Third Parties to Contracts

Third Parties to Contracts

In our study of contracts up to this point, there were generally two parties to the agreement: the
offeror and the offeree. In some contracts, however, there may be a third party. The third party
may be there as a result of one party assigning his or her rights under the contract to another
person or as a result of one party delegating his or her responsibilities under the contract to
another party. In a third case, a contract may specify that some performance be directed not for
the benefit of one of the parties to the contract but to another person who is called the third party
beneficiary.

1. Assignments of rights: In every contract, a right and an obligation are created. If Thomas
promises to paint Sandra’s house for $10,000, Thomas has the obligation to paint the house
and Sandra has the obligation to pay $10,000. In return, Sandra would have the right to have
her house painted and Thomas would have the right to receive $10,000 in payment.
a. Obligor and obligee: The person with the obligation to perform is called the obligor and
the person who will receive the benefit of the bargain is called the obligee.

b. Assignment: An assignment of a contractual right takes place when one of the original
parties to the contract indicates that the benefits of the contract be given not to the obligee
but to a third person.

Example: Mark, who was injured by slates falling from a roof, sues the home owner.
They sign a settlement in which the home owner’s insurance company will pay Mark
$30,000 per year for the next ten years. After receiving the first year’s payment, Mark
indicates that the second year’s payment be made not to him but to his nephew Nick.
Mark has made an assignment of his rights under the contract.

1) Assignor and assignee: The person making the assignment is called the assignor and
the person who is designated to receive the benefits of the contract is called the
assignee. In the above example, Mark is the assignor and Nick is the assignee.

2) Consideration: Consideration is not required for an assignment to take place.

3) Revocability of assignments: If the assignee gives consideration in return for the
assignment, the assignment is irrevocable. If the assignment is a gift (no consideration
given in return), the assignor may revoke the assignment as long as the object of the
assignment has not been delivered to the assignee.

a) Partial assignments: Partial assignments, where the assignment is made to a
number of people, are permitted. If a partial assignment is made and a lawsuit is
brought by one of the assignees against the obligor, the obligor may require all the
assignees to sue in one case.

Example: Johnson owes Smith $10,000. Smith assigns half of the right to the
money to Bailey and the other half to Thompkins. If Johnson does not pay and
Smith and Bailey decide to sue, Johnson may require them to sue together in one
trial. This will prevent Smith and Thompkins from suing in different trials.

c. Rights that may not be assigned: In most cases, just about any contract right may be
assigned. There are exceptions. Contract rights that may not be assigned include:

1) Assignments that materially increase the duty, risk, or burden of the obligor. An
assignment cannot be made if it would greatly increase the duty or risks of the
obligor.

Example: Paula buys auto insurance from Triple A. Paula is a good driver. She
assigns her insurance coverage to Jane who has a terrible driving record. In this case,
the assignment would impose greater risks upon the insurance company. For this
reason, the assignment cannot be made.

2) Assignments that transfer highly personal contract rights. Some rights are so
personal they cannot be assigned to another person.

Example: Jennifer and Stanley exchange promises to marry one another. Jennifer
assigns this right to her best friend Mary. This assignment is one where the personal
element is so important, the assignment may not be made.

3) Assignments that are specifically prohibited by contract. When a contract contains
a provision preventing assignments, the courts will interpret this clause very narrowly
as just a promise not to assign, rather than a clause prohibiting assignments
altogether. The distinction is important because a promise not to assign means that an
assignment can be made, but the assignor must pay damages for breaking the promise
not to do so.

4) Assignments that are prohibited by law. Local, state, federal statutes and public
policy prevents the assignment of certain types of contracts.

Example: By law, assignments of future wages cannot be made in many jurisdictions.
d. Rights of the assignee: When the assignee receives an assignment, he or she stands in
the shoes of the assignor with respect to the contract. If the other party to the contract has
some defenses that can be used against the assignor, it can also be used against the
assignee.

Example: Nathan uses fraud to sell a car to Charles for $2,000. Nathan assigns the right
to receive the $2,000 to Lenny. Charles has a defense of fraud against Nathan. Since
Lenny is now standing in Nathan’s shoes with respect to the contract, Charles may use
this defense against Lenny and refuse to make the payment.

Example: The claim the obligor can assert against the assignee need not arise from the
contract itself. For example, Paula sells her car to Rose for $4,000. Paula, however, owes
Rose $4,000 on a personal loan that she had received from her. If Paula assigns the rights
to receive the $4,000 to Jonathan, Rose could offset the $4,000 payment she must make
against the $4,000 that Paula owes.

e. Notice to the obligor of the assignment: When an assignment is made, the assignee or
the assignor should notify the obligor. If notification is not made and the obligor pays the
assignor, the obligor’s responsibilities are fully discharged.

1) Protection against subsequent events: Notification of assignment is important
because it can protect the assignee against subsequent dealings between the obligor
and assignor. Example: Gary sells his piano to Linda for $1,000. Gary assigns the rights to receive
the $1,000 to Andy, but notice of the assignment is not made to Linda. Subsequently,
Gary borrows $1,000 from Linda and Linda offsets the $1,000 she must pay for the
piano against the loan. Linda may do this since she had no notice of the assignment.
Had Andy or Gary given notice of the assignment to Linda, Linda could not have
made the offset.

2) Implied warranties of the assignor: When an assignor makes an assignment for
value, he or she gives the following implied guarantees:

a) The assignor will do nothing to damage the assignment,

b) The assigned rights exist and are not subject to any defenses other than those
indicated,

c) Any evidence that is presented to the assignee as evidence of the assigned rights is
genuine,

d) The assignor has no knowledge of any fact that would impair the value of the
assignment.

f. Express warranties of assignor: If the assignor makes an express promise in connection
with an assignment, the assignor will be bound by the promise he or she made.

