Legal Definitions - third-party beneficiary

A third-party beneficiary is an individual or entity who is not one of the original parties to a contract but is specifically intended to benefit from that contract's performance. Although they did not sign the agreement, they gain rights under it and, in certain circumstances, can even enforce its terms.

To understand this concept, consider the three main roles:

• The promisor is the party who makes a promise within the contract that directly benefits the third party.
• The promisee is the party who contracts with the promisor and provides something of value (consideration) in exchange for the promisor's promise to benefit the third party.
• The third-party beneficiary is the person or entity who stands to receive the benefit from the promisor's performance.

The law distinguishes between two types of beneficiaries:

• Intended Beneficiary: This is a person or entity whom the original contracting parties specifically meant to benefit when they created the contract. An intended beneficiary has legal rights and can sue to enforce the contract if its terms are not met. Intended beneficiaries are further categorized:
  • Donee Beneficiary: The promisee's primary goal in arranging the contract was to make a gift to the third party.
  • Creditor Beneficiary: The promisee's goal was to satisfy an existing debt or obligation owed to the third party by having the promisor perform the contract.
• Incidental Beneficiary: This is a person or entity who happens to benefit from a contract, but the original parties did not specifically intend for them to receive that benefit. Incidental beneficiaries have no legal rights under the contract and cannot sue to enforce it.

For an intended third-party beneficiary to enforce their rights, those rights must have "vested." Vesting typically occurs when the beneficiary becomes aware of the contract and either agrees to it, sues to enforce it, or reasonably relies on the promise to their detriment. Once rights are vested, the original contracting parties generally cannot modify or cancel the beneficiary's rights without their consent.

Examples of Third-Party Beneficiaries:

• Example 1: A Construction Contract for a New Home

  Imagine a couple, Sarah and Tom, hire a construction company, "BuildRight Inc.," to build their dream home. As part of the contract, BuildRight Inc. agrees to install high-end kitchen appliances from "Gourmet Kitchens Ltd." and pay Gourmet Kitchens directly upon installation. Gourmet Kitchens Ltd. is a creditor third-party beneficiary.

  How it illustrates the term: Sarah and Tom (the promisees) contracted with BuildRight Inc. (the promisor) to build their home and pay for the appliances. Gourmet Kitchens Ltd. is not a party to the contract between Sarah and Tom and BuildRight Inc., but they are intended to benefit by receiving payment for the appliances. They are a creditor beneficiary because BuildRight Inc.'s payment satisfies an obligation owed by Sarah and Tom (or rather, an obligation that would arise once the appliances are installed) to Gourmet Kitchens Ltd. If BuildRight Inc. fails to pay Gourmet Kitchens Ltd. after installation, Gourmet Kitchens Ltd. could potentially sue BuildRight Inc. directly to enforce the payment term.

• Example 2: A Trust Fund for a Child's Education

  A wealthy grandmother, Eleanor, enters into a contract with a financial institution, "SecureWealth Bank," to establish a trust fund. The contract specifies that SecureWealth Bank will manage the funds and disburse them directly to Eleanor's granddaughter, Lily, for her college tuition and living expenses when Lily turns 18. Lily is a donee third-party beneficiary.

  How it illustrates the term: Eleanor (the promisee) contracted with SecureWealth Bank (the promisor) to manage and disburse funds. Lily is not a party to this contract, but she is the express beneficiary of Eleanor's generosity. She is a donee beneficiary because Eleanor's intent was to make a gift to Lily. If SecureWealth Bank fails to disburse the funds as agreed when Lily turns 18, Lily, as an intended beneficiary, would have the right to sue SecureWealth Bank to enforce the terms of the trust agreement.

• Example 3: A Business Merger Agreement

  Company A agrees to acquire Company B. As part of the acquisition contract, Company A explicitly promises to assume all of Company B's outstanding debts, including a significant loan owed to "MegaBank." MegaBank is a creditor third-party beneficiary.

  How it illustrates the term: Company A (the promisor) and Company B (the promisee) entered into an acquisition agreement. MegaBank is not a party to this acquisition contract, but it is an intended beneficiary because Company A's promise to assume Company B's debts directly benefits MegaBank by ensuring its loan is repaid. MegaBank is a creditor beneficiary because Company A's performance (paying the debt) satisfies an obligation Company B owes to MegaBank. If Company A fails to repay the loan as agreed, MegaBank could sue Company A directly to recover the debt.