Once it has been determined

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1 Once it has been determined that a valid and legally enforceable contract exists, attention can turn to the rights and duties of the parties to the contract. A contract is a private agreement between the parties who have entered into it, and traditionally these parties alone have rights and liabilities under the contract. This principle is referred to as privity of contract. A third party one who is not a direct party to a particular contract normally does not have rights under that contract. There are exceptions to the rule of privity of contract. For example, privity of contract between a seller and a buyer is no longer a requirement to recover damages under product liability laws (see Chapter 22). In this chapter, we look at two other exceptions. One exception allows a party to a contract to transfer the rights or duties arising from the contract to another person through an assignment (of rights) or a delegation (of duties). The other exception involves a third party beneficiary contract a contract in which the parties to the contract intend that the contract benefit a third party. SECTION 1 ASSIGNMENTS AND DELEGATIONS In a bilateral contract, the two parties have corresponding rights and duties. One party has a right to require the other to perform some task, and the other has a duty to perform it. The transfer of contractual rights to a third party is known as an assignment. The transfer of contractual duties to a third party is known as a delegation. An assignment or a delegation occurs after the original contract was made. Assignments Assignments are important because they are involved in many types of business financing. Banks, for example, frequently assign their rights to receive payments under their loan contracts to other firms, which pay for those rights. If Tia obtains a loan from a bank to purchase a car, she may later receive a notice from the bank stating that it has transferred (assigned) its rights to receive payments on the loan to another firm. When it is time to repay the loan, Tia must make the payments to that other firm. Financial institutions that make mortgage loans (loans to enable prospective home buyers to purchase land or a home) often assign their rights to collect the mortgage payments to a third party, such as GMAC Mortgage. Following the assignment, the home buyers are notified that they must make future payments not to the bank that loaned them the funds but to the third party. Millions of dollars change hands daily in the business world in the form of assignments of rights in contracts. If it were not possible to transfer contractual rights, many businesses could not continue to operate. TERMINOLOGY In an assignment, the party assigning the rights to a third party is known as the assignor, 1 and the party receiving the rights is the assignee. 2 Other traditional terms used to describe the parties in assignment relationships are obligee (the person to whom a duty, or obligation, is owed) and obligor (the person who is obligated to perform the duty). 1. Pronounced uh-sye-nore. 2. Pronounced uh-sye-nee. 304 Clarkson 12e Ch16_ indd 304 8/27/10 9:22:01 AM

2 CHAPTER 16 Third Party Rights 305 THE EFFECT OF AN ASSIGNMENT When rights under a contract are assigned unconditionally, the rights of the assignor are extinguished. 3 The third party (the assignee) has a right to demand performance from the other original party to the contract. The assignee takes only those rights that the assignor originally had, however. Suppose that Brower is obligated by contract to pay Horton $1,000. In this situation, Brower is the obligor because she owes an obligation, or duty, to Horton. Horton is the obligee, the one to whom the obligation, or duty, is owed. Now suppose that Horton assigns his right to receive the $1,000 to Kuhn. Horton is the assignor, and Kuhn is the assignee. Kuhn now becomes the obligee because Brower owes Kuhn the $1,000. Here, a valid assignment of a debt exists. Kuhn (the assignee-obligee) is entitled to enforce payment in court if Brower (the obligor) does not pay him the $1,000. These concepts are illustrated in Exhibit RIGHTS ASSIGNED ARE SUBJECT TO THE SAME DEFENSES The assignee s rights are subject to the defenses that the obligor has against the assignor. Assume that in the preceding scenario, Brower owes Horton the $1,000 under a contract in which Brower agreed to buy Horton s MacBook Pro laptop. When Brower decided to purchase the laptop, she relied on Horton s fraudulent misrepresentation that the 3. Restatement (Second) of Contracts, Section 317. computer had eight megabytes of memory. When Brower discovers that the computer has only four megabytes of memory, she tells Horton that she is going to return the laptop to him and cancel the contract. Even though Horton has assigned his right to receive the $1,000 to Kuhn, Brower need not pay Kuhn the $1,000 Brower can raise the defense of Horton s fraudulent misrepresentation to avoid payment. FORM OF THE ASSIGNMENT In general, an assignment can take any form, oral or written. Naturally, it is more difficult to prove that an oral assignment occurred, so it is practical to put all assignments in writing. Of course, assignments covered by the Statute of Frauds must be in writing to be enforceable. For example, an assignment of an interest in land must be in writing to be enforceable. In addition, most states require contracts for the assignment of wages to be in writing. 4 The circumstances in the following case illustrate some of the problems that can arise with oral assignments. The case also stands for the principle that an assignment, like any contract, must have consideration in this case, a dance center s assumption of a choreographer s legal and financial duties associated with her choreography. 4. See, for example, California Labor Code Section 300. There are other assignments that must be in writing as well. EXHIBIT 16 1 Assignment Relationships In the assignment relationship illustrated here, Horton assigns his rights under a contract that he made with Brower to a third party, Kuhn. Horton thus becomes the assignor and Kuhn the assignee of the contractual rights. Brower, the obligor, now owes performance to Kuhn instead of Horton. Horton s original contract rights are extinguished after assignment. Horton (obligeeassignor) STEP 1: Original Contract Formed STEP 2: Horton Assigns Rights under Contract to Kuhn Duties Owed after Assignment Brower (obligor) Kuhn (assignee) Clarkson 12e Ch16_ indd 305 8/27/10 9:22:02 AM

