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Third-Party Rights in Contracts

Making Sense of Contracts

Contracts are confusing.

When you have a valid and legally enforceable contract, there are rights and duties of the parties to the contract. In general, only the parties that entered the contract have rights and liabilities according to it. This is called the privity of the contract, excluding third parties.

However, there are two exceptions to the privity of contracts: assignment of rights and delegations of duties. Another form of third-party rights in a contract is a third-party beneficiary contract. What are these types of third-party rights in contracts? When is a third party part of a legal contract?

Assignment of Rights

When you sign a bilateral contract, one party has a right to perform a task assigned by the other. The assignment of rights occurs when a third party is assigned the job of performing the task. When rights are assigned unconditionally, the rights of the assignor or person making the assignment are extinguished. The assignee has the right to demand the performance of the original party on this new person. The assignee only gains the rights the original assignor had. For example, if someone sells book rights to a company in exchange for royalties and that company then sells or transfers rights to yet another firm, the new firm gains the book rights but cannot add film rights that the first company didn't have.

Some rights cannot be assigned. Statutes may prohibit assignment. The contract between the first two parties may prohibit the assignment of rights. Anti-assignment provisions are common in real estate, preventing a renter from transferring the lease to a new person that the landlord hasn't screened. When contracts are personal, the contract cannot be assigned unless the only thing that remains is a financial payment. For example, after a project is completed and only the bills need to be paid, the rights to the financial payment can be assigned such as to a bill collector. Rights cannot be assigned if the assignment changes the nature or increases the obligation or cost of the assignment. You cannot assign a payment to someone and alter the scope of work significantly or charge someone 20% more because you've assigned the job to someone else.

Assignments can be revoked if the same right is assigned to a third party, the assignor dies, the assignor files for bankruptcy, or the assignee gives notice of revocation.

Delegation of Duties

Duties are not assigned but delegated when they are part of a contract. Almost any duty can be delegated. The most common types of delegation of duties are to employees or subcontractors.

Delegation is not allowed if the task is delegated to someone not qualified to do the work. You can't hire an attorney and have a court case delegated to a paralegal or legal researcher. If you hire a doctor, they cannot delegate the work to someone without the necessary expertise. Delegation of duties isn't allowed when special trust is placed in the obligor, such as fiduciary duties. Duties cannot be delegated if the performance of the third party is very different than the results if performed by the assignee. If one artist is hired to create a work, they cannot delegate to someone who will create something very different.

Delegation of duties doesn't eliminate the requirement of the delegator to do the work or find someone else to delegate to if the delegate fails to perform the task. If a subcontractor doesn't complete the task as required or fails to meet standards outlined in the contractor, the person who delegated to the subcontractor can be sued by the person who entered the contract with the primary contractor. However, the obligee who hired the contractor can't sue the subcontractor; the contractor can use the subcontractor after the case with the obligee is resolved.

When you hire a contractor, their subcontractors are delegated the work and required to perform it to the original contract.

When you hire a contractor, their subcontractors are delegated the work and required to perform it to the original contract.

Third-Party Beneficiary Contracts

There are three main types of third-party beneficiary contracts: creditor, donee, and incidental. Creditor beneficiaries are a common form of third-party beneficiary contract. For this type of third-party right in a contract, there must either be an existing debtor-creditor relationship or one established, such as hiring a debt collector to collect what someone hasn't paid for completed work. Assumptions of mortgages are a type of third-party beneficiary contract, though not all lenders will permit this.

Donee beneficiaries occur when someone is entering a contract to give a gift to a third party. Some of the most common donee beneficiary contracts are life insurance policies, where one person enters a contract with a life insurance company to give money to the beneficiaries upon the death of the person entering into the contract with the insurer. Living revocable trusts are another type, where the donee is the person receiving the property.

Incidental beneficiaries receive benefits from a contract but were not intended to do so when the contract was drafted. Incidental beneficiaries may be created due to the performance of the third party, the rights of the third party control how the performance goes and per the express designation in the contract. Incidental beneficiaries typically cannot sue the original promisor. However, their rights can vest and they gain legal rights in some circumstances, such as when they learn of and consent to the contract, brings suit upon the contract, or alter their position while relying on the contract.

The child named as a beneficiary in a life insurance contract has third party rights per the contract between parent and insurer.

The child named as a beneficiary in a life insurance contract has third party rights per the contract between parent and insurer.

This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.