66The laws of astate changewith thechangingtimes,!l

Aeschylus, 525-+56 B.c.E(Greek dramatist)

CIIAPTER I6ffiww

.ASSICNMENTS

.DELECATIONS

-THIRD PARTY BEN EFICIARIES

CHAPTER OUTtI i lE tEARl{ ING OBIECTIVES

AFTER READING THIS CHAPTER, YOU SHOULD BE ABLE TOANSWER THE FOLLOWING QUESTIONS:

I What is the difference behveen an assisnment anda delegation?

2 If a contract requires a party to perform personalservices, can the right to receive those services beassigned?

5 What rights can be assigr-red despite a contractclause expressly prohibit ing assignment?

4 What factors indicate that a third party beneficiaryis an intended beneficiary?

5 How do a third party beneficiary's rights becomevested so that this party can sue to enforce thecontract?

PRIVITY OF CONTRACIThe relationship that exists betweenthe promisor and the promisee of acontract.

ASSIGNMENTThe act of transfening to another allor part of one's rights arising under acontract.

584 IINIIUE!CONTRACTS

ecause a contract is a private agreement between the parties who have entered intoit, it is fitting that these parties alone should have rights and liabilities under the

contract. This concept is referred to as privity of contract, and it establishes the basicprinciple that third parties have no rights in contracts to which they are not parties.

You may be convinced b)"to* that for every rule of contract law, there is an exception.As times change, so must the laws, as indicated in the chapter-opening quotation. Whenjustice cannot be served by adherence to a rule of law, exceptions to the rule must bemade. In this chapter, we look at some exceptions to the rule of privity of contract. Theseexceptions include assignments and delegations, as well as third party beneficiary contracts.

In a bilateral contract, the trvo parties have corresponding rights and duties. One party hasa right to require the other to perform some task, and the other has a du\, to perform it.Sometimes, though, a party will transfer her or his righis under the contract to someoneelse. The transfer of contract rights to a third person is known as an assignment. (Thetransfer of contract duties is a delegation, as discussed later in this chapter.)

Assignments are important because they are utilized in mr-rch business financing. Lendinginstitutions, such as banks, frequently assign the rights to receive payments under their loancontracts to other firms, which pay for those rights. If you obtain a loan fi-om a bank to pur-

chase a car, you may later receive a notice stating thai the bank has transferred (assigned) its

rights to receive payments on the loan to another firm and that you must make your payments

to that firrn.Lenders that make mortgage /oozs (loans to allow prospective home buyers to purchase

land or a home) often assign their rights to collect the mortgage payments to a third parf,,

such as GMAC Mortgage Corporation. Following an assignment, the home buyer is noti-

fied that future payments must be made to the third party, rather than to the original

lender. Billions of dollars change hands daily in the business world in the form of assign-

ments of rights in contracts.

Effect of an AssignmentIn an assignment, the party assigning the rights to a third party is known as the assignor,l

and the par\, receiving ihe rights is the assignee. Oiher traditional terrninology used to

describe ihe parties in assignment relationships are the obligee2 (the person to whom a duty,

or obligation, is owed) and the obligor (the person who is obligated to perforrn the duty).

When rigl-rts under a contract are assigned unconditionally, the rights of the assignor

(the party making the assignrnent) are extinguished. The third party (the assignee, or the

party receiving the assignment) has a right to demand performance from the other original

party to the contract (the obligor, the person who is obligated to perforrn). laExAMPLtleilBrent (the obligor) owes Alex $1,000, and Alex, the obligee, assigns to Carmen the righi to

receive the $1,000 (thus, Nex is now the assignor). Here, a valid assigr-iment of a debt exists.

Carmen, the assignee, can enforce the contract againsi Brent, the obligor, if Brent fails to

perform (pay the $1,000). H g"hiblt l6-1 illushates assignment relationships.

The assignee obtains only those rights that the assignor originally had. Also, the

assignee's rights are subject to the defenses that the obligor has against the assignor.

lEExAMprEl6r-l Brent owes Alex $1,000 under a contract in which Brent agreed to buy

l . Pronounced uh-syelore.

2. Pronounced obJih-gee (with a hard g).

In the assignment relationship illustrated here, Alex assigns his rights under a contract that he madewith Brent to a third party, Carmen. Alex thus becomes the ossignor and Carmen the ossrgnee ofthe contractual rights. Brent, the obligor (the party owing performance under the contract), nowowes performance to Carmen instead of Alex. Alex's original contract rights are extinguished afterthe assignment.

Original Contract

Duties Owedafter Assignment

Assignment of Rights

585 EIEIETNTHIRD PARTY RIGHTS

ASSIGNOR

A party who transfers (assigns) hisor her rights under a contract toanother party (called the ossignee).

ASSIGNEEA party to whom the rights under acontract are transferred, or assigned,

OBIIGEEOne to whom an obligation is owed.

oBUCOROne who owes an obligation toanother.

386 IlNiIiMCONTRACTS

You can find a number offorms that can be used inthe assignment of differenttypes of contracts, at

This site is maintained by thelnternet Legal Research Group.

Alex's MacBook Pro laptop. Alex assigns his right to receive the $1,000 to Carmen. Brent,in cleciding to purchase the laptop, relied on Alex's frar-rdulent misrepresentation that tl'iecomputer had 2 gigabytes of mernory. When Brent discovers that the computer has onlrI gigabyte of rnemory, I're tells Aler that he is going to retr-irn the laptop and cancel thecontract. Even though Alex has assigned l-ris "right" to receive the $1,000 to Carmen,Brent need not pay Carmen the $ I ,000 - Brent can raise the defense of Alex's fraudulentmisrepresentation to avoicl payrner-rt. leJ

Unless the Statr-rte of Frar-rds applies, an assignn'ient can take any forn, oral or written.Naturally, it is n'rore difficuit to prove that an oral assignment occurred, so it is practicalto put all assignments ir-r writing. The circurnstances in the following case illustrate someof the problems that can arise with oral assignments. 'fhe case also stands for the princi-ple that an assignment, l ike any contract, must have consideratior-r-in this case, a dancecenter's assumption of a choreographer's legal ancl financial duties associatecl witl'i hercnoreograpn)'.

