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Third Parties to a Contract – Beneficiaries and Assignees

Who are the beneficiaries of the contract?

The parties to the contract are the primary beneficiaries. In general, individuals who are not parties to a contract have no rights to sue to enforce the contract or to get damages for a breach of contract. There are, however, exceptions to this rule. It is possible for third parties to have rights in a contract. A third-party beneficiary may have rights under a contract if the original parties to the contract intend for the agreement to benefit the third party and that intent is demonstrated in the agreement. This may happen at the time of the contract, or a third party may also acquire rights in an already executed contract if one party to the contract validly transfers those rights to the third party.

Example: I enter into a contract with ABC Corp to provide them consulting services. As part of the agreement, ABC Corp is to make payments for those services directly to XYZ Corp. Because XYZ Corp is a named (intended) beneficiary, it has rights under the contract that are enforceable against ABC Corp.

The extent of the third party’s rights is determined by her status as either a donee beneficiary or creditor beneficiary.

Donee Beneficiary – A donee beneficiary is a third party who receives contractual rights as a gift from the promisee. If a promisee makes a contract for the benefit of a donee beneficiary and the promisor fails to perform, the third-party may not bring an action against the promisee (individual transferring the contract), but may bring an action against the promisor (individual obligated under the contract). Since the transfer to the beneficiary is a gift, there are no grounds for recourse against the promisee.

Example: ABC Corp has an obligation to pay me. I instruct ABC Corp to make the payments directly to you. The payments to you are a gift to help your business get started. If ABC Corp refuses to pay you, you may enforce your right to payment against ABC Corp. You cannot, however, sue me if ABC fails to pay.

Creditor Beneficiary – A creditor beneficiary is a third party who receives contractual rights from the promisee as satisfaction of a debt. When a promisor fails to perform under the subject contract, the creditor beneficiary can bring an action against the promisee, as the value of the consideration transferred is gone. The promisee may also bring an action against the promisor, as her rights have been harmed by the promisor’s failure to perform.

Example: ABC Corp has an obligation to pay me. I instruct ABC Corp to make the payments directly to you. The payments to you are in satisfaction of a debt I owe to you for services you have already performed. If ABC Corp refuses to pay you, you may enforce your right to payment against ABC Corp. You can also sue me if ABC fails to pay.

Discussion: Why do you think that the rules change depending on whether the beneficiary is intended vs unintended? Donee vs creditor beneficiary?

Practice Question: Big Corp does business with Town Corp. Town Corp is the lifeblood of many smaller businesses in its town. These businesses exist to provide goods and services to Town Corp. Big Corp has a dispute with Town Corp which results in Big Corp breaking off relations with Town Corp and, in turn, breaching a major purchasing contract. The loss of Big Corp as a purchaser is detrimental to Town Corp and they are forced to reduce their output. This affects all of the businesses in Town Corp’s town. What legal options exist for the small businesses in Town Corp’s town?

What is “assignment” and “delegation” of contracts?

Assignment is the transfer by one party of her right to receive performance from the other party to the contract. Delegation is the transfer by one party of her duties to perform under a contract.

Methods of Assignment or Delegation – The rights under a contract can be assigned or the duties delegated through agreement between the assignor and assignee. Assignments/delegations can be a gift or an exchange for other value. In general, unless the contract deems otherwise, obligees may assign their rights or delegate their duties under the contract to third parties.

Note: The assignor/delegator must give notice to the other party immediately upon assignment/delegation.

Writing Requirement – Assignments and delegations of common law contracts do not have to be in writing. Assignments of contracts for the sale of goods, however, must be in writing if the original contract was subject to the statute of frauds.

Non-Assignable/Delegable Contracts: Unless the agreement limits assignment of rights, most contracts are assignable. Delegation of duties pursuant to contract is more limited. The following contracts are not capable of delegation:

Material Changes of Responsibility – A contract that materially alters the obligor’s duties under the agreement is not transferable. Particularly, an assignment that greatly increases a party’s delivery requirements cannot be assigned. Doing so may detriment the obligor who has to meet a new (and possibly more taxing) delivery schedule.

Example: I sign a contract to supply all of the cement that your company needs. You are a small construction business with about $1 million per year in revenue. You attempt to assign the contract to ABC Corp, which is a large company with $10 million per year in revenue. If this will dramatically increase my supply requirements, it cannot be assigned without my consent.

Increases Burden or Risk – Generally, any contract that materially increases the other party’s burden, risk, or ability to receive return performance is not delegable. As such, requirement contracts generally cannot be delegated because the producer’s duty depends on the individual output requirements of the purchaser.

Example: I sign a contract to supply all of the cement that your company needs. You signed the contract with my company because of my reputation and ability to perform. I cannot then delegate the duties under the contract to another company without your consent. This could increase your risk of not receiving performance.

Special Skills – A party to a contract cannot delegate performance of duties under a contract when performance depends on the character, skill, or training of that party.

Example: One singer cannot transfer her obligations under a contract to another singer if the other party depended upon the skill of that particular vocalist.

