Contract Rights Under Third Party Beneficiary Clause

Key Takeaways

• A third party beneficiary clause determines whether someone not party to a contract has enforceable rights under it.
• These clauses can explicitly allow or deny third-party enforcement, depending on the parties’ intent.
• There are two types of third-party beneficiaries: intended (with enforceable rights) and incidental (without enforceable rights).
• Common use cases include trust agreements, insurance contracts, and commercial vendor relationships.
• Courts examine contract language and intent to determine if a third party is a beneficiary.
• Standard third party beneficiary clauses may also restrict the rights of unintended third parties.

A third-party beneficiary contract is an agreement between two parties where a third party (the beneficiary) stands to benefit from the contract.

As the name suggests, a beneficiary is a person who stands to receive some type of benefit. For example, a beneficiary receives an inheritance from being named in a will. Another example is a person — named as a beneficiary on the policy — who receives money in the event of an insurance policy payout. 

What Is a Third-Party Beneficiary?

A third-party beneficiary is neither the contract's promisor or promisee. However, the beneficiary can benefit from the contract's performance. The beneficiary can take legal action to enforce a contract only after his or her rights have been vested (by either justifiable reliance on the contractual promise or the assent of the contracting parties).

The beneficiary can be either an incidental or intended beneficiary.

Incidental beneficiaries aren't specifically named in the contract but can still benefit from it. They hold no rights to the contract. They simply get a reward from the agreement by chance.

Intended beneficiaries receive direct benefits from the contract. Usually, they're named somewhere in the agreement, and they're entitled to sue for contract breach in the same way as a primary party.

If intended beneficiaries decide to sue, they must prove they were indeed intended beneficiaries. In this instance, the agreement must have intended to benefit them by putting their name somewhere in the contract. Two specific situations often involve intended beneficiaries: a donee beneficiary and a creditor beneficiary.

Purpose of a Third Party Beneficiary Clause

A third party beneficiary clause is a contractual provision that defines whether an individual or entity not directly named as a party to the agreement can claim rights or enforce terms of the contract. These clauses serve several key purposes:

• Clarify Intent: They ensure that only specific third parties—such as a lender, affiliate, or family member—can benefit from or enforce the agreement.
• Limit Liability: They may explicitly disclaim third-party rights, thereby shielding the contracting parties from unintended legal claims.
• Support Enforceability: When a third party is designated as an “express” beneficiary, the clause provides legal grounding for their enforcement rights.

Courts often rely on the presence or absence of such a clause when determining if a third party may sue for breach of contract.

Specifics for Third-Party Beneficiaries

Even though a third party isn't actually a party in the contract, he or she may still benefit from the execution of the agreement. Certain standards must be met for a third-party beneficiary to have the legal rights to enforce a contract. 

Usually, third-party beneficiaries are not simply incidental ones; instead, they're intended to receive a benefit. If the contract doesn't expressly state an intention to benefit a third party, other evidence may be used to show intent.

Factors that go into consideration to show intent include the following:

• Who the alleged beneficiaries are
• The nature of the contract
• The duty created toward the beneficiaries

Beneficiaries may be eligible to recover funds if they can show they were intended to benefit from the contract. For instance, one court holds that someone can enforce an agreement's terms if the following conditions are met:

• The contractual parties haven't otherwise agreed.
• The parties' intention for contract performance was to benefit the beneficiary.

The contract's terms or the circumstances surrounding its performance indicate one of the following:

• The performance satisfies a duty or obligation owed to the beneficiary from the promisee.
• The intention of the promisee is to benefit the beneficiary with the promised performance.

Common Contract Scenarios Involving Third Party Beneficiary Clauses

You’ll commonly find third party beneficiary clauses in:

• Loan Agreements: Where a lender or administrative agent is expressly given the right to enforce borrower obligations.
• Insurance Policies: Where a beneficiary (such as a family member) is named to receive death benefits or coverage payouts.
• Trusts and Estates: Where the trustee agrees to act in the interest of the beneficiary, who can enforce the trust's terms.
• Vendor and Supply Agreements: In which an end client may have the right to enforce service levels or warranties.

