Chapter 11: Third Party Beneficiaries Introduction | Kessler, Gilmore & Kronman | September 14, 2012


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CHAPTER 11 Third Party Beneficiaries

Section 1. Introductory Note

In preceding chapters the focus of attention has been on the two-party relationship. In this chapter on so-called Third Party Beneficiaries and in the following chapter on Assignment we shall consider the more complicated situation that results when C joins, or attempts to join, in the game along with those veteran warriors A and B.

The cast of characters need not, of course, remain frozen at three. Consider, for example, the contractual arrangements that cluster around the typical building contract. Landowner (A) enters into a contract with a construction company (B) under which B is to put a structure (house, factory, office building, airport) on A's land. The A-B contract requires B to furnish, for A's protection, a bond under which a surety company (C) guarantees that, if B defaults, C will complete the contract (performance bond) or pay all claims of laborers and materialmen against B (payment bond) or both. (If A is the United States, a federal statute known as the Miller Act [1] requires that all general contractors furnish both payment and performance bonds.) The general or prime contractor typically re- quires his subcontractors to furnish the same types of bonds running in the general contractor's favor — so that there may be several layers or levels of surety bonds arranged in hierarchical order below the prime contract. In form, the surety's payment bond may be described as a promise by C (surety company) to A (landowner) that the claims of D1, D2 , D3 , etc. (laborers, materialmen, subcontractors) against B (construction company) will be paid. (If they were not paid, many of the claimants might be in a position, under applicable state law, to go against A directly and to acquire so-called mechanics' liens against his property.) In order to protect itself against possible liability on its bond, C (surety company) will require B (construction company) to assign to it moneys to be earned under the contract — the assignment to C to take effect on B's default under the A-B contract. If the construction project is a large one, B will have to get outside financing. Usually it will borrow the money it needs from a bank (E). As security for the loan the bank will require that B assign to it all moneys to be earned in the course of performance of the A-B contract. (B's assignments to surety company and bank are of course in conflict with each other, since both assignments cover the same fund.)

The foregoing description of the relationships generated by the ordinary construction contract has been drastically oversimplified. Enough has been said, however, so that the student will not be surprised to learn that, for more than a hundred years past, state and federal courts have had to devote an inordinate amount of their time to disentangling the rights, duties and priorities of A, B, C, D, and E. Nor is there any present indication that the judges will ever produce a general agreement as to what those rights, duties, and priorities are. Business practice in the construction industry changes; the practices of banks and surety companies change; new statutes, state or federal, are passed that arguably may have, by accident or design, a bearing on some aspect of the complex. It is always possible to argue — it always is argued — that something has happened this year to cast doubt on last year's precedents. And so the dreary game drags on.[2]

For present purposes, we may restrict ourselves to the triangular or A-B-C relationship, which is already difficult enough without the additional presence of D and E.

The suggestion that C can acquire rights in a contract between A and B to which C is not a party is one that has always, when first put forward in some context, aroused judicial suspicion or hostility. The idea that a contract between A and B is a private link between them, and between them alone, is one that dies hard. A and B, we say, are in "privity" with each other; C is not in "privity" with them or with their contract; lacking "privity," C can acquire no rights (or duties) under the A-B contract. That, at all events, is a recurrent judicial reaction when a novel type of claim on behalf of C is put forward: what "privity" is or why the lack of it should be fatal is never inquired into. We may take the word "privity" as a sort of mystical absolute. To lack privity is to have failed to achieve the requisite state of contractual grace.

The history of the common law over the past several hundred years nevertheless reveals a succession of instances in which C has prevailed - however grudgingly his rights may have been recognized as an initial matter. Often, however, C's position has been vindicated by an appeal to the principles of agency or trust law, and his rights under the A-B agreement have therefore not appeared to be contractual at all. And even where C's rights have been upheld on contractual grounds, they have typically been explained not by general principles of promissory liability hut by the specialized rules belonging to one or another of the satellite systems thrown off by the common law of contracts in the course of its historical development.

The assumed unity of contract law has in fact always masked a centrifugal tendency. The law of sales and the law of labor agreements, to take two examples, both have (or once had) their roots in contract; sales law has long since become, and labor law is clearly in process of becoming, independent of the general law of contract. This centrifugal tendency has been particularly marked in what we may generically describe as the area of third party claims. Many types of triangular or A-B-C relationships have so completely won their independence that for generations or centuries no lawyer has thought of them as being a part of general contract law. This is true, for example, of the law of suretyship and the law of negotiable instruments. The fact that they split off from contract at an early date may reflect the deep-rooted difficulty that our contract theory has always had with third party claims. It seems to have been easier to establish a whole new body of law — and call it, say, suretyship — than to work out a general theory of contractual obligation under which A could transfer property to B for C's benefit.