3 306 UNIT THREE CONTRACTS AND E-CONTRACTS United States Court of Appeals, Second Circuit, 380 F.3d 624 (2004). BACKGROUND AND FACTS Martha Graham s career as a dancer, dance instructor, and choreographer began in the fi rst third of the twentieth century. In the 1920s, she started a dance company and a dance school and choreographed works on commission. In the 1940s, she funded the Martha Graham Center of Contemporary Dance, Inc. (the Center). She sold her school to the Martha Graham School of Contemporary Dance, Inc. (the School), in By 1980, the Center encompassed the School. In 1989, two years before her death, Graham executed a will in which she gave Ronald Protas, the Center s general director, any rights or interests in dance works, musical scores [and] scenery sets. After her death, Protas asserted ownership of all of Graham s dances and related property. In 1999, the Center s board removed Protas and, due to fi nancial problems, suspended operations. Meanwhile, Protas founded the Martha Graham School and Dance Foundation, Inc., and began licensing Graham s dances. When the School reopened in 2001, Protas and his foundation fi led a suit in a federal district court against the Center and others to enjoin their use of, among other things, seventy of the dances. The Center responded, in part, that Graham had assigned the dances to it. The court ruled that twenty-one of the dances had been assigned to the Center. The plaintiffs appealed to the U.S. Court of Appeals for the Second Circuit. IN THE LANGUAGE OF THE COURT Jon O. NEWMAN, Circuit Judge. The Appellants contend that the District Court erred in finding that Graham assigned to the Center 21 dances, * * * which were created before 1956, unpublished at the time of assignment, and not commissioned. We disagree. Although there is no document memorializing Graham s assignment of copyright in her pre-1956 dances to the Center, the District Court was entitled to find that Graham assigned to the Center, orally or in writing, her copyrights in her noncommissioned pre-1956 dances that were not published at the time she assigned them. The District Court relied on several items of evidence to reach its conclusion. For example, Jeannette Roosevelt, former President of the Center s board of directors, testified that Graham had given the dances to the Center prior to 1965 or 1966, when she joined the board. There was additional evidence that the Center acted as the owner of the dances by entering into contracts with third parties, and that Graham was aware of this and did not object. Other evidence showed that the Center received royalties for the dances and treated them as its assets. However, the only evidence that Graham had assigned the entire group of her pre-1956 dances (noncommissioned and unpublished) to the Center are two letters from Lee Leatherman, the Center s Executive Administrator at that time, written in 1968 and These letters indicated that [r]ecently Miss Graham assigned performing rights to all of her works to the Martha Graham Center of Contemporary Dance, Inc., and that Martha has assigned all rights to all of her works to the Martha Graham Center, Inc. The Appellants contend that these letters are hearsay a and were impermissibly considered These two letters, both in existence 20 years or more at the time they were offered as evidence, were authenticated * * *. There was no reason to suspect their authenticity. Moreover, Linda Hodes, a witness with relevant knowledge, testified that the letters were what they purported to be. The letters were therefore exceptions to the hearsay rule [under which the letters would otherwise be inadmissible]. The District Court did not err in admitting and relying on these letters. [Emphasis added.] Under New York law, an assignment * * * may be made without writing or delivery of any written statement of the claim assigned, * * * provided only that the assignment is founded on a. Hearsay is testimony given in court about a statement made by someone else, as was discussed in Chapter 3. Clarkson 12e Ch16_ indd 306 8/27/10 9:22:02 AM

4 CHAPTER 16 Third Party Rights 307 CASE 16.1 CONTINUED a valid consideration between the parties. The District Court was entitled to find 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 associated with her choreography; assigning to the Center the copyrights in her dances gave her what she wished freedom from the responsibilities of copyright registration and renewal, licensing, collection of royalties, and archival tasks. [Emphasis added.] The District Court was entitled to find that Graham assigned her pre-1956 dances * * * to the Center sometime between 1957 and the mid-1960s. DECISION AND REMEDY The U.S. Court of Appeals for the Second Circuit affi rmed the lower court s judgment on this issue, commend[ing] the District Court for its careful rulings on the many issues in this complicated case. The appellate court held that Graham had received consideration for her assignment of certain dances and that, although the assignment had been oral, it had been reliably proved by written testimony. WHAT IF THE FACTS WERE DIFFERENT? Suppose that Graham had not benefi ted from the Center s assumption of the duties associated with her choreography. Would the alleged assignment have been valid? Why or why not? THE E-COMMERCE DIMENSION If Graham s dances had existed as part of a database available only over the Internet, would the principles applied in this case, and the way in which they were applied, have been different? Why or why not? RIGHTS THAT CANNOT BE ASSIGNED As a general rule, all rights can be assigned. Exceptions are made, however, under certain circumstances. Some of these exceptions are described next. When a Statute Prohibits Assignment. When a statute expressly prohibits assignment of a particular right, that right cannot be assigned. Suppose that Quincy is an employee of Specialty Computer, Inc. Specialty Computer is an employer under workers compensation statutes in this state, and thus Quincy is a covered employee. Quincy is injured on the job and begins to collect monthly workers compensation checks (see Chapter 34 for a discussion of workers compensation laws). In need of a loan, Quincy borrows from Draper, assigning to Draper all of her future workers compensation benefits. A state statute prohibits the assignment of future workers compensation benefits, and thus such rights cannot be assigned. When a Contract Is Personal in Nature. If a contract is for personal services, the rights under the contract normally cannot be assigned unless all that remains is a monetary payment. 