1) Guarantee of performance by the obligor: Unless the assignor specifically
guarantees that the obligor will pay the assignee, this risk is assumed by the assignee.

g. Assignment of same right to more than one person: What if an assignor assigns the
same right to more than one person?

Example: Dale sold his antique chair to Nora for $500. He assigned the right to the $500
to Vicky for $450 because he needed the money right away. Four days later, Dale
assigned the right to receive the $500 to Wade in return for $450. When Nora is ready to
pay, who should get the money?

1) Majority rule: The first assignee (Vicky) will get the money.

2) Minority rule: The first assignee to notify the obligor will get the money.

3) Restatement rule:

a) The first assignee will win unless
b) The first assignment is voidable by the assignor or
c) The second assignee gives value in good faith and without knowledge of the prior
assignment and can show one of the following:

(1) receives payment from the obligor
(2) obtains a judgment against the obligor
(3) obtains a new contract with the obligor
(4) obtains documentary evidence of the assigned right

2. Delegation of duties: A duty to do something under a contract may be delegated to another. Example: Lamar buys a Ford Taurus from Concord Ford for $21,000. Concord Ford,
however, sold the last Taurus in stock to another customer. Concord Ford arranges with a
Ford dealership in San Francisco to deliver a Ford Taurus to Lamar. Concord Ford has
delegated its contractual duty to another party to perform.

a. Parties to a delegation:

1) Delegator: The party making the delegation is the delegator. In the above example,
the delegator would be Concord Ford.

2) Delegatee: The new party who assumes the responsibility to perform under the
contract is the delegatee. In the above example, the delegatee would be the
San Francisco Ford dealer.

a) Assumption of the delegated duty: In order for the delegation to be effective, the
delegatee must accept the delegation and assume the delegated duty.

3) Obligee: The obligee is the person who is entitled to receive the performance under
the contract. In the above example, the obligee would be Lamar.

b. Prohibition on delegation: Delegations cannot be made if:

1) The delegator’s performance requires a very high degree of skill that is personal to
the delegator so that the same performance by another person would not be the same
2) Delegation is prohibited by contract
3) Delegation is prohibited by public policy.

Courts will review delegation of responsibilities more closely than assignments
because it places the obligee in the position of receiving performance from a person
that the obligee did not select. For this reason, the court will strike down a delegation
unless the obligee will receive the same performance that he or she negotiated in the
contract.

c. Duties of the parties: When a delegation is made, the delegator is still responsible for the
performance of the contract. If there is a defective performance or non performance by
the delegatee, the obligee may sue either the delegator or the delegatee or both.
Example: Robert signs a contract with Martin for Martin to clean out his garage. Martin
delegates the duty to Ned. If Ned does not perform, Robert may sue both Martin and Ned.
The job has been delegated, but Martin is still liable.

1) Novation: Novation is a case where a new contract is negotiated and it replaces an
existing contract. A novation is more than a mere delegation, where the responsibility
for performing under an existing contract is assigned to another person. When the
duty to perform is given to another person by way of a new contract, the original
party is no longer liable for performance.

Example: In the above case where Martin signed a contract to clean Robert’s garage,
if Martin and Robert negotiate to end the contract between them and create a new one
in which Ned will be responsible for the cleanup, Martin’s responsibility for the job
will come to an end. 2. Third party beneficiary contracts: In most contracts, one party (promisor) promises to  render performance to the other party to the contract (promisee). In some cases, the promisor
will promise to do something, not for the promisee but for a third person indicated by the
promisee. This kind of a contract is a called a third party beneficiary contract.

Example: Nelson signs a contract to buy a car from Burlingame Lexus for his daughter
Nellie. The parties to this contract are Nelson and Burlingame Lexus. Nellie is an intended
beneficiary.

a. Classification of intended beneficiaries: Intended beneficiaries can be classified as
donee beneficiaries and creditor beneficiaries.

1) Donee beneficiary: A donee beneficiary is a person who is receiving benefits as a
gift. In the above example, Nellie appears to be a donee beneficiary.

2) Creditor beneficiary: If a third party is named as a beneficiary of a contract in order
to settle an existing debt to that person, the third party is a creditor beneficiary.

Example: Sally borrows $50,000 from Henry to start a small high-tech business. She
succeeds in landing a great sales contract with IBM and arranges for the first payment
of $50,000 to be made to Henry as a partial settlement of the loan. Henry is a creditor
beneficiary.

b. Rights of the intended beneficiary:

1) Creditor beneficiary: A creditor beneficiary may sue both parties for performance.
In the example of the contract between Sally and IBM, Henry may sue both Sally and
IBM if he does not receive payment.

2) Donee beneficiary: A donee beneficiary may only sue the party who has arranged for
the gift. In the above example involving Nelson and Burlingame Lexus, Nellie may
only sue Nelson. This is because Nellie’s contractual obligations are with Nelson, not
the automobile dealership.

c. When the legal rights of the third party beneficiaries vest (become enforceable):
Until the rights of the third party beneficiaries vest (take effect) the two parties to a
contract may change the terms of the agreement and omit the third party. When the rights
of the third parties to enforce the terms of the contract take effect varies from state to
state:

1) Contract is signed: In some states, as soon as the contract is signed the rights of the
third party will vest.

2) Contract is signed and third party is informed: In some states the third party must
learn of the contract and agree to it.

3) Contract is signed; the third party is informed and changes his or her position in 
reliance:

4) Restatement: The restatement requires that the contract be made, and the intended
beneficiary responds with one of the following:

a) Sues to enforce the agreement
b) Changes his or her position in reliance upon the agreement
c) Gives his or her assent to the contract