13.3: Third-Party Beneficiaries

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LEARNING OBJECTIVES

Know what a third-party beneficiary is, and what the types of such beneficiaries are.
Recognize the rights obtained by third-party beneficiaries.
Understand when the public might be a third-party beneficiary of government contracts.

The fundamental issue with third-party beneficiaries gets to this: can a person who is not a party to a contract sue to enforce its terms?

The General Rule

Imagine this scenario: Olivia takes out a life insurance policy with Evergreen Insurance. She faithfully pays her monthly premiums. The policy states that, upon her death, Evergreen will pay $250,000 to her son, Marcus. Years later, when Olivia passes away, Evergreen refuses to pay Marcus, arguing that Marcus was never a party to the contract between Olivia and the insurer.

This raises an important question: can Marcus enforce the agreement even though he never signed it?

Under traditional contract law, only the parties who made a contract have the right to enforce it. Outsiders—those who were not part of the agreement—are said to lack privity of contract, meaning they have no direct legal relationship with the contracting parties.

But there is an exception. If a contract is made with the clear purpose of benefiting someone outside the agreement, that person is an intended beneficiary and has legal rights. This doctrine allows Marcus to enforce Olivia’s life insurance contract.

By contrast, someone who benefits only indirectly—called an incidental beneficiary—has no enforceable rights.

Two Types of Third-Party Beneficiaries

The Restatement (Second) of Contracts defines an intended beneficiary as a third party whom the contracting parties specifically intended to benefit. There are two main types: creditor beneficiaries and donee beneficiaries.

1. Creditor Beneficiary

A creditor beneficiary arises when the promisee owes a debt to the third party, and the promisor agrees to discharge that debt.

Example: Alex owes Bella $5,000. Alex then contracts with Chris, agreeing to paint Chris’s house if Chris pays $5,000 directly to Bella. Here, Bella is a creditor beneficiary. If Chris fails to pay, Bella may sue Chris directly, even though she wasn’t part of the original bargain.
Tie-in to scenario: If Olivia had taken out a policy requiring Evergreen to pay Marcus directly to satisfy a debt she owed him, Marcus would also qualify as a creditor beneficiary.

2. Donee Beneficiary

A donee beneficiary receives a contractual benefit as a gift rather than to satisfy a debt.

Example: Olivia’s life insurance policy is a classic case. She (the promisee) paid premiums to Evergreen (the promisor) with the intent that Marcus (the donee beneficiary) would receive the payout. Marcus, therefore, has standing to enforce the policy.
Another Example: Anna contracts with a landscaper to improve her yard so her elderly mother can enjoy the view. The mother is a donee beneficiary who can enforce performance if the landscaper fails to deliver.

Incidental Beneficiaries

Not everyone who benefits from a contract is an intended beneficiary. If the benefit is merely a by-product, the third party is only an incidental beneficiary with no rights to sue.

Example: Suppose Olivia hires a contractor to remodel her home. Marcus enjoys the upgraded living space but was never the intended recipient of the benefit. He is only an incidental beneficiary and cannot sue if the contractor performs poorly.

Limits on Beneficiary Rights

Even intended beneficiaries are not absolute winners. Their rights depend on the terms of the contract.

Example: If Olivia stopped paying her premiums, Marcus’s rights would fail, because Evergreen could raise the same defense against Marcus that it could have raised against Olivia.

Modification of Beneficiary Rights

The parties who made the contract may generally modify or cancel the benefit until the beneficiary’s rights vest.

Vesting occurs when:

The contract itself grants immediate rights to the beneficiary,
The beneficiary assents to the benefit,
The beneficiary reasonably relies on the promise to their detriment, or
The beneficiary files suit.

Example: If Evergreen and Olivia agreed to cancel the life insurance policy before Marcus knew about it, Marcus would have no rights. But once Marcus learned of the policy, relied on it, or brought a lawsuit, his rights would vest and could not be canceled without his consent.

Government Contracts and the Public

Generally, members of the public are only incidental beneficiaries of government contracts.

Example: If a county contracts with a construction company to build a new bridge, nearby businesses (like a restaurant anticipating more traffic) cannot sue if the project is delayed. The contract was not intended to benefit them directly.
Exception: Where contracts are tailored to specific individuals, those individuals may be intended beneficiaries. For example, if a city contracts with a towing company to provide emergency roadside assistance for stranded motorists, those motorists may enforce the contract when the service fails.

KEY TAKEAWAY

Normally, only contracting parties can enforce a contract. But intended third-party beneficiaries—such as creditor beneficiaries and donee beneficiaries—are exceptions to the rule and may sue to enforce their rights. By contrast, incidental beneficiaries cannot.

Returning to our scenario: Marcus, as the intended beneficiary of Olivia’s life insurance contract, has enforceable rights against Evergreen Insurance. If Olivia had never designated Marcus and he only benefited indirectly, he would be an incidental beneficiary and unable to enforce the agreement.

EXERCISES

What are the two types of intended beneficiaries?
Smith contracted to deliver a truck on behalf of Truck Sales to Byers, who had purchased it from Truck Sales. Smith was entitled to payment by Byers for the delivery. The truck was defective. May Byers withhold payment from Smith to offset the repair costs?
Why is the public not usually considered an intended beneficiary of contracts made by the government?

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