5 For example, Brower signs a contract to be a tutor for Horton s children. Horton then attempts to assign to Kuhn his right to Brower s services. Kuhn cannot enforce 5. Restatement (Second) of Contracts, Sections 317 and 318. the contract against Brower. Kuhn s children may be more difficult to tutor than Horton s; thus, if Horton could assign his rights to Brower s services to Kuhn, it would change the nature of Brower s obligation. Because personal services are unique to the person rendering them, rights to receive personal services are likewise unique and cannot be assigned. Note that when legal actions involve personal rights, they are considered personal in nature and cannot be assigned. For instance, personal-injury tort claims generally are nonassignable as a matter of public policy. If Elizabeth is injured by Randy s defamation, she cannot assign her right to sue Randy for damages to someone else. CASE IN POINT Accrued Financial Services, Inc. (AFS), conducts audits on behalf of tenants in commercial buildings to determine if the landlords have overcharged the tenants. As part of AFS s standard contract, the tenants assign their rights to file lawsuits against the landlord to AFS. AFS performed an audit for tenants of Prime Retail, Inc., and subsequently brought a lawsuit against Prime Retail. The court, however, held that it was against public policy to allow tenants to assign their right to file legal claims against their landlord to AFS. Therefore, the purported assignment was illegal, and the contract was unenforceable Accrued Financial Services, Inc. v. Prime Retail, Inc., 298 F.3d 291 (4th Cir. 2002). Clarkson 12e Ch16_ indd 307 8/27/10 9:22:03 AM

5 308 UNIT THREE CONTRACTS AND E-CONTRACTS When an Assignment Will Significantly Change the Risk or Duties of the Obligor. A right cannot be assigned if the assignment will significantly increase or alter the risks to or the duties of the obligor (the party owing performance under the contract). 7 For example, Horton has a hotel, and to insure it, he takes out a policy with Southeast Insurance. The policy insures against fire, theft, floods, and vandalism. Horton attempts to assign the insurance policy to Kuhn, who also owns a hotel. The assignment is ineffective because it substantially alters Southeast Insurance s duty of performance. An insurance company evaluates the particular risk of a certain party and tailors its policy to fit that risk. If the policy is assigned to a third party, the insurance risk is materially altered because the insurance company may have no information on the third party. Therefore, the assignment will not operate to give Kuhn any rights against Southeast Insurance. When the Contract Prohibits Assignment. When a contract specifically stipulates that a right cannot be assigned, then ordinarily it cannot be assigned. Whether an antiassignment clause is effective depends, in part, on how it is phrased. A contract that states that any assignment is void effectively prohibits any assignment. Note that restraints on the power to assign operate only against the parties themselves. They do not prohibit an assignment by operation of law, such as an assignment pursuant to bankruptcy or death. The general rule that a contract can prohibit assignment has several exceptions. 1. A contract cannot prevent an assignment of the right to receive funds. This exception exists to encourage the free flow of funds and credit in modern business settings. 2. The assignment of rights in real estate often cannot be prohibited because such a prohibition is contrary to public policy in most states. Prohibitions of this kind are called restraints against alienation (transfer of land ownership). 3. The assignment of negotiable instruments (see Chapter 24) cannot be prohibited. 4. In a contract for the sale of goods, the right to receive damages for breach of contract or payment of an account owed may be assigned even though the sales contract prohibits such an assignment Section 2 210(2) of the Uniform Commercial Code (UCC). 8. UCC 2 210(2). NOTICE OF ASSIGNMENT Once a valid assignment of rights has been made, the assignee (the third party to whom the rights have been assigned) should notify the obligor (the one owing performance) of the assignment. For instance, in the previously discussed example, when Horton assigns to Kuhn his right to receive the $1,000 from Brower, Kuhn should notify Brower, the obligor, of the assignment. Giving notice is not legally necessary to establish the validity of the assignment: an assignment is effective immediately, whether or not notice is given. Two major problems arise, however, when notice of the assignment is not given to the obligor. 1. If the assignor assigns the same right to two different persons, the question arises as to which one has priority that is, which one has the right to the performance by the obligor. Although the rule most often observed in the United States is that the first assignment in time is the first in right, some states follow the English rule, which basically gives priority to the first assignee who gives notice. 