any of the following occurs:

• When the third party demonstrates express consent to the agreement

• When the third party materially alters their position in detrimental reliance on the contract

• When the conditions for vesting are satisfied

If the contract expressly reserves to the contracting parties the right to cancel, rescind, or modify the contract…

the rights of the third party beneficiary are subject to any changes that result.

• If the original contract reserves the right to revoke the promise or change the beneficiary…

the vesting of the third party’s rights does not terminate that power.

• Example: In most life insurance contracts, the policyholder reserves the right to change the designated beneficiary.

Incidental beneficiary

A third party who incidentally benefits from a contract but whose benefit was not the reason the contract was formed.

• has no rights in a contract and cannot sue to have the contract enforced.

Courts focus on…

intent, as expressed in the contract language and implied by the surrounding circumstances.

• Any beneficiary who is not deemed an intended beneficiary is considered incidental.

• Courts often apply the reasonable person test:

  • Would a reasonable person in the position of the beneficiary believe that the promisee intended to confer on the beneficiary the right to enforce the contract?

In addition, the presence of one or more of the following factors strongly indicates…

that the third party is an intended beneficiary to the contract:

• Performance is rendered directly to the third party.

• The third party has the right to control the details of performance.

• The third party is expressly designated as a beneficiary in the contract.