United States Court of Appeals, Second Circuit, 380 F.3d 624 (2OO4)-

8A[KGROUND AND FACTS--.-j lW.-.".! Martha Craham's career as a

dancer, dance instructor, and choreographer began in the firstthird of the twentieth century. In the 1920s, she started adance company and a dance school and choreographed workson commission. In the 1940s, she funded the Martha GrahamCenter of Contemporary Dance, Inc. (the Center). She sold herschool to the Martha Graham School of Contemporary Dance,Inc. (the School), in 1956. By 1980, the Center encompassedthe School. In I989, h/yo years before her death, Crahamexecuted a wil l in which she gave Ronald Protas, the Center'sgeneral director, "any rights or interests" in "dance works,musical scores [and] scenery sets." After her death, Protas

f N THt WORDS 0F THt C0URT . . . roN o. NEWMAN.

asserted ownership of all of Craham's dances and relatedproperty. In 1999, the Center's board removed Protas and, dueto financial problems, suspended operations. Meanwhile,Protas founded the Martha Graham School and DanceFoundation, lnc., and began licensing Graham's dances. Whenthe School reooened in 2001. Protas and his foundation fi leda suit in a {ederal district court against the Center and othersto enjoin their use of, among other things, seventy of thedances. The Center responded, in part, that Craham hadassigned the dances to it. The court ruled that hruenty-one ofthe dances had been assigned to the Center. The plaintiffsappealed to the U.S. Court of Appeals for the Second Circuit.

Circuit Judge.

T'he Appeilants contend that the District Cor-rrt errecl in finding tliat Crahan assignedto the Center 21 dances, x * * which were created before 1956, unpublished at the time

"f Trlgi"1""t, and not commissioned. We disagree.

Altl-rough there is no document memorializir-rg Grahan'r's assignrnent of copyright inher pre-i956 dances to the Center, the District Court was entit led to find that Crahanrassigned to the Center, orally or in lvriting, her copyrights in her noncon'imissioned pre-1956 dances that u'ere not published at the time she assigned thern.

The District Court relied on several items of evidence to reach its conclusion. Forexample, Jeannette Roosevelt, former President of the Center's board of directors, testifiedthat Graham had given the dances to the Center prior to 1965 or 1966, when she joinedthe board. There was additional evidence that the Center acted as the owner of the dancesby entering into contracts with third parties, and ti'iat Grahan'i was aware of this and didnot object. Other evidence showed that the Center received royalties for the dances and

CASE l6. l -Cont inued

treated them as its assets. However, the only evidence that Graham had assigned theentire group of her pre-1956 dances (noncommissioned and unpublished) to the Centerare hvo letters from Lee Leatherman, the Center's Executive Administrator ai that time,written in l968 and 1971. These letters indicated that "recently Miss Graham assignedperforming rights to all of her works to the Martha Graham Center of ContemporaryDance, Inc.," and that "Martha has assigned all rights to all of her works to the MarthaGraham Center, Inc." The Appellants contend that these letters are hearsaya and wereimpermissibly considered.

These two letters, both in existence 20 years or more at the time they were offered asevidence, were authenticated x x x . There was no reason to suspect their authenticity.Moreover, Linda Hodes, a witness with relevant knowledge, testified that the letters werewhat they purported Iobe. The letters were therefore exceptions to the hearsay rule [underwhich the letters would othenuise be inadmissiblel. The District Court did not err in admit-iing and relying on these letters. flEmphasis added.]

Under New York law, an assignment * * *

-"y be made without writing or delivery

of any written statement of the claim assigned, x x x provided only IhaI the assignment is

founded on d rdlid consideration between the parties. The District Court was entitled tofind that Graham received consideration for the assignment of her pre-1956 dances.Graham benefited from the Center's assumption of the legal and financial duties associ-ated with her choreography; assigning to the Center the copyrights in her dances gave herwhat she wished-freedom from the responsibilities of copyright registration and renewal,licensing, collection of royalties, and archival tasks. IEmphasis added.]

The District Court was entitled to find that Graham assigned her pre-1956 dances * * *

to the Center sometime behveen 1957 and the mid-l960s.

587 EIEEtrIHIRD PARTY RIGHTs

WHAT IF THE FACTS WERE DIFFERENT?Suppose thot Grahom hod not benefited from the

Center's assumption of the duties associated with herchoreogrophy. Would the olleged ossignment hove been volid?Why or why not?

DEClSl0N AND REMEDY rtre U.s. court of Appeals forthe Second Circuit affirmed the lower court's judgment on thisissue, "commend[ing] the District Court for its careful rulingson the many issues in this complicated case." The appellatecourt held that Craham had received consideration for herassignment of certain dances and that, although theassignment had been oral, it had been reliably proved bywritten testimonv.

a, Hearsay is testimony given in court about a statement made by someone else, as was discussed in Chapter 5.

@

Rights That Cannot Be AssignedAs a general rule, all rights can be assigned. Exceptions are made, however, in the follow-ing special circumstances.

When a Statute Expressly Prohibits Assignment If a statute expressly prohibits assign-ment, the particular right in question cannot be assigned. IEExAMilE tG"il Marn is a newemployee of CompuFuture, Inc. CompuFuture is an employer under workers'compen-sation statutes (see Chapter 40) in this state, so Marn is a covered employee. Marn has arelatively high+isk iob. In need of a loan, she borrows from Stark, assigning to Stark allworkers' compensation benefits due her should she be injured on the job. A state statute

r88 llNil@CONTRACTS

A music teocher instrucb his pupil.Assuming thot the boy's mother,Kotherine, controded with theteocher for his seruices, conKatherine assign the right to receivemusic lessons to another pofi?Why or why noQ(Buccina Studios/PhotoDisc Green)

ATIENATIONThe process of transferring landout of one's possession (thus"alienating" the land from oneself),

prohibits the assignmerr1r of future workers' cornpensationbenefits, and thus such rights cannot be assigned. El

When a Contract Is Personal in Nature When a con-tract is for personal services, the rights under the contractnormally cannot be assigned unless all that remains is amonetary payment. IEEXAMpLE-I6"+l Brent signs a contractto be a tutor for Alex's children. Alex then atternpts toassign to Carrnen his right to Brent's services. Carmencannot enforce the contract against Brent. Brent may notlike Carmen's children or for some other reason may notwant to tutor them. Because personal services are uniqueto the person rendering them, rights to receive personalservices cannot be assigned. E

