Chapter 17: Third Party Rights

Introduction to Third Party Rights

• A contract is a private agreement, traditionally binding only the parties involved.
• Privity of Contract: This is the relationship between the promisor (the one making the promise) and the promisee (the one to whom the promise is made).
• Generally, a third party (someone not directly involved in the contract) doesn't have rights under that contract.
• Exceptions to this rule exist:
  • Assignment: Transferring rights from one party to another.
  • Delegation: Transferring duties from one party to another.
  • Third Party Beneficiary Contract: A contract specifically intended to benefit a third party.

Assignments and Delegations

• In a bilateral contract, each party has rights and duties.
  • One party has the right to demand performance.
  • The other has the duty to perform.
• Assignment: Transferring rights arising under a contract.
• Delegation: Transferring a contractual duty to a third party.
• Delegator: The party delegating the duty remains obligated if the delegatee (the third party) fails to perform.
• Assignments and delegations occur after the original contract is made.

Assignments Explained

• Assignments are common in business. Example: Mortgage loans are often assigned to third parties for payment collection.
• Without the ability to transfer contractual rights, many businesses would struggle.

Effect of an Assignment

• Assignor: The one assigning the rights.
• Assignee: The one receiving the rights.
• Obligee: The one to whom an obligation is owed.
• Obligor: The one who owes an obligation.
• When rights are unconditionally assigned:
  • The assignor's rights are extinguished.
  • The assignee can demand performance from the original party (obligor).
  • The assignee's rights are subject to any defenses the obligor had against the assignor.
  • The assignee only obtains the rights the assignor originally possessed.
• Assignments can be oral or written but putting them in writing is advisable.
• Exhibit 17-1: Horton assigns his rights under contract with Brower to Kuhn. Horton is the assignor, Kuhn the assignee, and Brower the obligor who now owes performance to Kuhn.

Restrictions on Assignments

• Generally, all rights can be assigned, but exceptions exist:
  • Assignments prohibited by statute.
  • Contracts that are personal in nature.
  • Assignments that significantly alter the obligor's risk or duties.
  • Contracts that explicitly prohibit assignment.
• Exceptions to the rule against prohibiting assignment:
  • The right to receive funds cannot be restricted to encourage free flow of funds.
  • Real estate assignment prohibitions are often against public policy (restraints against alienation).
  • Alienation: Voluntary transfer of property.
  • Negotiable instruments (checks, notes) assignments cannot be prohibited.
  • In contracts for the sale of goods, the right to receive damages for breach or payment of an account can be assigned even if the contract prohibits it.

Notice of Assignment

• The assignee should notify the obligor of the assignment for clarity, though notice isn't legally required for validity.
• The assignment is effective immediately, whether or not notice is given.
• Problems arising without notice:
  • If the assignor assigns the same right to multiple parties, the first assignment in time generally has priority.
  • Until the obligor is notified, they can fulfill obligations by performing to the assignor.

Delegations Explained

• A party can transfer duties via delegation.
• Delegator: One who delegates duties.
• Delegatee: One who receives delegated duties.
• Delegation doesn't relieve the delegator of their obligation if the delegatee fails to perform.
• No specific form is needed for valid delegation; intention to delegate is sufficient.
• Exhibit 17-2: Brower delegates her duties under a contract with Horton to Kuhn. Brower is the delegator, Kuhn the delegatee, and Horton is owed performance; Brower remains liable if Kuhn doesn't perform.

Restrictions on Delegations

• Generally, any duty can be delegated, but there are exceptions:
  • When special trust is placed in the obligor.
  • When performance relies on the obligor's personal skills or talents.
  • When third-party performance would materially differ from what the obligee expects.
  • When the contract expressly prohibits delegation.

Effect of Delegation

• If delegation is enforceable, the obligee must accept performance from the delegatee, unless the duty is non-delegable.
• Valid delegation doesn't relieve the delegator of their obligations.
• The obligee can generally sue both the delegatee and delegator for nonperformance.

Assignment of "All Rights"

• "Assignment of all rights" may imply both assignment of rights and delegation of duties.
• This happens typically when general terms are used; (e.g., "I assign the contract").
• Courts interpret such wording as implying both assignments of rights and delegation of duties.
• The assignor remains liable if the assignee doesn't fulfill the contractual obligations.

Third Party Beneficiaries

• Another exception to privity of contract: when the contract intends to benefit a third party.
• Third Party Beneficiary: Someone who benefits from a contract but isn't a party to it.
• Intended Beneficiary: A third party the contract is formed to benefit, and who can sue the promisor if the contract is breached.

Identifying the Promisor

• In a bilateral contract, both parties make promises.
• The court determines which party made the promise that benefits the third party; that party is the promisor.
• Allowing the third party to directly sue the promisor simplifies the process and reduces the burden on the courts.

Types of Intended Beneficiaries

• Traditionally:
  • Creditor Beneficiaries: Benefits from a contract where one party (promisor) promises to fulfill a duty the other party (promisee) owes to them.
  • Donee Beneficiaries: Contract made to give a gift to a third party, who can sue the promisor directly. A common example is a life insurance contract.
• Modern View (Restatement (Second) of Contracts):
  • Distinguishes only between intended beneficiaries (who can sue) and incidental beneficiaries (who cannot sue).

When Rights Vest

• An intended third party beneficiary can't enforce a contract until their rights have vested (taken effect and can't be taken away).
• Before vesting, the original parties can modify or rescind the contract without the third party's consent.
• Rights typically vest when:
  • The third party demonstrates express consent to the agreement.
  • The third party materially alters his/her position in detrimental reliance on the contract. (Example: contracting to have a home built based on promised funds).
  • When the conditions for vesting are satisfied (Example: life insurance beneficiary rights vest upon the insured's death).
• If the contract reserves the right to cancel, rescind, or modify the contract, the third party beneficiary's rights are subject to those changes.
• If the original contract allows revocation or beneficiary changes, vesting doesn't terminate that power. (e.g., policyholder's right to change a life insurance beneficiary).

Incidental Beneficiaries

• Incidental Beneficiary: A third party who incidentally benefits from a contract without the contract being formed for that purpose.
• Incidental beneficiaries have no rights in the contract and can't sue to enforce it.

Intended vs. Incidental Beneficiaries

• Courts focus on intent, as expressed in the contract and surrounding circumstances, to determine if a third party is an intended beneficiary.
• Any beneficiary not deemed intended is considered incidental.
• The reasonable person test is often applied: Would a reasonable person believe the promisee intended to confer the right to enforce the contract on the beneficiary?
• Factors indicating an intended beneficiary:
  • 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.