Types of Third Party Beneficiary Clauses

Contractual language around third party beneficiary clauses generally falls into two categories:

1. Inclusive Clauses (Granting Rights):
   • These clauses state that a third party is an express beneficiary and is entitled to enforce certain provisions.
   • Example: “The Financing Agent shall be deemed an express third party beneficiary of this Agreement and may enforce any rights hereunder.”
2. Exclusive Clauses (Disclaiming Rights):
   • These disclaimers clarify that the contract is not intended to benefit any third parties.
   • Example: “No person other than the parties to this Agreement shall have any rights hereunder as a third party beneficiary.”

This distinction is vital, particularly in commercial agreements, where parties want to prevent unintended claims from affiliates, subcontractors, or other outside parties.

Examples

Terry agrees to buy a car and then give it to Ellen as a gift. Terry asks the car dealer, Tom, to order the car. When it arrives, Terry refuses to honor the contract by paying for the car. Tom can then sue for damages because the contract breach hurts him financially, although he's not a party to the contract.

A contract is created when a person purchases an insurance policy. The agreement is between the insurance company and the person buying the policy. However, a third party is the one who stands to receive insurance payments. This is the third-party beneficiary in the event the person who purchased the policy passes away. The beneficiary has the legal right to receive benefits and is entitled to sue if the contract isn't upheld.

Grandpa enters into an agreement with a car dealer to buy a Jaguar to give to his grandson as a graduation gift. If the dealer accepts a down payment and then doesn't go through with the sale, the grandson can sue the dealer as a third-party beneficiary. He would sue for specific performance of the agreement.

Contracts can be complex, so if you have any questions or concerns about one, it's best to consult with a professional skilled in contract law. You want to protect your rights as much as possible, so having someone explain everything you need to know can be a big advantage.

Real-World Examples of Third Party Beneficiary Clauses

Here are sample third party beneficiary clauses derived from actual contracts:

• Affirmative Beneficiary Rights Example:
  “The Indemnified Party shall be an express third party beneficiary of this clause and shall have the right to enforce it.”
• Negative Clause Example:
  “This Agreement is entered into solely for the benefit of the parties hereto, and nothing in this Agreement, express or implied, is intended to or shall confer upon any person other than the parties hereto any legal or equitable right, benefit, or remedy.”
• Conditional Beneficiary Example:
  “Notwithstanding anything in this Agreement to the contrary, any third party shall only have enforcement rights if such rights are expressly granted under Section 9.”

Such clauses are commonly used to define whether and how rights may be enforced by third parties, with implications for litigation, arbitration, and contract termination.

Enforceability and Legal Considerations

To determine whether a third party beneficiary clause is enforceable, courts generally examine:

• The language of the contract: Clear and explicit identification of the third party is crucial.
• The purpose of the agreement: Was it intended to directly benefit the third party?
• State law: Some jurisdictions require specific language for a third party to have enforceable rights.

Courts are reluctant to recognize third-party rights unless the contract unequivocally indicates such intent. Without a clear clause, most third parties will be considered incidental beneficiaries and lack standing to sue.

Drafting Tips for Third Party Beneficiary Clauses

To effectively draft a third party beneficiary clause:

• Be explicit: Clearly state whether third parties have rights—and if so, which parties and under what circumstances.
• Use defined terms: Reference defined roles (e.g., "Lender," "Affiliate") to avoid ambiguity.
• Limit unintended claims: Include language that explicitly disclaims rights to all other non-parties.
• Address modification and waiver: Clarify whether the clause can be altered without the third party’s consent.

Including a well-drafted third party beneficiary clause reduces legal uncertainty and prevents disputes about enforcement rights.

Frequently Asked Questions

1. What is the purpose of a third party beneficiary clause?
   It defines whether someone not named in a contract can legally enforce its terms.
2. Can a third party sue under a contract without a third party beneficiary clause?
   Only if they are considered an "intended beneficiary" under contract law. A clear clause strengthens their legal standing.
3. Are all beneficiaries entitled to enforce a contract?
   No. Only intended beneficiaries—not incidental ones—have enforceable rights under most jurisdictions.
4. Can the parties to a contract remove or change a third party’s rights?
   Yes, unless the contract restricts such changes or the rights have already vested.
5. What language should be included in a third party beneficiary clause?
   Clearly identify the beneficiary and state whether they have rights, enforcement power, or are excluded altogether.

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