When an fusignment Will Significantly Change theRisk or Duties of the Obligor A right cannot beassigned if assignment will significantly increase or alterthe risks or the duties of the obligor (the party owing per-formance under the contract).i lEExAMnFt6.t Alex has ahotel, and to insure it, he takes out a policy with Northwest

Insurance Company. The policy insures against fire, theft, floods, and vandalism. Alex

attempts to assign the insurance policy to Carmen, who also owns a hotel. The assignmentis ineffective because it may substantially alter the insurance company's duty of perfor-mance and the risk that the company undertakes. An insurance company evaluates theparticular risk of a certain party and tailors its policy to fit that risk. If the policy is assignedto a third party, the insurance risk is materially altered. E

When the Contract Prohibits Assignment If a contract stipulates that the right cannotbe assigned, lhen ordinarily it cannot be assigned. lEExAltpLE 16A Brent agrees to build ahouse for Alex. The conhact beh.rreen Brent and Alex states, "This contract cannot beassigned by Alex without Brent's consent. Any assignment without such consent rendersthis contract void, and all rights hereunder will thereupon terminate." Alex then assigns hisrights to Carmen, without first obtaining Brent's consent. Carmen cannot enforce the con-tract against Brent. E This rule has several exceptions:

A contract cannot prevent an assignment of the right to receive funds. This exceptionexists to encourage the free flow of funds and credit in modern business settings.

The assignment of ownership rights in real estate often cannot be prohibited becausesuch a prohibition is contrary to public policy in most states. Prohibitions of this kindare called restraints against alienation (the voluntary transfer of land ownership).

The assignment of negotiable instruments (see Chapter 22) cannol be prohibited.

In a contract for the sale of goods, the right to receive damages for breach of contractor for payment of an account owed may be assigned even though the sales contract pro-hibits such an assignment.a

See Section 2-210(2) of the Uniform Commercial Code (UCC)

ucc 2-210(2).

5

4

3.4.

589]?!ET'IEJlt:rIHIRD PARTY RICHTS

DETEGATION OF DUTIESThe act of transfening to another allor part of one's duties arising undera contract.

DETEGATORA party who transfers (delegates) heror his obligations under a contract toanother party (called the delegatee).

Notice of AssignmentOnce a valid assignment of rights has been made to a third party, the third party shouldnotify the obligor of the assignment (for example, in Exhibit l6-l on page )85, Carmenshould notify Brent). Giving notice is not legally necessary to establish the validity of theassignment because an assignment is effective immediately, whether or not notice isgiven. Two major problems arise, however, when notice of the assignment is nof given tothe obligor:

I If the assignor assigns the same right to two different persons, the question arises as towhich one has priority-that is, which one has the right to the performance by theobligor. Although the rule most often observed in the United States is that the firstassignment in time is the first in right, some states follow the English rule, whichbasically gives priority to the first assignee who gives notice. lrExAMnFr6T Brent owesAlex $5,000 on a contractual obligation. On May l, Alex assigns this monetary claimto Carmen, but she does not give notice of the assignment to Brent. On June l, forservices Dorman has rendered to Alex, Alex assigns the same monetary claim (tocollect $5,000 from Brent) to Dorman. Dorman immediately notifies Brent of theassignment. In the majority of states, Carmen would have priority because theassignment to her was first in time. In some states, however, Dorman would havepriority because he gave first notice. E

2 Until the obligor has notice of an assignment, the obligor can discharge his or her obli-gation by performance to the assignor, and this performance constitutes a discharge tothe assignee. Once the obligor receives proper notice, only performance to theassignee can discharge the obligor's obligations. lEExAMpi.l t6.gl Alex, in the aboveexample, assigns to Carmen his right to collect $5,000 from Brent, and Carmen doesnot give notice to Brent. Brent subsequently pays Nex the $5,000. Although the assign-ment was valid, Brent's payment to Alex is a discharge of the debt, and Carmen's fail-ure to notifu Brent of the assignment causes her to lose the right to collect the $5,000from Brent. (Note that Carmen still has a claim againstAlex for the $5,000.) If Carmer-rhad given Brent notice of the assignment, however, Brent's payment to Alex would nothave discharged the debt. E

Providing notice of assignment, though not legally required, is one of the bestways to avoid potential legal disputes over assignments. wh€ther you are theassignee or the assignor, you should inform the obligor of the assignment. Anassignee who does not give notice may lose the right to performance, but failureto notify the obligor may have repercussions for the assignor as well. lf no noticeis given and the obligor performs the duty for the assignor, the assignee, towhom the right to receive perlormance was assigned, can sue the assignor forbreach of contract. Litigation may also ensue if the assignor has assigned a rightto two different parties, which can happen when assigning rights that overlapsomewhat (such as rights to receive profits from a given enterprise).

fust as a paiy can transfer rights to a third party through an assignment, a party canalso transfer duties. Duties are not assigned, however; they are delegated. Normally, adelegation of duties does not relieve the par!' making the delegation (the delegator) of

tr

5e0 l!NI@CONTRACTS

DELEGATEEA party to whom contractualobligations are transferred, ordelegated.

the obligation to perform in the event that the party to whom the duty l-ras been delegated

(the deiegatee) fails to perform. No special form is required to create-a valid delegation

of duties.is long as the delegator expr;sses an intention to rnake the delegation, it is effec-

tive; the delegaLr ,'r""d roieuen use the word delegate. Exhibit l6-2 graphically illus-

trates delegation relationships.

Duties That Cannot Be DelegatedAs a general mle, any duty can be delegated. This iule has some erceptions' howerer'

Delegation is prohibitecl in the foilowittg circumstances:

I When performance depends on the personal skill or talents of the obligor.

2 When special trust has been placed in the obligor.

5 When performance by a third party will vary materially frorn that expected by the

obligee (the one to whom performance is owed) under the contract'

4 When the contract expressly prohibits delegation.

The following examples will help to clarily the kinds of duties that can and cannot be

delegated:

I Brent contracts with Alex to tutor Alex in various aspects of financial ur-rderwriting and

investment banking. Brent, who is known for his expertise in finance, delegates his

duties to a thircl prr.-ty, Cnrrr.i.r-r. This delegation is ineffective because Brer-rt contracted

to render a service founded on his expertise and Alex placed special trust in Brent's

teaching ability. The delegation changes Alex's expectancy under the contract.

