Key Takeaways

  • A third party beneficiary clause allows a non-signing party to enforce a contract if the contract expressly grants them rights.
  • There are two types of beneficiaries: intended (with legal standing) and incidental (without).
  • To be enforceable, the clause must clearly express the intent to benefit the third party.
  • Courts may interpret these clauses differently across jurisdictions, especially in construction and complex agreements.
  • Including specific language about modification, waiver, and termination rights is crucial to avoid disputes.

A third party beneficiary clause determines if a non-contractual party has any rights to enforce the contract's terms. Sometimes, beneficiaries are named, and other times, they receive rewards by chance.

An Overview of the Third Party Beneficiary Clause

A third party beneficiary clause may prescribe rights to a third party. In a few instances, the clause grants those rights. The clause has to be present for the beneficiary to be treated as an intended beneficiary.

When contractual parties include this clause, they intend for a third party to benefit in some way. If a contract doesn't include the clause and a third party still benefits, the beneficiary is “incidental” instead of “intended.”

When granting rights in a contract, the drafter should consider the specific rights being granted and if the contractual parties can change the contract without the consent of the third party.

Why Include a Third Party Beneficiary Clause?

Including a third party beneficiary clause clarifies whether a non-signing party has enforceable rights under a contract. Without clear language, courts may default to finding the third party as an incidental beneficiary—one who benefits but cannot sue. This clause can minimize litigation risk by:

  • Defining who qualifies as an intended beneficiary.
  • Establishing whether consent is needed to amend or terminate the agreement.
  • Protecting critical relationships (e.g., subcontractors, lenders, or downstream stakeholders).

This is particularly important in industries like construction, software licensing, and finance, where third parties regularly rely on underlying contracts.

About Third Party Beneficiaries

As the name implies, a beneficiary is a person who receives some type of benefit. In all contracts, the two primary parties who are involved are known as the promisee and the promisor. When a third party is able to benefit, that's where a third party beneficiary comes in. This beneficiary isn't a contractual party but still benefits from the agreement.

For example, this may be a person who receives an inheritance due to being named in someone else's will. A person who receives a payout from someone else's insurance policy is also a beneficiary.

Some situations give third-party beneficiaries legal rights to enforce a contract and get a share of proceeds.

For the clause to be enforceable, it has to be irreversible. The following criteria can accomplish that:

  • Evidence exists that the third party was aware of the clause intended to benefit him or her.
  • The third party receives the contract.
  • The third party receives hints that he or she may benefit from the contract.
  • The third party believes it must fulfill some burdensome obligations in exchange for receiving benefits.

If a promisor fails to pay a third party beneficiary, a promisee can bring suit against it for “specific performance” of the agreement. However, the promisee can only bring suit if the third party beneficiary hasn't already sued.

As an example, consider the following scenario:

Robert plans to purchase a new automobile for his son, Everett, as a birthday gift. Robert enters into a contract with an auto dealer, and he puts down a $10,000 down payment and signs financing paperwork. Everett isn't a contractual party, but, because he knows he's going to get a brand new car, he sells his old car.

On the agreed-upon date, the auto dealer doesn't deliver the car. Robert finds out the new car was never ordered. In this case, Everett could show he knew about the benefit he would receive from the contract and if he relied on that belief when he sold his old car. Since he knew about the new car, he's a third party beneficiary with a right to enforce the agreement against the auto dealer.

Drafting Tips for Third Party Beneficiary Clauses

Effective third party beneficiary clauses should be precise to avoid ambiguity. Consider the following tips when drafting:

  • Express intent clearly: Use language such as “X is an express third party beneficiary of this Agreement” to avoid interpretation issues.
  • Define modification rights: State whether the contract can be changed or canceled without the third party's consent.
  • Be specific: Name the third party when possible to reinforce their intended status.
  • Address enforceability: Indicate that the third party has standing to enforce the agreement.

Example clause:"The Lender shall be an express third party beneficiary of this Agreement and shall have the right to enforce its provisions directly."

Intended or Incidental Beneficiaries

Third party beneficiaries may be intended or incidental. Intended beneficiaries receive direct benefits from the agreement outlined in a contract. Somewhere in the contract, an intended beneficiary is typically named. Someone who's an intended beneficiary has the same rights to sue for breach of contract as one of the primary contractual parties.

A person who is an incidental beneficiary isn't specifically named in the agreement but may still benefit from the contract. Incidental beneficiaries don't hold any contractual rights. Instead, they may receive a reward simply by chance.

If an intended beneficiary chooses to sue for rewards or damages, he or she has to prove their status as an intended beneficiary. It's easy enough to identify someone as an intended beneficiary if his or her name appears somewhere in the contract. That means there was an intention or promise of a benefit to that person.

Because contract law can be complex, it may be in your best interest to consult with an expert in the field so that you fully understand the terms and conditions you're agreeing to before you sign a contract.

How Courts Evaluate Third Party Beneficiary Status

Courts determine a third party’s right to enforce a contract by analyzing the contract language and surrounding circumstances. Key considerations include:

  • Contract language: Does the text show intent to benefit the third party?
  • Performance reliance: Has the third party acted in reliance on the contract (e.g., by incurring costs or giving up rights)?
  • Jurisdictional differences: States vary in how liberally they interpret third party beneficiary rights. For instance, some courts may presume intent from performance context, while others demand explicit terms.

In construction cases, courts often assess whether subcontractors or suppliers were meant to benefit from agreements between general contractors and owners. This reinforces the importance of clarity in clause drafting.

Limitations of Third Party Rights

Even intended beneficiaries face certain limitations:

  • Modification or termination: If the clause permits changes without beneficiary consent, their rights may be extinguished.
  • Statutory limitations: Some jurisdictions impose restrictions on enforcing rights unless certain thresholds are met (e.g., performance reliance or delivery of the contract).
  • No greater rights: Third party beneficiaries can’t enforce rights beyond those granted in the original agreement.

By setting boundaries, contract drafters can preserve flexibility while still protecting the third party's interests.

Frequently Asked Questions

1. What is a third party beneficiary clause? A third party beneficiary clause identifies whether a non-signing individual or entity has rights under a contract and can enforce its terms.

2. Can an incidental beneficiary sue under a contract? No. Only intended beneficiaries, whose benefit was clearly intended by the contracting parties, have the legal right to enforce the agreement.

3. How do you make someone an intended beneficiary? By explicitly naming them in the contract and clearly stating that they have enforceable rights under the agreement.

4. Are third party beneficiary clauses enforceable in all states? Yes, but how they’re interpreted varies by jurisdiction. Some states require explicit language, while others consider surrounding circumstances.

5. Can the original parties change a contract with a third party beneficiary clause? Only if the contract allows modification without the third party’s consent. If consent is required, changes may be restricted after the third party’s rights vest.

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