Chapter 17 – Rights of Third Parties
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This chapter discusses the rights of third parties in contracts. It covers the concepts of assignment, where a right under a contract is transferred, and delegation, where a duty is appointed to another person. There are limitations on assignment and delegation if they violate public policy or a contract clause. The chapter also discusses third party beneficiaries, who can enforce a contract if they were intended to benefit from it, versus incidental beneficiaries who were unintended. It provides examples and case summaries to illustrate these concepts.
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Chapter 17 – Rights of Third Parties
- 1. C H A P T E R 17 Rights of Third Parties The best minute I spend is the one I invest in people. Kenneth Blanchard, The One Minute Manager (1993) 17-1
- 2. Learning Objectives • Explain the concept and consequences of assignment • Explain the concept and consequences of delegation • Discuss the concept of the third party beneficiary and identify the three kinds of beneficiaries 17-2
- 3. Overview • Sometimes a person who entered into a contract must transfer the contract rights or duties to another person (third party) – Examples: sublease of your apartment, asking another person take over work you agreed to do, or doing something to benefit a third person • Key to successful transfer: understand the third party’s abilities, limitations, and needs 17-3
- 4. Overview • A person who owes a duty to perform under a contract is called an obligor • The person to whom the duty is owed is called the obligee 17-4
- 5. Assignment of Contracts • Transfer of a right under a contract is called an assignment • Example: Jane arranges for her employer to transfer her next paycheck to her parents’ bank account – Employer is the obligor (owes Jane money) – Jane is the obligee and assignor – Jane’s parents are the assignees 17-5
- 6. 17-6
- 7. Details of Assignment • Assignments may be made in any way sufficient to show assignor’s intent to assign • A writing is not necessary – Unless statute of frauds applies • Assignee does not need to give consideration to assignor in exchange for the assignment 17-7
- 8. Limitations on Assignment • Assignment will not be effective if it: – Is contrary to public policy – Violates a non-assignment clause in a contract – Adversely affects obligor in significant way • Assignment may be ineffective if the contract right involved a personal relationship or element of personal skill or character 17-8
- 9. Delegation of Duties • Appointment of another person to perform a duty under a contract is called a delegation • Example: Mike mows Janet’s lawn weekly. Mike becomes ill and arranges for Sonny to mow Janet’s lawn – Janet is the obligee – Mike is the obligor and delegator – Sonny is the delegatee 17-9
- 10. Delegation of Duties • Caution: an assignment extinguishes the assignor’s right and transfers it to the assignee, but the delegation of a duty does not extinguish the duty owed by delegator – Delegator remains liable to the obligee unless the obligee agrees to make a new contract substituting the delegatee’s for the delegator 17-10
- 11. Delegation Process 17-11
- 12. Effective Delegation • In an effective delegation, performance by the delegatee will discharge the delegator – Why you should understand delegatee’s abilities and limitations 17-12
- 13. Watts v. Simpson • Facts and Opinion: – Watts (seller) and MW Development (buyer; MW) entered into contract for sale of real estate – Simpson loaned MW money and, as security, MW assigned rights in real estate contract to Simpson – MW defaulted and Watts sued Simpson alleging that Simpson obligated under assignment – Court: Simpson did not assume obligation to purchase under the assignment contract with MW – Affirmed in favor of Simpson 17-13
- 14. Non-delegable Duties • Duties are not delegable if the delegation: – Is contrary to public policy – Is prohibited by a contract clause • Also, duties that are dependent on the individual traits, skill, or judgment of the person who owes the duty to perform may not be delegable – Example: hip hop artist could not reasonably delegate concert obligation to opera star 17-14
- 15. Details of Delegation • Delegation may be made in any way that shows the delegator’s intent to delegate • Delegator may be discharged from performance by a substituted contract (novation) in which obligee agrees to discharge original obligor and substitute a new obligor – Effect: Original obligor has no further obligation 17-15
- 16. Rosenberg v. Son, Inc. • Facts and Procedural History: – Pratt entered into a contract to buy a Dairy Queen restaurant from Harold and Gladys Rosenberg – Pratt assigned rights and delegated duties under contract to Son; contract contained "Consent to Assignment" clause, signed by the Rosenbergs – Son assigned to Merit Corporation (bankrupt) – Rosenbergs brought collection action for debt against Son and Pratt; trial court granted summary judgment in favor of Son and Pratt – Rosenbergs appealed 17-16