2 Brent, a famous musician, contracts with Alex to persorLally perform at a concert. Then

Brent receives a better offer and delegates his duty to perforrn to another musician'

Miles. Regardless of Miles's musical talents, the delegation is not effective without

Alex's consent because tl-re contract was for personal performance'

In the delegation relationship illustrated here, Brent delegates his dufies under a contract that he

made with"Rlex to a third pjrty, Carmen. Brent thus becomes the delegotor and Carmen the

delegatee of the contractual duties. Carmen now owes performance_of the contractual duties to

Alex]Note that a delegation of duties normally does not relieve the delegator (Brent) of liability if

the delegatee (Carmen) fails to perform the contractual duties.

Original Contract

Delegat ionol Dut ies

Pe rf orma nce

Brent, an accountant, contracts to perform annual audits ofAlex's business records forthe next five years. 'l'he cor-rtract states that Brent rr-rust provide the services himself andcannot delegate these duties to another. Tu'o years later, Brent is busy on other proj-ects and delegates his obligations to perform Alex's audit to Arianna, who is a certifiedpublic accountar-rt at the same firm. This delegatior-r is not effective because the con-tract expressly prohihited delegation.

AIex is a wealthy philanthropist r'vho just created a charitable foundatior-r. Alex hasknown Brent for twenty years and knorvs that Brent shares his beliefs on many human-itarian issues. He contracts with Brent to be in charge of allocating funds among vari-ous charitable causes. Six months later, Brer-rt is experiencing health problems anddelegates his duties to Drew. Alex does not approve of Drew as a replacemer-it. In thissituation, Alex can claim the delegation was not effective because it materially alteredhis expectations under the contract. Alex had reasonable expectations about the typesof charities to which Brent would give the foundation's funds, and substituting Drelr,'sperforrnance materially char-rges those erpectations.

Brent contracts with Alex to pick up and deliver heavy construction machinery toAlex's property. Brent delegates this dut1,' to Carmen, who is in the business of deliver-ing hear'y machinery. This deiegation is effective. The performance requiied is of aroutine and nonpersonal nature, and tl-ie clelegation does not change Alex's erpecta-tions under the contracl.

Effect of a Delegat ionIf a delegation of dr-rties is enforceable, the obligee (the one to whom performance isru'ed) must accept performance from tl-re delegatee (the one to whoin the duties are del-rgated). trExAMpLE te'sl In the fifth example in the above 1ist, Brent delegates his duty (topick up and deiiver heavy- construction rnachinery to Alex's property) to Carmen. Alexthe obligee) nust accept perfornrance from Carn-ren (the delegatee) because the delega-

iron was effective. The obligee can legally refuse performance from the delegatee only ifr l re drr ty is one that cannol be delegated. @

A valid delegation of dr,rties does not relieve the delegator of obligations rrnder the con-iract.) In the above example, if Carrnen (the delegatee) fails to perform, Brent (the dele-gator) is sti l l l iable to Alex (the obligee). The obligee can also hold the delegatee l iable ifthe delegatee made a promise of performance that rvill directly benefit the obligee. In thissituation, there is an "assumption of dutyi' on the part of the delegatee, and breach of thisduh, makes the delegatee liable to the obligee. For exaniple, if Carrnen (the delegatee)promises Brent (the delegator), in a contract, to pick up and deliver the constructionequipment to Aler's property but fails to do so, Alex (the obligee) can sue Brent, Carmen,or both. Although there are many exceptions, the general rule today is that the obligeecan sue both the delegatee and tl-re delegator.

"Assignment of Al l Rights"Sometimes, a contract provides for an "assignment of all rights." The traditional view was thatunder this type of assignment, the assignee did not assume any duties. This vierv was basedon the theory that the assignee's agreement to accept the benefits of the contract was not suf-ticient to irnply a promise to assune the duties of the contract.

5. I.-or a classic case on this issue, see CrcLne Ice Cream Co. t,. Terminal Freezing & Heatitlg Co., 1'17 Md. 588, 128 A

r5(.) (1925)

5gl m7ffi?imTHIRD PARTY RICHTS

ftfffiIfil'il'll In an assignment,the assignor's original contractrights are extinguished after theassignment. In a delegation,the delegator remains l iable foroerformance under the contractif the delegatee fails to perform.

592 l!triluilCONTRACTS

THIRD PARTY BENEFICIARYone for whose benefit a promise ismade in a contract but who is not aparty to the contract.

INTENDED BENEFICIARYA third party for whose benefit acontract is formed. An intendedbeneficiary can sue the promisor ifsuch a contract is breached.

decisions from the New York Courtof Appeals is online at

thereshallbe/pg5l.htm.

Modern authorities, however, take the view that the probable intent in using such gen-eral words is to create both an assignment of rights and an assumption of duties.b Therefore,when general words are used (for example, "l assign the conhact" or "a11 my rights underthe contract"), the contract is construed as implying both an assignment of righ* and anassumption of duties. (See the Application feature at the end of this chapter for factors thatbusinesspersons should consider when dealing with assignments and delegations.)

As mentioned earlier in this chapter, to have contractual rights, a person normally mustbe a party to the contract. In other words, privity of contract must exist. An exception tothe doctrine of privity exists when the original parties to the contract intend, at the timeof contracting, that the contract performance directly benefit a third person. In this situ-ation, the third person becomes a third party beneficiary of the contract. As an intendedbeneficiary of the contract, the third party has legal rights and can sue the promisordirectly for breach ofthe contract.

Who, though, is the promisor? In bilateral contracts, both parties to the contract arepromisors because tl-rey both make promises that can be enforced. In third party benefici-ary contracts, courts determine the identity of the promisor by asking which party madethe promise that benefits the third party-that person is the promisor. Allowing the thirdpar[u to sue the promisor directly in effect circumvents the "middle person" (thepromisee) and thus reduces the burden on the courts. Otherwise, the third party wouldsue the promisee, who would then sue the promisor.

A classic case in the area of third party beneficiary contracts is Lawrence y. Fox - a casedecided in 1859. In the Lawrence case, which is presented as this chapter's Landmark inthe Law feature, the court set aside the traditional requirement of privity and allowed athird party to bring a suit directly against the promisor.