2. Until the obligor has notice of an assignment, the obligor can discharge his or her obligation by performance to the assignor (the obligee), and performance by the obligor to the assignor (obligee) constitutes a discharge to the assignee. Once the obligor receives proper notice, however, only performance to the assignee can discharge the obligor s obligations. In the Horton-Brower- Kuhn example, assume that Brower, the obligor, is not notified of Horton s assignment of his rights to Kuhn. Brower subsequently pays Horton the $1,000. Although the assignment was valid, Brower s payment to Horton discharges the debt. Kuhn s failure to give notice to Brower of the assignment has caused Kuhn to lose the right to collect the cash from Brower. If, however, Kuhn had given Brower notice of the assignment, Brower s payment to Horton would not have discharged the debt, and Kuhn would have had a legal right to require payment from Brower. Delegations Just as a party can transfer rights through an assignment, a party can also transfer duties. Duties are not assigned, however; they are delegated. Normally, a delegation of duties does not relieve the party making the delegation (the delegator) of the obligation to perform in the event that the party to whom the duty has been delegated (the delegatee) fails to perform. No special form is required to create a valid delegation Clarkson 12e Ch16_ indd 308 8/27/10 9:22:03 AM

6 CHAPTER 16 Third Party Rights 309 of duties. As long as the delegator expresses an intention to make the delegation, it is effective; the delegator need not even use the word delegate. Exhibit 16 2 illustrates delegation relationships. DUTIES THAT CANNOT BE DELEGATED As a general rule, any duty can be delegated. There are, however, some exceptions to this rule. Delegation is prohibited in the circumstances discussed next. When the Duties Are Personal in Nature. When special trust has been placed in the obligor or when performance depends on the personal skill or talents of the obligor, contractual duties cannot be delegated. For example, Horton, who is impressed with Brower s ability to perform veterinary surgery, contracts with Brower to have her perform surgery on Horton s prize-winning stallion in July. Brower later decides that she would rather spend the summer at the beach, so she delegates her duties under the contract to Kuhn, who is also a competent veterinary surgeon. The delegation is not effective without Horton s consent, no matter how competent Kuhn is, because the contract is for personal performance. In contrast, nonpersonal duties may be delegated. Assume that Brower contracts with Horton to pick up and deliver heavy construction machinery to Horton s property. Brower delegates this duty to Kuhn, who is in the business of delivering heavy machinery. This delegation is effective because the performance required is of a routine and nonpersonal nature. When Performance by a Third Party Will Vary Materially from That Expected by the Obligee. When performance by a third party will vary materially from that expected by the obligee under the contract, contractual duties cannot be delegated. Suppose that Alex Payton is a wealthy philanthropist who recently established a charitable foundation. Payton has known Brent Murdoch for twenty years and knows that Murdoch shares his beliefs on many humanitarian issues. He contracts with Murdoch to be in charge of allocating funds among various charitable causes. Six months later, Murdoch is experiencing health problems and delegates his duties to Drew Cole. Payton does not approve of Cole as a replacement. In this situation, Payton can claim the delegation was not effective because it materially altered his expectations under the contract. Payton had reasonable expectations about the types of charities to which Murdoch would give the foundation s funds, and the substitution of Cole s performance materially changed those expectations. When the Contract Prohibits Delegation. When the contract expressly prohibits delegation by including an antidelegation clause, the duties cannot EXHIBIT 16 2 Delegation Relationships In the delegation relationship illustrated here, Brower delegates her duties under a contract that she made with Horton to a third party, Kuhn. Brower thus becomes the delegator and Kuhn the delegatee of the contractual duties. Kuhn now owes performance of the contractual duties to Horton. Note that a delegation of duties normally does not relieve the delegator (Brower) of liability if the delegatee (Kuhn) fails to perform the contractual duties. STEP 1: Original Contract Formed Brower (obligor-delegator) Horton (obligee) Performance Owed after Delegation STEP 2: Brower Delegates Contract Duties to Kuhn Kuhn (delegatee) Clarkson 12e Ch16_ indd 309 8/27/10 9:22:03 AM

7 310 UNIT THREE CONTRACTS AND E-CONTRACTS be delegated. R.W. Stern Company contracts with Jan Pearson, a certified public accountant, to perform its annual audits for the next five years. If the contract prohibits delegation, then Pearson cannot delegate her duty to perform the audit to another accountant at the same firm. In some situations, however, when the duties are completely impersonal in nature, courts have held that the duties can be delegated notwithstanding an antidelegation clause. can also hold the delegatee liable if the delegatee made a promise of performance that will directly benefit the obligee. In this situation, there is an assumption of duty on the part of the delegatee, and breach of this duty makes the delegatee liable to the obligee. For example, if Kuhn (the delegatee) promises Brower (the delegator), in a contract, to pick up and deliver the construction equipment to Horton s property but fails to do so, Horton (the obligee) can sue Brower, Kuhn, or both. Although there are many exceptions, the general rule today is that the obligee can sue both the delegatee and the delegator. Concept Summary 16.1 outlines the basic principles of the laws governing assignments and delegations. EFFECT OF A DELEGATION If a delegation of duties is enforceable, the obligee must accept performance from the delegatee. Consider again the example in which Brower delegates to Kuhn the duty to pick up and deliver heavy construction machinery to Horton s property. In that situation, Horton (the Assignment of All Rights obligee) must accept performance from Kuhn (the delegatee) because the delegation was effective. When a contract provides for an assignment of The obligee can legally refuse performance from all rights, this wording may create both an assignment of rights and a delegation of duties. 