11.5.4.1 Note on The Restatement of Contracts and the Problem of Rescission | Joe Srednicki | November 01, 2012

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11.5.4.1 Note on The Restatement of Contracts and the Problem of Rescission

Original Creator: Kessler, Gilmore & Kronman Current Version: Joe Srednicki
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Under the Restatement First, the power of A and B to rescind their contract; depriving C of his rights as a beneficiary, depended upon whether C was a "donee" or "creditor" of the promisee; this was, in fact, the most important consequence of the distinction between these two types of beneficiaries. Sections 142 and 143 read as follows:

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§142. Variation of the Duty to a Donee Beneficiary by Agreement of Promisor and Promisee

Unless the power to do so is reserved, the duty of the promisor to the donee beneficiary cannot be released by the promisee or affected by any agreement between the promisee and the promisor, but if the promisee receives consideration for an attempted release or discharge of the promisor's duty, the donee beneficiary can assert a right to the consideration so received, and on doing so loses his right against the promisor.

§143. Variation of the Promisor's Duty to a Creditor Beneficiary by Agreement of Promisor and Promisee

A discharge of the promisor by the promisee in a contract or a variation thereof by them is effective against a creditor beneficiary if,

(a)  the creditor beneficiary does not bring suit upon the promise or otherwise materially change his position in reliance thereon before he knows of the discharge or variation, and

(b) the promisee's action is not a fraud on creditors.

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Under §142, it would seem, a donee beneficiary's rights "vest" immediately; unless the promisor and promisee have in their contract reserved the right to do so, they cannot, once the promise to the donee has been made, thereafter rescind or modify it without the donee's consent. On the other hand, as against a creditor beneficiary, promisor and promisee remain free to rescind or vary their agreement until the creditor has taken the type of action described in §143(a).

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The Restatement's disparate treatment of creditor and donee beneficiaries was explained, and the distinction itself vigorously criticized, in Page, The Power of the Contracting Parties to Alter a Contract for Rendering Performance to a Third Person, 12 Wis. L. Rev. 141 (1937). After an elaborate review of the authorities, Professor Page concluded (at 183-184; footnotes have been omitted):

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It seems that neither the rule of section 142 of the Restatement nor the rule of section 143 is taken from the common law as it exists in states which recognize the right of C as a contract right against A. While these states differ among themselves as to the stage of the transaction at which the right of A and B to terminate or to modify the contract by mutual agreement, without the consent of C, ends, they agree in the main that the stage of the transaction, wherever it may end, is the same whether C has a claim against B or whether he does not have a claim against B; and they agree that no advantage is to be given to C in the situation in which he does not have a claim against B, as compared to the situation in which he has a claim against B.

The rule of section 143, which applies where C has a claim against B, bears a strong resemblance to the rule which is laid down by the courts which deny that C has a contract right against A and which hold that C's right, if any, is by way of subrogation to B's right against A. Both under the holdings of these courts, and under section 143, A and B may terminate or modify the contract by mutual agreement up to the time that C brings suit against A or changes his position materially in reliance upon the contract, unless B's discharge of A would operate as a fraud against C.

The rule of section 142, which applies where C has no claim against B, bears a strong resemblance to the rule which the courts apply in cases of life insurance (not benefit certificates); a rule which originated in statute, and which is applied by courts, many of which say that C's right under the policy is either a gift or a trust, and not a contractual right against the insurance company.

Sections 142 and 143 of the Restatement, when taken together, are thus contrary to the common law rule as applied by the courts which treat the transactions in question as contracts; and they seem to be borrowed from cases in which the courts did not recognize as contracts the transactions with reference to which they laid down these rules.

The position of contracts to render performance to a third person would seem to be so clearly established in the United States (except in a few of the Eastern States) that the rights which arise should be determined by principles of contract law; and not by principles of gift, trust, and subrogation.

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The Restatement Second adopts the position urged by Professor Page, asserting that "[t]he weight of authority is opposed to a distinction between donee beneficiaries and creditor beneficiaries with respect to the power of promisor and promisee to vary [their agreement)" (Reporter's Note to §311). Instead, the draftsmen of the Restatement Second have chosen to emphasize the elements of reliance and assent in formulating a rule that applies to all intended beneficiaries. Section 311 (Variation of a Duty to a Beneficiary) provides:

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(1) Discharge or modification of a duty to an intended beneficiary by conduct of the promisee or by a subsequent agreement between promisor and promisee is ineffective if a term of the promise creating the duty so provides.

(2) In the absence of such a term, the promisor and promisee retain power to discharge or modify the duty by subsequent agreement.

(3) Such a power terminates when the beneficiary, before he receives notification of the discharge or modification, materially changes his position in justifiable reliance on the promise or brings suit on it or manifests assent to it at the request of the promisor or promisee.

(4) If the promisee receives consideration for an attempted discharge or modification of the promisor's duty which is ineffective against the beneficiary, the beneficiary can assert a right to the consideration so received. The promisor's duty is discharged to the extent of the amount received by the beneficiary.

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Annotated Text Information

June 30, 2014

11.5.4.1 Note on The Restatement of Contracts and the Problem of Rescission

11.5.4.1 Note on The Restatement of Contracts and the Problem of Rescission

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Joe Srednicki

Contract Technical Writer

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