Types of Intended Benef ic iar iesThe law distinguisl-res beh.rreen intended beneficiaries and incidental beneficiaries. Onlyintended beneficiaries acquire legal rights in a conhact. One type of intended beneficiary isa creditor beneficiary. Like the plaintiff in Lawerence v. Fox, a creditor beneficiary benefitsfrom a conhact in which one party (the promisor) promises another party (the promisee) topay a debt that the promisee owes to a third party (the creditor beneficiary). fu an intendedbeneficiary, the creditor beneficiary can sue the promisor directly to enforce the conhact.

Another type of intended beneficiary is a donee beneficiary. When a contract is madefor the express purpose of giving a gift to a third party, the third party (the donee benefi-ciary) can sue the promisor directly to enforce the promise.T The most common doneebeneficiary contract is a life insurance contract. IEEXAMpLE t6Jol Akins (the promisee)pays premiums to Standard Life, a life insurance company, and Standard Life (thepromisor) promises to pay a certain amount on Akins's death to anyone Akins designatesas a beneficiary. The designated beneficiary is a donee beneficiary under the life insur-ance policy and can enforce the promise made by the insurance company to pay her orhim on Akins's death. E

As the law concerning third party beneficiaries evolved, numerous cases arose in whichthe third party beneficiary did not fit readily into either the creditor beneficiary or thedonee beneficiary category. Thus, the modern view, and the one adopted by theRestatement (Second) of Contracts, does not draw such clear lines and distinguishes only

6. See UCC Z-ZI0]), (4); and Restatement (S econd) of Contracts, Section J28.7. Thispr inciplewasf i rstenrnciatedinSeavery.Ransom,224N.Y.ZSS,I20N.tr .6 i9(1918)

A New York Low Journolarticle discussing leading

59I EIEEtrTHIRD PARTY RICHTS

,:

. l In 1859, the New York Court of Appeals (that state'shighest court) decided a case, Lawrence v. Fox,a inwhich the court departed from the doctrine ofprivity of contract and allowed a third party to sue

the promisor directly. Prior to that t ime, contractual l iabil i ty had always been limited tothe parties to the contract.

Case Background The case involved three parties-Holly, Lawrence, and Fox. Hollyhad borrowed $300 from Lawrence. Shortly thereafter, Holly loaned $300 to Fox, who inreturn promised Holly that he would pay Holly's debt to Lawrence on the following day.When Lawrence failed in his attempts to obtain the $300 from Fox, he sued Fox torecover the funds.

Why didn't Lawrence sue Holly directly, rather than pursue the unusual route of suingFox, which meant that his chances at recovery were much slimmer? According to onescholar, the answer to this question is that the "Holly" in this case was probably MerwinSpencer Hawley. Both Hawley and the defendant, Arthur Wellesley Fox, were prominentmembers of the business community in Buffalo, New York. Evidence at trial suggestedthat the debt Hawley owed Lawrence was a gambling debt. Because gambling wasil legal under New York lary Lawrence could not recover directly from Hawley in court,as the contract would have been deemed il legal b

The lssue before the Court and the Court 's Ruling In any event, the issuebefore the court was whether Lawrence, who was not a party to the Holly-Fox contract,could sue Fox directly to recover the 9300. The court held that Lawrence could do so. ltwas manifestly "just," declared the court, to allow Lawrence to recover the funds fromFox. The court enunciated the principle of law that "[in the case ofj a promise made forthe benefit of another, he for whose benefit i t is made may bring an action for itsbreach."

At the time this decision wos rendered,ollowing o third party to sue a promisor directly was o novel ideo ond represented orodicol deporture from contrqct low. Although privity of controd remoined the guidingprinciple until ofter the turn of the century, in two leading cases decided in I9t6c ondt g t ad the New York Court of Appeals cited Lawrence v. Fox in iustifying its deporturefrom the principle of privity of controd. Since then, the third party beneficiory rule hosbeen continuously exponded in scope.

ffi To locate information on the web concerning fhe Lawrencev. Fox decision, go to this text's Web sife of www.cengage.com/blaw/blt , select "Chopter

| 6," ond click on "URLs for Landmorks!'

a. 20 N.Y.268 (18s9).b. See Antony Jon Waters, 'The Property in the Promise: A Study of the Third Pafi Beneficiary Rule," 98Harvord Law Review 11O9, I I68 (1985).

c MocPherson v. Buick Motor Co.,217 N.Y. 382, I I I N.E. 1050 ('|9'16).

d. Seover v. Ronsom, 224 N.y.233, 12O N.E. 639 (1918).

.

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5e4 MIIUETCONTRACTS

INCIDENTAT BENEFICIARYA third party who incidentallybenefits from a contract but whosebenefit was not the reason thecontract was formed. An incidentalbeneficiary has no rights in a contractand cannot sue to have the contractenforced.

between intended beneficiaries (who can sue to enforce conhacts made for their benefit)and incidental beneficiaries (who cannot sue, as wil l be discussed shortly).

When the Rights of an Intended Benef ic iary VestAn intended third party beneficiary cannot enforce a contract against the original partiesuntil the rights of the third party l-rave vested, meaning that the rights have taken effectand cannot be taken away. Until these rights have vested, the original parties to the con-tract-the promisor and the promisee-can modify or rescind the contract without theconsent of the third party. When do the rights of third parties vest? Generally, the rightsvest when one of the following occurs:

I When the third party demonstrates manifest assent to the contract, such as sending ale tter or note acknowledging awareness of and consent to a contract formed for her orl-ris benefit.

2 When the third party materially changes his or her position in detrimer-rtai reliance onthe contract, such as when a donee beneficiary contracts to have a home builtin reliance on the receipt of funds promised to him or her in a donee beneficiarycontract.

5 When the conditions for vesting are satisfied. For example, the rights of a beneficiaryunder a l ife insurance policy vest when the insured person dies.

If the contract erpressiy reserves to the contracting parties the rigl-it to cancel, rescind,or modif, the contract, the rights of the third party beneficiary are subject to any changesthat result. In such a situation, the vesting of the third party's rights does not terminate thepower of the original contractir-rg parties to alter their legal relationships.d For example, inmost life insurance contracts, the policyholder reserves the right to change the designatedbeneficiary.

