A third-party beneficiary is a person who is not a contracting party of a contract but can still receive the benefits from the performance of the contract. The privity of the contract is between the contracting parties - the promisor and promisee. A promisor is a party that makes promises to benefit the third-party beneficiary. A promisee is a party who pays consideration to obtain the promisor’s promise. For instance, a mother purchased medical insurance for her son from an insurance company; the mother is the promisee, the son is the third-party beneficiary and the company is the promisor.
If a person is not the original party to a contract, they usually cannot enforce the contract or assert a claim of a breach of contract against any party; however, there is an exception. If the person is an intended third-party beneficiary and their rights of the contract are vested, then they have the same rights as the parties of the contract.
Intended third-party beneficiary
- An intended beneficiary is an identified third-party that contracting parties intend to give benefits via their promised performances, like doing or not doing something or paying money. The beneficiary may get named in a contract to have contractual rights, but it is not necessary for them to be identifiable at the time the contract is formed. Meanwhile, even if the promise is not made to them directly, they may still enforce the contract.
The Restatement of Contract §133 divides intended beneficiaries into two categories:
- The law says: “A donee beneficiary if it appears from the terms of the promise in view of the accompanying circumstances that the promise of the promisee in obtaining the promise of all or part of the performance thereof is to make a gift to the beneficiary or to confer upon him a right against the promisor to some performance neither due nor supposed or asserted to be due from the promisee to the beneficiary.”
- It is a default rule to confer gifts. A donee is a person the promisee intends to benefit without asking for any payback. Once the donee knows the contract, the right is vested. If any contracting party breaches a promise, the creditor can only sue the promisor unless the donee has detrimental reliance on it.
- The law says: “A creditor beneficiary if no purpose to make a gift appears from the terms of the promise in view of the accompanying circumstances and performance of the promise will satisfy an actual or supposed or asserted duty of the promisee to the beneficiary, or a right of the beneficiary against the promisee which has been barred by the Statute of Limitations or by a discharge in bankruptcy, or which is unenforceable because of the Statute of Frauds.”
- A creditor is a person whom a debt is owed by the promisee and paid by the promisor. The creation of it is to extinguish debt. Once the creditor has detrimental reliance on it, the right is vested. If any contracting party breaches promise, the creditor can sue both promisor and promisee. The contracting parties can defend the creditor by asserting claims they have against the other contracting party.
Incidental third-party beneficiary
- If a beneficiary does not belong to above categories, they are an incidental beneficiary. An incidental beneficiary is a person whom contracting parties did not intend to benefit when they contracted but happens to get benefits.
- Since an incidental beneficiary is not named in the contract and not intentionally included, they have no rights under the contract and cannot sue for breach of contract.
The contractual rights cannot be enforced by the third-party beneficiary until the rights are vested. Vesting occurs when the beneficiary:
- Has knowledge of the promise and:
- Manifests assent to a promise in the manner requested by the contract or contracting parties, or
- Sues to enforce the promise, or
- Detrimentally relies on the promise, or
- Express contract term vesting rights.
Prior to vesting, contracting parties can rescind or modify the beneficiary’s contractual rights without the beneficiary's consent or knowledge. Once rights are vested, the contract cannot be changed or modified unless the third-party consent.
- Even though there is no contract privity among the third-party beneficiary and contracting parties, the third-party beneficiary may still have the right to sue them to enforce the contract or seek damages for the breach.
- Generally, the beneficiary can only sue the promisor to enforce the duty created by the promise in the contract. The promisor can defend against the promisee. The beneficiary cannot sue the promisee unless they detrimentally rely on the promise. If the beneficiary is a donee beneficiary, they cannot ask for delivery of a promised gift, but only for recovery under equitable principles of justice. However, there is an exception that the creditor beneficiary can sue on the debt, which is the original obligation, for getting debts paid by promisee.
- If a contract is conditioned on the satisfaction of the beneficiary, then the subjective test only depends on whether the beneficiary honestly believes that the contract was satisfied – the opinions of other reasonable persons are not relevant.
Contracting parties: promisor & promisee
- If the promisor did not perform their promise to benefit the third party, the promisee may sue them for a specific performance.
- The contracting parties can modify or rescind the contract via a subsequent contract if the contract didn’t vest, as they retain the right to change their duty. This right will be terminated if the beneficiary materially relies on the promise.
[Last updated in June of 2022 by the Wex Definitions Team]