The doctrine of third party beneficiaries starts from the idea that C can have rights under a contract to which he is not himself a party even though he has none of the special legal attributes that have long been recognized as a basis of third party claims. To this extent, the doctrine may be viewed as a generalization of what has been, until quite recently, an exceptional principle limited to certain specialized and largely independent branches of contract Law. The recency of this development, and the resistance the doctrine has encountered in many jurisdictions — English courts still refuse to recognize any general principle establishing the rights of contract beneficiaries — attest to the influence that the idea of privity still exercises on our legal imagination. (It may be that recognition of the rights of beneficiaries as a matter of contract law was a belated acknowledgment of the fact that such rights had long been upheld under the noncontractual principles of trust or agency theory. A not uncommon theme in the opinions written in the early third party beneficiary cases was that C should be allowed to sue on the contract made between A and B because C's situation was essentially "like" that of the beneficiary of a trust. If C prevailed as a beneficiary when A and B bad used language of trust, why should he not equally prevail when A and B had sought to achieve the same result but had used contract language instead? The contract beneficiary soon went on to argue, often successfully, that he should prevail even when the trust analogy failed — even when there was nothing remotely like a trust res anywhere in sight. And it may be that the success of the contract beneficiary's argument has contributed, in turn, to the expansion of the concept of fiduciary obligation that has been a notable feature of trust law in this century. A common law development not infrequently stimulates a process of reciprocal cross-fertilization.)

 Established in our American law of contracts by the wonderfully obscure case of Lawrence v. Fox (1859), the doctrine of third party beneficiaries has followed a meandering course and been a subject of intense controversy (in Massachusetts, for example, the doctrine was not finally approved until 1979). [3] On the whole, however, the tendency of the third party beneficiary idea has been, in the words of a New York judge, "progressive, not retrograde,"[4] and in recent years the doctrine has been put to such expansive use that today one must wonder whether it has any limits at all. Efforts to impose limits on the doctrine have of course been made (by judges and restaters), but the third party beneficiary, loose in our law of contracts now for more than a century, appears to have gained an almost irresistible momentum.

The triumph of the third party beneficiary idea may be looked on as still another instance of the progressive liberalization or erosion of the rigid rules of the late nineteenth-century theory of contractual obligation. That such a process has been going on throughout this century is so clear as to be beyond argument. The movement on all fronts has been in the direction of expanding the range and the quantum of obligation and liability. We have seen the development of theories of quasi-contractual liability, of the doctrines of promissory estoppel and culpa in contrahendo, of the perhaps revolutionary idea that the law imposes on the parties to a contract an affirmative duty to act in good. faith. During the same period the sanctions for breach of contract have been notably expanded. Recovery of "special" or "consequential" damages has become routinely available in situations in which the recovery would have been as routinely denied seventy-five years ago. The once "exceptional" remedy of specific performance is rapidly becoming the order of the day. On the other hand the party who has failed to perform his contractual duty but who, in the light of the circumstances, is nevertheless felt to be without fault has been protected by a notable expansion of theories of excuse, such as the overlapping ideas of mistake and frustration. To the nineteenth-century legal mind the propositions that no man was his brother's keeper, that the race was to the swift, and that the devil should take the hindmost seemed not only obvious but morally right. The most striking feature of nineteenth-century contract theory is the narrow scope of social duty it implicitly assumed. In our own century we have witnessed what it does not seem too fanciful to describe as a socialization of our theory of contract. The progressive expansion of the range of non-parties allowed to sue as contract beneficiaries as well as of the situations in which they have been allowed to sue is one of the entries to be made in this ledger.


[1] 40 U.S.C.A. §§270a-270e (West 1965 & Supp. 1985).

[2] For more on this problem, see p. 1364 infra, and the Note following that case.

[3] Choate, Hall & Stewart v. SCA Serv., Inc., 378 Mass. 535, 392 N.E.2d 1045 (1979).

[4] Kellogg, P.J., quoted in Seaver v. Ransom, 224 N.Y. 233, 120 N.E. 639 (1918), infra p. 1356.


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