9 Therefore, the delegatee only if the duty is one that cannot be delegated. when general words are used (for example, I assign As noted, a valid delegation of duties does not the contract or I assign all my rights under the relieve the delegator of obligations under the contract. Thus, in the above example, if Kuhn (the contract ), the contract normally is construed as delegatee) fails to perform, Brower (the delegator) is still liable to Horton (the obligee). The obligee 9. Restatement (Second) of Contracts, Section 328; UCC 2 210(3), (4). Which Rights Can Be Assigned, and Which Duties Can Be Delegated? What If the Contract Prohibits Assignment or Delegation? What Is the Effect on the Original Party s Rights? All rights can be assigned unless: 1. A statute expressly prohibits assignment. 2. The contract is for personal services. 3. The assignment will materially alter the obligor s risk or duties. 4. The contract prohibits assignment. No rights can be assigned except: 1. Rights to receive funds. 2. Ownership rights in real estate. 3. Rights to negotiable instruments. 4. Rights to damages for breach of a sales contract or payments under a sales contract. On a valid assignment, effective immediately, the original party (assignor) no longer has any rights under the contract. All duties can be delegated unless: 1. Performance depends on the obligor s personal skills or talents. 2. Special trust has been placed in the obligor. 3. Performance by a third party will materially vary from that expected by the obligee. 4. The contract prohibits delegation. No duties can be delegated. On a valid delegation, if the delegatee fails to perform, the original party (delegator) is liable to the obligee (who may also hold the delegatee liable). Clarkson 12e Ch16_ indd 310 8/27/10 9:22:03 AM

8 CHAPTER 16 Third Party Rights 311 implying both an assignment of the assignor s rights and a delegation of any duties of performance owed by the assignor under the contract being assigned. Thus, the assignor remains liable if the assignee fails to perform the contractual obligations. SECTION 2 THIRD PARTY BENEFICIARIES Another exception to the doctrine of privity of contract arises when the contract is intended to benefit a third party. When the original parties to the contract agree that the contract performance should be rendered to or directly benefit a third person, the third person becomes an intended third party beneficiary of the contract. As the intended beneficiary of the contract, the third party has legal rights and can sue the promisor directly for breach of the contract. Who, though, is the promisor? In a bilateral contract, both parties to the contract make promises that can be enforced, so the court has to determine which party made the promise that benefits the third party that person is the promisor. Allowing a third party to sue the promisor directly in effect circumvents the middle person (the promisee) and thus reduces the burden on the courts. Otherwise, the third party would sue the promisee, who would then sue the promisor. CASE IN POINT The classic case that gave third party beneficiaries the right to bring a suit directly against a promisor was decided in The case involved three parties Holly, Lawrence, and Fox. Holly had borrowed $300 from Lawrence. Shortly thereafter, Holly loaned $300 to Fox, who in return promised Holly that he would pay Holly s debt to Lawrence on the following day. When Lawrence failed to obtain the $300 from Fox, he sued Fox to recover the funds. The court had to decide whether Lawrence could sue Fox directly (rather than suing Holly). The court held that when a promise [is] made for the benefit of another, he for whose benefit it is made may bring an action for its breach. 10 Types of Intended Beneficiaries The law distinguishes between intended beneficiaries and incidental beneficiaries. Only intended beneficiaries acquire legal rights in a contract. CREDITOR BENEFICIARY One type of intended beneficiary is a creditor beneficiary. Like the plaintiff in the Case in Point just discussed, a creditor beneficiary benefits from a contract in which one party (the promisor) promises another party (the promisee) to pay a debt that the promisee owes to a third party (the creditor beneficiary). For example, Jay Carrera owns a business firm that is making monthly payments on equipment bought from Speedwell. Carerra sells the firm to Miller, who agrees in their contract to take over the payments to Speedwell for the equipment. Speedwell is a creditor beneficiary and can sue Miller directly to enforce the contract and obtain payment on the debt. In the following case, the court had to decide whether an aggrieved owner of a condominium unit was an intended third party beneficiary of another owner s contract with the condominium association. 10. Lawrence v. Fox, 20 N.Y. 268 (1859). Court of Appeals of Texas, Dallas, 307 S.W.3d 564 (2010). a IN THE LANGUAGE OF THE COURT Opinion by Justice SMITH. [Autumn] Allan and [Aslan] Koraev both owned units in the Boardwalk on the Parkway Condominiums. Allan s unit was directly beneath Koraev s.* * * Between March 2005 and July 2007, Allan s unit suffered eight incidents of water and sewage incursion as a result of plumbing problems and misuse of appliances in Koraev s unit. Allan sued Koraev [and Ekaterina Nersesova, who was the property manager for Koraev s unit] on a variety of causes of action, including * * * breach of contract. a. In the left-hand column, select Search Opinions. When that page opens, key in the title of this case and click on the Search box. From the search results, click on the file number that precedes the case title to access the opinion. The Fifth District Court of Appeals in Dallas, Texas, maintains this Web site. EXTENDED CASE CONTINUES Clarkson 12e Ch16_ indd 311 8/27/10 9:22:04 AM

