Third-Party Beneficiaries

AuthorFranklin G. Snyder, Mark Edwin Burge
Unit 27
Part One
Third-Party Beneficiaries
Consider the common life insurance policy. Suppose that Mario has purchased
life insurance from Mushroom Mutual Insurance Company. As part of the purchase,
Mario has designated Peach as his beneficiary. Peach may not know anything about
this contract until long after its making, but both Mario and Mushroom Mutual
understand that the purpose of the contract is to make a payment to Peach in the
event of Mario’s demise during the term of the policy. Suppose Mario dies and Mutual
does not pay the policy amount. The late Mario cannot sue because he is (still) dead.
Can Peachwho was not a party to the contractsue Mutual? The answer, as you
probably suspect, is going to be yes. After all, it would make no sense to have a life
insurance policy that could not be enforced because the policy holder was dead. It only
makes sense for Peach to have rights under the contract. The nonparty allowed to sue
in such circumstances is known as a “third party beneficiary.”
Intended or Incidental? Suppose, however, that Peach does not sue for the
money. But Mario’s brother Luigi—to whom Peach owes a great deal of money
wants to sue Mushroom Mutual to have it pay Peach, so that Peach will have the
money to pay Luigi. Can Luigi enforce the contract against Mutual? No. Luigi would
benefit if the contract were performed, but he is not allowed to enforce it. As you will
see from the cases below, Peach is what lawyers call an “intended beneficiary,” while
Luigi is an “incidental beneficiary.” The distinction is important. If an aircraft
company signs a new contract to build fifty passenger planes, a lot of people will
incidentally benefit from the contractemployees, stockholders, subcontractors and
suppliers (and their employees, stockholders, and suppliers), and so on. But only
intended beneficiaries can enforce the contract.
Defenses Against Beneficiary Claims. The rights of a third-party beneficiary
do not exist apart from the underlying contract between the promisor and promisee.
Put differently, the third party’s rights are derivative of the rights of the promisee.
As a result, the beneficiary gets contract rights that are no greater than the promisee
had. You may recall an otherwise enforceable contract is subject to defenses, such as
fraud, mistake, and illegality. If the promisor in an underlying contract would have
the right to raise defenses against the promisee, those same defenses are effective
against a claim brought by a third-party beneficiary. Section 309 of the Restatement
(Second) of Contracts also states a useful rule that obviously follows from the nature
of derivative claims: if no contract was ever formed between the promisor and the
promisee, there can be no third-party beneficiary.
Cases and Materials
Court of Appeals of New York
20 N.Y. 268 (1859)
[Holly owed $300 to Lawrence. Holly then agreed to loan Fox $300, and Fox in
return Fox promised to settle Holly’s debt by paying the $300 to Lawrence. Fox failed
to do so. Lawrence sued Fox. Fox argued that he was not a party to Lawrence’s
contract with Holly, and Lawrence was not a party to his own contract with Holly,
and therefore Lawrence could not sue him.]
It is now more than a quarter of a century since it was settled by the Supreme
Court of this Statein an able and pains-taking opinion by the late Chief Justice
SAVAGE, in which the authorities were fully examined and carefully analyzedthat
a promise in all material respects like the one under consideration was valid; and the
judgment of that court was unanimously affirmed by the Court for the Correction of
Errors. Farley v. Cleveland, 4 Cow. 432 (N.Y. 1825), same case in error, 9 Cow. 639
(N.Y. 1827). In that case one Moon owed Farley and sold to Cleveland a quantity of
hay, in consideration of which Cleveland promised to pay Moon’s debt to Farley; and
the decision in favor of Farley's right to recover was placed upon the ground that the
hay received by Cleveland from Moon was a valid consideration for Cleveland's
promise to pay Farley, and that the subsisting liability of Moon to pay Farley was no
objection to the recovery.
The report of that case shows that the promise was not only made to Moon but
to the plaintiff Farley. In this case, the promise was made to Holly and not expressly
to the plaintiff; and this difference between the two cases presents the question,
[If you are wondering why Lawrence ch ose to sue Fox instead of the man who actually owed
him the money, the best guess is that of Professor Waters, wh o concluded t hat Holly owed an illegal
gambling debt to Lawrence. As you learned in the unit on illegality, courts do not enforce such
agreements. Do y ou think Lawrence’s lawyer earned his fee by prevailing in this case? For the story
of the case, see Anthony J. Waters, The Property In the Promise: A Study of the Third Party Beneficiary
Rule, 98 HARV. L. REV. 1109, 1123-1127 (1985). Eds.]

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