Multiple Assignments – A party can partially assign a contract or assign the same contract to multiple parties. Different jurisdictions follow different rules regarding the priority of the assignees. Some jurisdictions allow that the first assignee of a contract who gives notice to the obligor has priority over other assignees. Other jurisdictions follow the rule that the first assignee to receive assignment of a contract has priority to performance by the obligor. Still other jurisdictions follow the rule that the first assignee has priority, unless:

Purchaser in Good Faith for Value – If an assignee pays value for the assignment in good faith without notice of a prior assignment (and the prior assignee did not receive the assignment in good faith and for value), she has priority over prior assignments.

Example: ABC Corp has a duty to deliver goods to me. I assign the right to receive the goods to 123 Corp as a gift. I later decide to assign the right to receive goods to XYZ Corp in exchange for $1,000. XYZ Corp has no knowledge of my prior assignment to 123 Corp. ABC Corp will have priority over 123 Corp, as 123 Corp did not pay anything for receiving the assignment.

Court Action – If an assignee receives a judgment against the obligor. If a court adjudicates the matter, the assignee winning at court may be vested with the authority to establish priority in performance of assigned rights.

Example: I am a party to a contract with ABC Corp. I assign my rights under a contract to Tammy and later to June. Tammy sues me and ABC Corp to establish her priority regarding performance of the contract. The court may award priority to Tammy or June.

Novations – If the assignee executes a novation, the novation establishes priority. A novation is a new contract between individuals that replaces a party to the contract or obligations or rights under the agreement.

Example: I am a party to a contract with ABC Corp. I assign my rights under a contract to Tammy and later to June. June enters into a novation agreement with ABC Corp that replaces me under the contract and establishes her as the obligee. June will have priority of performance above Tammy.

Written Assignment – If a later assignee receives a written assignment capable of transfer that is not in writing, she will have rights superior to those of an earlier assignee. Some agreements, such as assignments that are subject to the statute of frauds, are only capable of being assigned via a valid writing. If a prior assignment does not satisfy the statute of frauds, a subsequent transfer could take precedent. It is important to review the specific rules applicable to the specific jurisdiction when determining one’s rights under an assigned contract.

Example: I am party to a written contract to sell goods to ABC Corp. I verbally transfer my right to receive payment to Amy. I later transfer the right to receive payment to Zora in a written agreement. Zora may have priority over Amy.

Revoking an Assignment – A gratuitous (gift) assignment cannot be revoked if the assignment is made pursuant to a written document signed by the assignor. If no writing exists, revoking a gratuitous assignment that has not been performed is extremely easy (because no physical transfer has taken place). It can be revoked by an assignor later assigning the same right (the last assignment controls), the death or incapacity of the assignor, or by the delivery of notification of revocation to the assignee or obligor.

Example: I verbally assign to you my rights to receive payment under a contract. I later tell you that I am revoking the assignment. This is effect to revoke the assignment because the original assignment was a gift and I did not make the assignment in writing.

Modification after Assignment – Generally, a contract cannot be modified after assignment. As previously discussed, once a contract has vested, the parties generally cannot modify the contract in a way that impairs the assignee’s rights. If, however, a modification does not affect the assignee’s rights, it may be modified.

Example: I have the right under a contract with ABC Corp to receive payment. I transfer the right to receive payment to you. I later approach ABC Corp and alter my obligation to deliver goods on a specific date. If the alteration of my duties does not affect your rights as assignee, the alteration is not prohibited.

Note: There is an exception in commercial contracts under the UCC that allows for modifications or substitutions in accordance with commercially acceptable standards. This allows for slight modifications that are within the expectations of the parties.

Continued Delegator Responsibilities – The party delegating the contract is still potentially liable under the contract if the delegatee fails to perform. If, however, the delegatee and the obligee under the contract enter into a novation, the delegator is relieved of responsibility.

Example: I am obligated to perform services to ABC Corp. I delegate my responsibilities to you. If you fail to perform the consulting duties, ABC Corp can still sue me. If, however, you enter into a novation with ABC Corp that substitutes you for me in the original contract, your failure to perform does not affect me.

Note: If the delegator expresses her intent to repudiate the contract upon assignment to the delegatee, there is an implied novation if the obligee does not object. Also, the delegatee will be liable under the contract if she expressly or impliedly accepts responsibility for performance.

Most of the above rules regarding assignment and delegation are capable of modification in a contract between the parties.

Discussion: How do you feel about treating assignments of rights and delegation of duties under contracts differently? Which of the assignment priority rules do you believe is most fair to the parties? Why? Should a party be able to modify a contract after assigning her benefits?

Practice Question: Cleo is a party to a contract with ABC Corp to provide consulting services. Cleo verbally assigns her rights to receive payment to Austin. Cleo later verbally assigns her rights to receive payment to Steve. Austin complains to Cleo about her subsequent assignment. What can Austin do to establish his priority to receive payment from ABC Corp?

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