- 17. Rosenberg v. Son, Inc. • Opinion: – Well-established principle of contract law that a contracting party cannot escape contractual liability by merely assigning its duties and rights under the contract to a third party – Evident from express language of agreement between Pratt and Son that only an assignment was intended, not a novation – Mere consent to agreement by Rosenbergs was not consent to discharge of principle obligor – Reversed and remanded in favor of Rosenbergs 17-17
- 18. Third-Party Beneficiaries • If parties to a contract intended to benefit a third party, courts give effect to their intent permitting third party to enforce the contract – Referred to as third-party beneficiary • Example: Father contracts and pays for Homes, Inc. to build house as gift for Son – Son (third-party beneficiary) may sue Homes, Inc. if the company breaches the contract • Father may also sue Homes, Inc. 17-18
- 19. 17-19
- 20. Incidental Beneficiaries • Incidental beneficiary is one obtaining a benefit as unintended by- product of a contract – No rights under contract • In foregoing example, Son’s Wife would be an incidental beneficiary 17-20
- 21. Test Your Knowledge • True=A, False = B – A person who assigns a right is an obligee – All duties may be delegated – Non-assignment clauses are enforceable – If a contract contains a non-assignment clause, the clause actually means that duties may not be delegated 17-21
- 22. Test Your Knowledge • True=A, False = B – Sheila assigned her right to the proceeds of a prize to a charity. Sheila is an assignee and the charity is the assignor. – Joshua contracted with Bigg Homes to build a two-story house that will improve the value of nearby homes. Joshua’s neighbor is an incidental beneficiary. 17-22
- 23. Test Your Knowledge • Multiple Choice – James financed car purchase with CarCo, then sold the car to Marsha. Marsha agreed to pay remaining amount of the car loan, but failed to make payments. CarCo may sue: a) James only since he contracted with CarCo b) James and Marsha since CarCo is a creditor beneficiary of the contract between James and Marsha c) Marsha only since Marsha was substituted for James 17-23
- 24. Test Your Knowledge • Multiple Choice – Marlyn contracted with Dept. Store to play piano and holiday songs in the store during December. The contract had a “non-assignment” clause. Marlyn got another job and delegated her duties under the contract to John. Does Dept. Store have a valid claim against Marlyn? a) Yes. Marlyn breached the non-assignment clause by delegating her duties to John b) No. Marlyn found someone to replace her c) No. The contract didn’t have a non- delegation clause 17-24
- 25. Thought Question • If public policy favors freedom of contract, then should courts enforce non-assignment and non-competition clauses? What about agreements to arbitrate for donee beneficiaries? 17-25
Editor's Notes
- With regard to adversely affecting the obligor in some way, any assignment will change an obligor’s duty to some extent. For example, a right to receive money or goods or land is generally assignable, though it will burden an obligor. In addition, covenants not to compete are generally considered to be assignable to buyers of businesses. However, an assignment could be ineffective because of its variation of the obligor’s duty. For example, if the contract right involved a personal relationship or an element of personal skill, judgment, or character, the assignment may be ineffective. Case: PPG Industries, Inc. v. JMB/Houston Center One Houston Center, a 46-story skyscraper in Houston, was originally owned by Houston Center Corporation (HCC). The exterior included more than 12,000 Twindows , a dual-pane glass window unit manufactured and installed by PPG. Twindows were chosen for their insulating ability and color, which blended with other buildings in the Houston Center complex. By July 1982, a large number of the Twindows showed fogging and discoloration. At HCC’s request, PPG manufactured and installed replacements for one-fourth of the building’s windows pursuant to a contractual warranty. The replacement project took more than two years. Several years later, HCC entered negotiations to sell One Houston Center to JMB. During its due diligence, JMB learned of the earlier window problems, and that to a limited extent they continued. When JMB inquired whether any warranties still applied, PPG replied that all had expired. JMB bought the building “as is” in December 1989 as part of a $375 million purchase. HCC assigned to JMB all warranties relating to the building, and JMB waived all Deceptive Trade Practices Act claims against HHC. The DTPA is a state statute that provides remedies for certain unfair trade practices. When extensive Twindows problems appeared in 1991, JMB sued PPG for violating the DTPA and breaching warranties issued to HCC. Trivia: PPG began business as Pittsburgh Plate Glass in 1883 and developed the Twindow in 1945 with a registered trademark.