Intended versus lncidental Benef ic iar iesThe benefit that an incidental beneficiary receives from a contract between two partiesis ur-iintentior-ial. Because the benefit is unintentiona/, an incidental beneficiary cannotsue to enforce the contract.

Determining Whether a Third Party Is an Intended or an Incidental Beneficiary Indetermining whether a third party beneficiary is ar-i intended or an incidental beneficiary,the courts focus on the intent, as expressed in the contract language and impiied by thesurrounding circumstances. Although no single test can embrace all possible situations,one factor that courts consider is whether a reasonable person in the position of the ben-eficiary wouid believe that the pronisee intended to confer on the beneficiary the rightto enforce the contract. In addition, the presence of one or more of the following factorsstrongly indicates that the third party is an intended beneficiary.

I Performance is rendered directly to tl-re third party.

2 The third party has the right to control the details of performance.

5 The third party is expressly designated as a beneficiary in the contract.

Exhibit 16-3 graphically illustrates the distinction between intended beneficiaries andincidental beneficiaries

8. De{enses raised against third party beneficiaries are given tn the Restaternent (Second) of Contracts, Section 309

t95 nmn?mTHIRD PARTY RICHTS

In the following case, a sr,rbcontractor claimedgeneral contractor's contractual promise to obtarntion of an addition to a building was cornpleted.

to be an intended beneficiary of theproperty insurance after the construc-

contract with Systems Builders, Inc., a general contractor, toconstruct an addition to a commercial building inIndianapolis, lndiana. The contract provided that after theaddition's completion, Action Steel would obtain insurance,which "shall include the interest of . . . subcontractors." Theparties would then "waive all r ights against . . . any of theirsubcontractors." Varco-Pruden Building, a subcontractor,designed the addition and supplied the premade buildingsystem for it. The addition was completed in the summer of1995. Action Steel obtained an insurance policy fromMidwestern lndemnity Company. In January 1996, a heavy

lN THE W0RDS 0F THE COURT . . . SHARPNAC( Judge.

]_- - 1Here, the construction contract includes language ir-rdicating that if Action Steel

obtained property insurance after project completion it would waive its rights against con-tractors and subcontractors.

Court of Appeals of Indiana, 801 N.E.2d 661 (2004).t :

snowstorm caused the new addition to collapse. Midwesternpaid more than gl.3 mill ion to Action Steel for the loss.Because Midwestern paid for the loss, it stood in ActionSteel's place in a suit f i led in an Indiana state court againstVarco-Pruden and others to recover this amount. Varco-Pruden fi led a motion for summary judgment, arguing, amongother things, that it was a third party beneficiary of the waiverclause in the contract between Action Steel and SystemsBuilders. The court issued a summary judgment in {avor ofVarco-Pruden on this point. Midwestern appealed to a stateintermediate appellate court, arguing that Varco-Pruden wasnot a third party beneficiary of the contract.

' l+_Eij BAcKcRoUND AND FAcTs: H*{ : Action Steel, Inc., entered into a

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5e6 l!fiiffiilCONTRACTS

CASE 16.2-Cont inued

DECI$l0N AND RTMEDY rrre state intermediateappellate court affirmed the lower court's judgment that thesubcontractor, Varco-Pruden, was a third party beneficiary ofthe contract clause between Action Steel and SystemsBuilders.

WHY I5 THlS CASE IMP0RTANT? rhiscoseillustrotes how resolving the issue of whether o

beneficiary is intended or incidental con hove serious

* * * A person or entity who is not d pdrty to a contract may directly enforce that con-tract as a third par\t beneficiary if: (1) the parties intend to benefit a third par\; (2) thecontract imposes a du\, ot't one of the parties infator of the third pafty; and (3) the perfor-lnonce of the terms of the contract renders a direct benefit to the third parf. fEmpl-rasisadded. l

Varco-Prr-rden argues that it has satisfied the first element, which requires that the par-ties intended to benefit a third party. The plain reading of the construction contract indi-cates that Action Steel iirtended to benefit Varco-Pruden. * * * Accorclingly, the firstelement is satisfied because when Action Steel purchased property insurance after tl-reproject was completed, it ir-rtended that subcontractors, such as Varco-Pruden, would ben-efit from the waiver * * * clause.

Varco-Prr-rden also argues that it has satisfied the second element, whicir requires tirattl-re contract impose a duty r-rpon one of the parties in favor of the third party. Here, * * *

Section 11.3.5 of the construction contract provides tl-rat if Action Steel purchasedproperty insurance after project completion, it agreed to waive its right x * * with respectto subcontractors such as Varco-Pruden. Accordingly, the second element is satisfiedbecause the cor-rstruction contract imposed a duty upoir Action Steel ir-r favor of Varco-Pruden.

Finally, Varco-Prr-rden argues that it has satisfied the final elen'rent, which requires thatthe performance of the terms of the contract render a direct benefit to a third party. Again,the construction contract provides that if Action Steel purchased property insurance afterproject completion it would waive its right * * * with regard to subcontractors, therebyrequiring that it render a direct benefit to those subcontractors, namely Varco-Pruden.Varco-Pruden has satisfied all three elernents of the third party beneficiary test. Thus,Varco-Pruden is a third party beneficiary and can enforce the waiver * x x clause con-tainecl within the construction contract.

consequences for the beneficiory's liability. ln this situotion,Varco-Pruden designed and supplied the building system forthe oddition, which collopsed during a mojor snowstormresulting in millions of dollors in damoges. Nevertheless,because Vorco-Pruden wos the intended beneficiory of acontract clouse waiving liability, Vorco-Pruden could not beheld liable for even one cent of the damoqes.

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Examples of Incidental Third Party Beneficiaries The benefit tl'rat an incidentalbeneficiary receives frorn a contract between hvo parties is unintentional, which is why heor she cannot enforce a contract. Any beneficiary who is not deemed an intended bene-ficiary is considered incidental.