9 312 UNIT THREE CONTRACTS AND E-CONTRACTS EXTENDED CASE 16.2 CONTINUED The jury found for Allan on her claims for breach of contract against Koraev * * *. Koraev moved for judgment notwithstanding the verdict, asserting Allan failed to prove as a matter of law the existence of a contract between her and Koraev. The trial court granted the motion[.] * * * Allan contends the trial court erred by rendering judgment notwithstanding the verdict on her breach of contract claim. Allan asserted that the [governing documents of the condominium] formed a contract between each unit owner and the Owners Association. [The governing documents] * * * required Koraev to comply with the terms of the governing documents, and the Bylaws and Rules and Regulations made Koraev liable for any damage he caused to another unit. * * * Because Allan was not in privity of contract with Koraev, she has standing to bring a breach of contract claim only if she demonstrated she was a third-party beneficiary. A third party, such as Allan, may sue to enforce a contract as a third-party beneficiary only if the contracting parties entered into the contract directly and primarily for the third party s benefit. * * * There are three types of thirdparty beneficiaries donee, creditor, and incidental. * * * A party is a creditor beneficiary if no intent to make a gift appears from the contract, but performance will satisfy an actual or asserted duty of the promisee to the beneficiary, such as an indebtedness, contractual obligation, or other legally enforceable commitment to the third party, and the promisee must intend that the beneficiary will have the right to enforce the contract. [Emphasis added.] * * * Paragraph 19 of the Declaration [one of the governing documents] stated, Each Owner shall comply strictly with the provisions of the [governing documents.] * * * Failure to comply with any of the same shall be grounds for an action to recover sums due, for damages or injunctive relief or both, and for reimbursement of all attorneys fees incurred in connection therewith, which action shall be maintainable by the Managing Agent or Board of Directors in the name of the Association, in behalf of the Owners or, in a proper case, by an aggrieved owner. [Emphasis added.] * * * Allan s testimony about the damages she suffered as a result of Koraev and his tenants breach of the governing documents established that she was an aggrieved owner. * * * Koraev s failure to perform the contract between himself and the Association was a breach of his duty not to cause damage to Allan s unit. As an intended creditor beneficiary, Allan had standing to bring suit against Koraev for his breach of the governing documents. We conclude the governing documents made Allan an intended creditor beneficiary of the contract between Koraev and the Association and granted her authority to bring suit for Koraev s breach of those documents. Accordingly, we conclude the trial court erred by granting Koraev s motion for judgment notwithstanding the verdict on Allan s claim for breach of contract. 1. Why did the court use the term creditor beneficiary to describe Allan? 2. Suppose that Allan had sued Koraev for negligence. Would she have been successful? Discuss your answer. DONEE BENEFICIARY Another type of intended beneficiary is a donee beneficiary. When a contract is made for the express purpose of giving a gift to a third party, the third party (the donee beneficiary) can sue the promisor directly to enforce the promise. 11 The most common donee beneficiary contract is a life insurance contract. Suppose that Akins (the promisee) pays premiums to Standard Life, a life insurance company, and Standard Life (the promisor) promises to pay a certain amount on Akins s death to anyone Akins designates as a beneficiary. 11. This principle was first enunciated in Seaver v. Ransom, 224 N.Y. 233, 120 N.E. 639 (1918). The designated beneficiary is a donee beneficiary under the life insurance policy and can enforce the promise made by the insurance company to pay her or him on Akins s death. Most third party beneficiaries do not fit neatly into either the creditor beneficiary or the donee beneficiary category. Thus, the modern view adopted by the Restatement (Second) of Contracts does not draw clear lines between the types of intended beneficiaries. Today, courts frequently distinguish only between intended beneficiaries (who can sue to enforce contracts made for their benefit) and incidental beneficiaries (who cannot sue, as will be discussed shortly). Clarkson 12e Ch16_ indd 312 8/27/10 9:22:04 AM

10 CHAPTER 16 Third Party Rights 313 When the Rights of an Intended Beneficiary Vest An intended third party beneficiary cannot enforce a contract against the original parties until the rights of the third party have vested, which means the rights have taken effect and cannot be taken away. Until these rights have vested, the original parties to the contract the promisor and the promisee can modify or rescind the contract without the consent of the third party. When do the rights of third parties vest? The majority of courts hold that the rights vest when any of the following occurs: 1. The third party materially changes his or her position in justifiable reliance on the promise. 2. The third party brings a lawsuit on the promise. 3. The third party demonstrates her or his consent to the promise at the request of the promisor or promisee. 12 If the contract expressly reserves to the contracting parties the right to cancel, rescind, or modify the contract, the rights of the third party beneficiary are subject to any changes that result. If the original contract reserves the right to revoke the promise or change the beneficiary, the vesting of the third party s rights does not terminate that power. 