- * Delegator retains duty to obligee until performance is rendered by delegatee
- After MW Development failed to purchase the property, the Wattses sued MW Development, Richard Taylor, and Simpson for breach of contract. In January 2004, the court approved an agreed order which gave Simpson the right to purchase the property pursuant to the June 2003 real estate contract through and including February 25, 2004. The order further provided that if Simpson did not exercise his right to purchase, the Wattses could sell the property to a third party. After Simpson declined to exercise his right to purchase the property, the property was sold to a third party for $1,800,000. The trial court entered partial summary judgment in favor of the Wattses against MW Development in the amount of $91,605.78, which represented the interest accrued on the $1,917,222. It denied the Wattses’ motions for summary judgment against Simpson. It also dismissed the complaint against Simpson. The Wattses appealed. They argued that because of the assignment contract entered into between Simpson and MW Development, Simpson is obligated to perform all of the obligations set forth in the real estate contract, including the purchase of the property. Court: “In this case, there is no language in the assignment contract between Simpson and the Wattses which can be reasonably construed to obligate him to purchase the property pursuant to the terms of the real estate contract between MW Development and the Wattses. … To construe the assignment contract to have also assigned MW Development’s obligation to purchase the Wattses’ property, would be contrary to the ordinary meaning of the language used and the intention of Simpson and MW Development.”
- A novation requires more than the obligee’s consent to having the delegatee perform the duties. The mere fact that an obligee accepts performance from a delegatee does not create a novation. Rather, there must be some evidence that the obligee agrees to discharge the old obligor and substitute a new obligor. In the Rosenberg v Son, Inc. case, the agreement to discharge the old obligor can be inferred from the language of a contract or such other factors as the obligee’s conduct or the surrounding circumstances.
- Hyperlink is to the North Dakota Court’s opinion.
- Court regarding the assignment agreement language: “It is evident from the express language of the assignment agreement between Pratt and Son that only an assignment was intended, not a novation. The agreement made no mention of discharging Pratt from any further liability on the contract. To the contrary, the latter part of the agreement contained an indemnity clause holding Pratt harmless in the event of a breach by Son. Thus, it is apparent that Pratt contemplated being held ultimately responsible for performance of the obligation.”
- Note that Son is a donee beneficiary . While Son and/or Father could sue Homes, Inc. for breach of contract, Son could not sue Father.
- See Podraza v. New Century Physicians of Nebraska, Inc. : “As a matter of general contract law, we have strictly construed who has the right to enforce a contract as a third-party beneficiary. In order for those not named as parties to recover under a contract as third-party beneficiaries, it must appear by express stipulation or by reasonable intendment that the rights and interest of such unnamed parties were contemplated and that provision was being made for them. Authorities are in accord that one suing as a third-party beneficiary has the burden of showing that the provision was for his or her direct benefit…. We conclude that the actual intent of the contracting parties in this case must be determined by the trier of fact, and it is New Century’s burden to prove it was specifically intended to be benefited by the agreement.”
- True. The person is also an assignor. False. Duties may not be delegated if delegation of the duty is contrary to public policy, prohibited by contract, or the duty is unique to the obligor based upon individual traits, skill, or judgment of the person who owes the duty to perform . True. In general, non-assignment clauses are enforceable if reasonable in scope and time. In other words, non-assignment clauses will be interpreted narrowly by courts because public policy favors assignability. True. Under common law and UCC 2–210(2), general language prohibiting assignment of “the contract” or “all my rights under the contract” is interpreted as forbidding only the delegation of duties, unless the circumstances indicate to the contrary.
- False. Sheila is the assignor and the charity is the assignee. True. The neighbor will derive benefit from Joshua’s home as an incidental beneficiary, but could not sue Joshua or Bigg Homes if either party to the contract breaches the contract. Note that if the homebuilding caused damage to the neighbor’s house or devalued nearby homes, the neighbor may indeed have recourse under nuisance law or other property-based law.
- The correct answer is (b). CarCo is a creditor beneficiary.
- The correct answer is (a). Note that Dept. Store could accept the substitution and agree to a novation (essentially, a new contract with Sarah).
- Opportunity to discuss ethical issues in non-competition and non-assignment clauses as well as the Ethics in Action box on page 470.