EExAMpLE t6iil Spectators at a Mike Tyson boxing rnatch in whicl'r Tyson was dis-qualified for biting his opponent's ear sued Tyson and the fight's promoters for a refundon the basis of breach of contract. The spectators clain-red that they had standing to suethe defendants as third party beneficiaries of the contract between Tyson and the fight'sprornoters. The court, however, held that the spectators dicl not have star-rding to suebecause they were not in contractual privity with any of the defendants. Furtl-rermore,

an\.benefits they rs6eit.6 from the contract were incidental to the contract. The court

noted that the spectators got what they paid for: "the right to vierv whatever event

transpired."9 EIn the following case, a national beauty pageant organization and one of its state affil-

iates agreed tl-rat the national organization would accept the rvinner of the state contest as

a competitor in the national pageant. When the state winner was asked to resign her title,

,he fill<i a suit to enforce the agreement to have herself declared a contestant in the

national pageant. The national organization argued that she was an incidentai, not an

intended, beneficiary of the agreement.

9. Castillo t,. Tyson,268 A.D.Zd 316, 701 N.YS.Zd 423 (Sup.Ct.App.Div. 2000). See also Bouers v. Federation

,-:ternationale de I'Automobile,489 F.ld 316 (7th Cir. 2007)

[r*l+++r+iilriiCourt of Appeals of North Carolina, 182 N.C.APP. 334, 641 S'E.2d 721 (2007)-

. , , - . . ._a

C0MPANY PR0FILI tn1921, businesses in Atlantic City,

New Jersey, sponsored a "Miss America" contest as a publicity

stunt to extend the summer tourist season. The stunt soon

evolved into an event with contestants from each state vying

every September for the title of Miss America' More than

12,000 women participate each year in the local and state

events that culminate in the selection of the fifty-two national

finalists. To succeed requires commitment, hard work, and

talent. In 1945, the nonprofit Miss America Organization (MAO)

offered its first scholarship. Today, MAO is the largest provider

of scholarships to young women in the world, awarding more

than $45 mill ion in cash and tuit ion assistance annually.

BACKGR0UND AND FACTS Miss North carol inaPageant Organization, Inc. (MNCPO), is a franchisee of

Miss America Organization (MAO). Under the "Miss America

Organization Official Franchise Agreement," MNCPO conducts

a. ln the "Court of Appeals Opinions" section, click on "2007." In the result,

scroll to the "20 March 2007" section and click on the name of the case to

access the ooinion. The North Carolina Administrative Office of the Courts

maintains this Web site.

lN THE W0RDS 0F THE C0URT . . . McctrLLouGH,)udge'

*x<**

Plaintiff contends on appeal that there rvas sufficient evidence that she is a third-party

beneficiary under the franchise agreement between MAO and MNCPO to establish that

there is a genuine issue of material fact land thus for her clain'r to proceed to trial].

In orclei to assert rights as a third-party beneficiary under the franchise agreerrent, plain-

tiff must show she was an intended beneficiary of the contract. This Court has held that lrz

order to establish a claim as a third-party beneficiary, plaintiff must show: (1) that a contract

exists hetweerL two persons or entities; (2'1 that the contract is wlid and enforceable; and (3) that

5978mTHIRD PARTY RIGHTS

a public contest (the State Finals) to select Miss North Carolina

and to prepare her for participation in the Miss America

pageant (the National Finals).b In return, MAO "accept[s] the

winner of the State Finals . . as a contestant in the

Nat ional Finals." On June22,2002, MNCPO designated

Rebekah Revels "Miss North Carolin a 2oO2:' On July 19, MAO

received an anonymous e-mail (which was later determined to

have been sent by Revels's ex-boyfriend), implying that she

had formerly cohabited with a "male non-relative" and that

nude photos of her existed. Revels confirmed the existence of

the photos. on July 22, MAo and MNCPo asked Revels to

resign as Miss North Carolina and told her that if she refused,

she would be excluded from competing in the National Finals.

On July 23, she resigned. She then fi led a suit in a North

Carolina state court against MAO, MNCPO, and others,

asserting, among other things, breach of contract. The court

issued a summary judgment in MAO's favor. Revels appealed

this judgment to a state intermediate appellate court.

b. A fronchise is an anangement by which the owner of a trademarl! or

other intellectual ProPerty, licenses the use of the mark to another Partyunder specific conditions.

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598 tlNlruuCONTRACTS

CASE 15.5-€ont inued

DEe lSl0H AND nEnnEDY rtre court affirmed the lowercourt's judgment in favor of MAO. Revels was an incidental

beneficiary of the agreement between MAo and MNCPo. That

the agreement provided that MAO would accept the winner of

the State Finals as a contestant in the National Finals did not

establish that the two organizations intended to make the

winner a direct beneficiary of the agreement. Revels was thus

an incidental beneficiary and could not maintain an action

against MAO based on the agreement.

the contract was executed for the direct, and not incidental, benefit of the third party. A person

is a direct beneficiary of the contract if the conhacting parties intended to confer a legally

enforceable benefit on that person. It is not enough that the conhact, in fact, benefits the third

party, if, when the conhact was made, the conhacting parties did not intend it to benefit the

ihird party directly. In determining the intent of the contracting parties, the court should con-

sider ihe circumstances surrounding the transaction as well as the achral language of the con-

hact. When a third person seeks enforcement of a contract made between other parties, the

contract must be construed stnctly against the parTy seeking enforcement. fEmphasis added']

There was insufficient evidence before the trial court to support a conclusion that

plaintiffwas an intended beneficiary under the franchise agreement. Plaintiff was not des-

ignated as a beneficiary under the franchise agreement and there is absolutely no _evi-dence that the franchise agreement was executed for her direct benefit. The franchise

agreement does provide that MAO will accept the winner of the North Carolina pageant

as a contestant in the national finals. However, this evidence is insufficient to establish a

showing of intent on the parties to make plaintiff an intended beneficiary. Further, the

evidence addr-rced tended to show that the primary intent of the franchise agreement was

to ensure uniformity among all franchisees and it provided the incidental benefit of allow-

ing the winner of MNCPO's contest to compete in the national finals.

F0R CRITICAL A! ' lAl .YSIS- LegaIConsideration ff tne agreement between MAo

ond MNCPO hod involved o third porty-on internqtionalpogeont orgonizotion-would this hove been o bosis for

concluding thot Revels wos o third party intended beneficiory?

Why or why not?