13 For example, in most life insurance contracts, the policyholder reserves the right to change the designated beneficiary. Intended versus Incidental Beneficiaries The benefit that an incidental beneficiary receives from a contract between two parties is 12. Restatement (Second) of Contracts, Section Defenses against third party beneficiaries are given in the Restatement (Second) of Contracts, Section 309. unintentional. Because the benefit is unintentional, an incidental beneficiary cannot sue to enforce the contract. Exhibit 16 3 illustrates the distinction between intended beneficiaries and incidental beneficiaries. In determining whether a third party beneficiary is an intended or an incidental beneficiary, the courts focus on intent, as expressed in the contract language and implied by the surrounding circumstances. Any beneficiary who is not deemed an intended beneficiary is considered incidental. Although no single test can embrace all possible situations, courts often apply the reasonable person test: Would a reasonable person in the position of the beneficiary believe that the promisee intended to confer on the beneficiary the right to enforce the contract? In addition, the presence of one or more of the following factors strongly indicates that the third party is an intended beneficiary to the contract: 1. Performance is rendered directly to the third party. 2. The third party has the right to control the details of performance. 3. The third party is expressly designated as a beneficiary in the contract. In the following case, a national beauty pageant organization and one of its state affiliates agreed that the national organization would accept the winner of the state contest as a competitor in the national pageant. When the state winner was asked to resign her title, she filed a suit to enforce the agreement to have herself declared a contestant in the national pageant. The national organization argued that she was an incidental, not an intended, beneficiary of the agreement. EXHIBIT 16 3 Third Party Beneficiaries CONTRACT THAT BENEFITS A THIRD PARTY INTENDED BENEFICIARY An intended beneficiary is a third party To whom performance is rendered directly and/or Who has the right to control the details of performance or Who is designated a beneficiary in the contract INCIDENTAL BENEFICIARY An incidental beneficiary is a third party Who benefits from a contract but whose benefit was not the reason for the contract and/or Who has no rights in the contract CAN SUE TO ENFORCE THE CONTRACT CANNOT SUE TO ENFORCE THE CONTRACT Clarkson 12e Ch16_ indd 313 8/27/10 9:22:04 AM

11 314 UNIT THREE CONTRACTS AND E-CONTRACTS Court of Appeals of North Carolina, 182 N.C.App. 334, 641 S.E.2d 721 (2007). a COMPANY PROFILE In 1921, 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 all the states vying for the title of Miss America. More than twelve thousand women participate each year in the local and state events that culminate in the selection of the fi fty-two national fi nalists. To succeed requires commitment, hard work, and talent. In 1945, the nonprofi t Miss America Organization (MAO) offered its fi rst scholarship. Today, MAO is the largest provider of scholarships to young women in the world, awarding more than $45 million in cash and tuition assistance annually. BACKGROUND AND FACTS Miss North Carolina Pageant Organization, Inc. (MNCPO), is a franchisee of Miss America Organization (MAO). Under the Miss America Organization Offi cial Franchise Agreement, MNCPO conducts a public contest (the State Finals) to select Miss North Carolina and to prepare Miss North Carolina for participation in the Miss America pageant (the National Finals). b In return, MAO accepts the winner of the State Finals... as a contestant in the National Finals. On June 22, 2002, MNCPO designated Rebekah Revels Miss North Carolina On July 19, MAO received an anonymous (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 confi rmed 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. IN THE LANGUAGE OF THE COURT McCULLOUGH, Judge. Plaintiff contends on appeal that there was sufficient evidence that she is a thirdparty beneficiary under the franchise agreement between MAO and MNCPO to establish that there is a genuine issue of material fact [and thus for her claim to proceed to trial]. In order to assert rights as a third-party beneficiary under the franchise agreement, plaintiff must show she was an intended beneficiary of the contract. This Court has held that in order to establish a claim as a third-party beneficiary, plaintiff must show: (1) that a contract exists between two persons or entities; (2) that the contract is valid and enforceable; and (3) that 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 contracting parties intended to confer a legally enforceable benefit on that person. It is not enough that the contract, in fact, benefits the third party, if, when the contract was made, the contracting parties did not intend it to benefit the third party directly. In determining the intent of the contracting parties, the court should consider the circumstances surrounding the transaction as well as the actual language of the contract. When a third person seeks enforcement of a contract made between other parties, the contract must be construed strictly against the party seeking enforcement. [Emphasis added.] There was insufficient evidence before the trial court to support a conclusion that plaintiff was an intended beneficiary under the franchise agreement. Plaintiff was not designated as a beneficiary under the franchise agreement and there is absolutely no evidence that the a. In the Court of Appeals Opinions section, click on In the result, scroll to the 20 March 2007 section and click on the name of the case to access the opinion. The North Carolina Administrative Office of the Courts maintains this Web site. b. A franchise is an arrangement by which the owner of a trademark or other intellectual property licenses the use of the mark to another party under specific conditions. Clarkson 12e Ch16_ indd 314 8/27/10 9:22:05 AM

