Next Article: Assignment of a Contract
Back to: Contract Law
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?
- Generally, for an individual to have rights in a contract, they must be an identified party in the contract or an intended beneficiary. Generally, this means the beneficiary must somehow be named or identified as having a right of performance. In this scenario, the smaller businesses are not in privity of contract with Big Corp. They are not named in the agreement, and are thus not intended beneficiaries. As such, these business likely have no cause of action against Big Corp for breaches its agreement with Town Corp.