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Myrtle Jackson ownsseveral commercialbuildings that sheleases to businesses,one of which is a

restaurant. The lease states that tenants are responsible for

securing all necessary insurance policies but the landlord is

obligated to keep the buildings in good repair. The owner of

the restauranL Joe McCall, tells his restaurant manager to

purchase insurance, but the manager never does so. Jackson

tells her son-in-lary Rob Dunn, to perform any necessarymaintenance for the buildings. Dunn knows that the ceil ing in

the restaurant needs repair but fails to do anything about it.

One day a customer, lan Faught, is dining in the restaurant

when a chunk of the ceil ing falls on his head and fractures his

skull. Faught files suit against the restaurant and discovers that

there is no insurance policy in effect. Faught then files a suit

against Jackson, arguing that he is an intended third party

beneficiary of the lease provision requiring insurance and thus

can sue Jackson for failing to enforce the lease (which requires

the restaurant to carry insurance). Using the informationpresented in the chapter, answer the following questions.

I Can Jackson delegate her duty to maintain the buildings to

Dunn? Why or why not?

2 Who can be held liable for Dunn's failure to fix the ceiling,

Jackson or Dunn?

5 Was Faught an intended third party beneficiary of the lease

between Jackson and McCall? Why or why not?

4 Suppose that Jackson tells Dan Stryker, a local builder to

whom she owes $50,000, that he can collect the rents from

the buildings'tenants until the debt is satisfied. ls this a

valid assignment? Why or why not?

iJl ssigrments of conlrac-I n l t , ta l r ights and delega-tions of duties are commolin the busir-iess world. Asvou discovered in this chap-ter, third party rights andduties stem from the law orrassignments, delegations, and third party beneficiaries. A thirdparty may even be unaware that he or she has rights in a con-hact, as can happen when a person is the beneficiary ofa lifeinsurance policy. h-r certain situations, businesses n-ray wish toatten-rpt to proliibit a third party from acquiring such rigl-rts.

Tl-re general rule, though, is that any contractual rigl-rt orduty can be assigned or delegated unless the assignment ordelegation is prohibited by (1) the contract, (2) a statute,or (3) other l imitations.

!-or exarnple, a tenant under a long-term lease contractmay assign the lease to another party. To avoid such assign-nents, property owners ofter-r prohibit the assignment of thebalance of a lease term without the property owner's consent.

399@EtrTHIRD PARTY RIGHTS

Generally, manufacturers can assign or delegate the pro-duction of goods to a third party unless prohibited by cor-r-tract. Consequently, most purchase orders (contracts) have aclause that prohibits such assignments or delegations withoutthe buyer's consent.

CHECI(I I$T FOR THE BUSIFIE$SPERSONI Determine whether you can assign or delegate your

rights or duties under a contract to a third party.2 lf you can assign or delegate your contract rights or

performance, attempt to determine your benefits andobligations, such as notice to customers, if you domake the assignment or delegation.

3 lf you do not want your contract rights or duties tobe assigned or delegated, insert a contract clausethat prohibits assignment or delegation without yourconsent.

4 Whenever you might be a third party beneficiary to acontract, such as a creditor beneficiary take steps todetermine your rights.

a This Applicotion is not meant to substitute for the services of an attorney who is licensed to practice law in your state.

alienation 588assignee 585assignment 584assignor 585delegatee 590

delegation of duties 589delegator lasincidental beneficiary ls+intended beneficiary lszobligee 385

obl igor 585privity of contract 584third party beneficiary 592

l. An assignment is the transfer of rights under a contract to a third party. The person assigningthe rights is the ossignor, and the party to whom the rights are assigned is the assrgnee. Theassignee has a right to demand pedormance from the other original party to the contract.

2. Generally, all rights can be assigned, except in the following circumstances:a. When assignment is expressly prohibited by statute (for example, workers'compensation

benefits).

b. When a contract calls for the performance of personal seruices.c. When the assignment will materially increase or alter the risk or duties of the obligor (the

pafi that is obligated to perform).

(Continued)

400 llEiluuCONTRACTS

Delegations(See pages 389-392.)

Third PartvBeneficiaries(See pages 392-3e8.)

Answers for the even-numbered questions in this Fat Review section con be lound on this text's occomponying Web site ot

www-Cengage-qomlblayltlblt. Select "Chopter 16" and click on "For Review."

I What is the difference between an assignment and a delegation?

2 If a cor-rtract requires a party to perform personal services, can the right to receive those services be assigned?

5 What rights can be assigned despite a contract clause expressly prohibiting assignment?

4 What factors indicate that a third party beneficiary is an intended beneficiary?

5 How do a third party beneficiary's rights become vested so that this party can sue to enforce the contract?

d. When the contract itself stipulates that the rights cannot be assigned (with someexceptions).

3. The assignee should notify the obligor of the assignment. Although not legally required,

notification avoids two potential problems:

a. lf the assignor assigns the same right to two different persons, generally the first assignment

in time isihe first in right, but in some states the first assignee to give notice takes priority.

b. Untit the obligor is notified of the assignment, the obligor can tender performance to the

assignor. lf the assignor accepts the performance, the obligor's duties under the contract are

discharged without benefit to the assignee.

L A defegation is the transfer of duties under a contract to a third party (the delegotee),,who

then aisumes the obligation of performing the contractual duties previously held by the one

making the delegation (the delegator).

2. As a general rule, any duty can be delegated, except in the following circumstances:

a. When performance depends on the personal skill or talents of the obligor.

b. When special trust has been placed in the obligor'

c. When performance by a third party will vary materially from that expected by the obligee(the one to whom the duty is owed) under the contract'

d. When the contract expressly prohibits delegation.

3. A valid delegation of duties does not relieve the delegator of obligations under the contract' lf

the delegatee fails to perform, the delegator is still liable to the obligee'

4. An "assignment of all rights" or an "assignment of the contract" is often construed to mean

that botf the rights and the duties arising under the contract are transferred to a third party'

A third pafi beneficiary contract is one made for the purpose of benefiting a third partry.

1. Intended beneficiary-One for whose benefit a contract is created. When the promisor (the one

making the contraciual promise that benefits a third party) fails to perform as promised, the .third party can sue the promisor directly. Examples of third party beneficiaries are creditor and

donee beneficiaries.

2. tncidentol beneficiory-Athird pafi who indirectly (incidentally) benefits from a contract but

for whose benefit the contract was not specifically intended. Incidental beneficiaries have no

rights to the benefits received and cannot sue to have the contract enforced.

E