12 CHAPTER 16 Third Party Rights 315 CASE 16.3 CONTINUED 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 adduced 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 allowing the winner of MNCPO s contest to compete in the national finals. DECISION AND REMEDY The court affi rmed the lower court s judgment in favor of MAO. Revels was an incidental benefi ciary 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 benefi ciary of the agreement. Because Revels was not an intended benefi ciary, she could not maintain an action against MAO based on the agreement. THE GLOBAL DIMENSION If the agreement between MAO and MNCPO had involved a third party an international pageant organization would this have been a basis for concluding that Revels was an intended third party benefi ciary? Why or why not? THE E-COMMERCE DIMENSION How might Revels s third party status with respect to the agreement between MAO and MNCPO have been affected if the contracting parties had conducted their business online? Explain. Myrtle Jackson owns several commercial buildings that she leases 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 restaurant, Joe McCall, tells his restaurant manager to purchase insurance, but the manager never does so. Jackson tells her son-in-law, Rob Dunn, to perform any necessary maintenance for the buildings. Dunn knows that the ceiling in the restaurant needs repair but fails to do anything about it. One day a customer, Ian Faught, is dining in the restaurant when a chunk of the ceiling 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 information presented in the chapter, answer the following questions. 1. 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? 3. 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. Is this a valid assignment? Why or why not? DEBATE THIS: As a matter of public policy, personal-injury tort claims cannot be assigned. This public policy is wrong and should be changed. Clarkson 12e Ch16_ indd 315 8/27/10 9:22:05 AM

13 316 UNIT THREE CONTRACTS AND E-CONTRACTS alienation 308 assignee 304 assignment 304 assignor 304 delegatee 308 delegation 304 delegator 308 incidental beneficiary 313 intended beneficiary 311 obligee 304 obligor 304 privity of contract 304 third party beneficiary Third Party Beneficiary Alexander has been accepted as a freshman at a college two hundred miles from his home for the fall semester. Alexander s wealthy uncle, Michael, decides to give Alexander a car for Christmas. In November, Michael makes a contract with Jackson Auto Sales to purchase a new car for $18,000 to be delivered to Alexander just before the Christmas holidays, in mid-december. The title to the car is to be in Alexander s name. Michael pays the full purchase price, calls Alexander and tells him about the gift, and takes off for a six-month vacation in Europe. Is Alexander an intended third party beneficiary of the contract between Michael and Jackson Auto Sales? Suppose that Jackson Auto Sales never delivers the car to Alexander. Does Alexander have the right to sue Jackson Auto Sales for breaching its contract with Michael? Explain QUESTION WITH SAMPLE ANSWER: Assignment. Five years ago, Hensley purchased a house. At that time, being unable to pay the full purchase price, she borrowed funds from Thrift Savings and Loan, which in turn took a mortgage at 6.5 percent interest on the house. The mortgage contract did not prohibit the assignment of the mortgage. Then Hensley secured a new job in another city and sold the house to Sylvia. The purchase price included payment to Hensley of the value of her equity and the assumption of the mortgage debt still owed to Thrift. At the time the contract between Hensley and Sylvia was made, Thrift did not know about or consent to the sale. On the basis of these facts, if Sylvia defaults in making the house payments to Thrift, what are Thrift s rights? Discuss. For a sample answer to Question 16 2, go to Appendix I at the end of this text Assignment Marsala, a college student, signs a oneyear lease agreement that runs from September 1 to August 31. The lease agreement specifies that the lease cannot be assigned without the landlord s consent. In late May, Marsala decides not to go to summer school and assigns the balance of the lease (three months) to a close friend, Fred. The landlord objects to the assignment and denies Fred access to the apartment. Marsala claims that Fred is financially sound and should be allowed the full rights and privileges of an assignee. Discuss fully who is correct, the landlord or Marsala Delegation Inez has a specific set of plans to build a sailboat. The plans are detailed, and any boatbuilder can construct the boat. Inez secures bids, and the low bid is made by the Whale of a Boat Corp. Inez contracts with Whale to build the boat for $4,000. Whale then receives unexpected business from elsewhere. To meet the delivery date in the contract with Inez, Whale delegates its obligation to build the boat, without Inez s consent, to Quick Brothers, a reputable boatbuilder. When the boat is ready for delivery, Inez learns of the delegation and refuses to accept delivery, even though the boat is built to her specifications. Discuss fully whether Inez is obligated to accept and pay for the boat. Would your answer be any different if Inez had not had a specific set of plans but had instead contracted with Whale to design and build a sailboat for $4,000? Explain Third Party Beneficiary Acciai Speciali Terni USA, Inc. (AST), hired a carrier to ship steel sheets and coils from Italy to the United States on the M/V Berane. The ship s receipt for the goods included a forum-selection clause, which stated that any dispute would be decided in the country where the carrier has his principal place of business. The receipt also contained a Himalaya clause, which extended every right, exemption from liability, defense and immunity that the carrier enjoyed to those acting on the carrier s behalf. Transcom Terminals, Ltd., was the U.S. stevedore that is, Transcom off-loaded the vessel and stored the cargo for eventual delivery to AST. Finding the cargo damaged, AST filed a suit in a federal district court against Transcom and others, charging, among other things, negligence in the off-loading. Transcom filed a motion to dismiss on the basis of the forum-selection clause. Transcom argued that it was an intended third party beneficiary of this provision through the Himalaya clause. Is Transcom correct? What should the court rule? Explain. [Acciai Speciali Terni USA, Inc. v. M/V Berane, 181 F.Supp.2d 458 (D.Md. 2002)] Clarkson 12e Ch16_ indd 316 8/27/10 9:22:06 AM