(1) The parties (the “promisor” and the “promisee”) may confer by express or implied agreement a right on a third party (the “beneficiary”).
(2) The existence and content of the beneficiary’s right against the promisor are determined by the agreement of the parties and are subject to any conditions or other limitations under the agreement.
Usually contracts are intended by the parties to create rights and obligations between themselves. In such cases only the parties will acquire rights and duties under the contract. The mere fact that a third party will benefit from the performance of the contract does not in itself give that third party any rights under the contract.
1. Professor A makes a contract with the University of country X under which he agrees to give forty one-hour lectures comparing the laws of contract of countries X and Y. A only appears for twenty lectures and does not mention the law of country Y in the lectures. T, a student, does not acquire rights under the contract between A and the University.
However, third parties are not always left without rights. The underlying principle is that of the autonomy of the parties, who, if they wish to create rights in a third party, should be free to do so. The parties may state expressly that this is their intention, but this is not essential since the intention to benefit the third party may be implicit in the contract. In cases where implied intention is alleged, the decision will turn on all the terms of the contract and the circumstances of the case.
The following are illustrations of implied intention.
2. A takes out a policy of insurance on its fleet of lorries which are regularly driven by its employees. The contract provides that the insurance company will cover anyone driving a lorry with A’s consent. An employee, T, has an accident while driving the lorry. T is covered in respect of its liability for the accident.
3. A sells his business to B on the terms that B will pay A GBP 1,000 a month for the rest of his life and will pay A’s wife, T, GBP 500 a month if A predeceases her. A dies. B refuses to pay T anything. T is entitled to the GBP 500 a month.
4. A, the International World University, wishes to build a new law library on land owned by the University. For legitimate tax reasons the contract for the erection of the library is made by B, a company wholly owned by the University, although the contractor well knows that when completed the library will be occupied and used by A. The building has been badly built and it will cost USD 5,000,000 to complete it satisfactorily. A can recover the cost of the remedial work.
5. A, the developer of a shopping mall, concludes a contract with B, a security firm, to provide security at the mall. Both A and B know that the shops will be operated by tenants of A. These tenants are told that one of the major attractions of the mall will be the high level of security provided by B. It is a term of the contract between A and B that all employees of B working at the mall will be ex-policemen personally selected by B’s chief executive. In fact, selection is delegated to a consultancy firm which recruits many unsuitable people. There are many thefts at the shops. Tenants who suffer losses will have contractual claims against B.
The following are illustrations where there is no such implied intention unless the circumstances clearly indicate otherwise.
6. A goes to an expensive furrier and selects and buys a coat. A tells the assistant (truthfully) that it is for T, the wife of a visiting head of State. By the side of the coat is a prominent card saying “It looks like mink, it feels like mink but is guaranteed man made.” A gives the coat to T. In fact, owing to a mistake by the furrier, the coat is a real mink coat and T is subjected to violent and hostile criticism by animal lovers in her country. T has no enforceable contract right.
7. A, a company with a large factory, concludes a contract with a company operating the local sewage system. Under the contract, A is entitled to discharge its waste into the sewer but undertakes not to discharge certain types of waste. In breach of this undertaking, A discharges waste which blocks the sewer and causes damage to T, another user of the sewer. T has no enforceable contract right.
8. A, a company from country X, sells materials to B, a company from country Y. A knows that B plans to resell the materials to T, a pharmaceutical company from country Z, which will use the materials for the manufacture of a new drug under a contract which will effectively limit B’s liability to T to USD 1,000,000. The materials are defective and T’s losses greatly exceed USD 1,000,000. T has no enforceable contract right against A.
The application of this Article will often come up in the context of an associated claim in tort. This possibility is outside the scope of the Principles.
It follows from the scheme of this Article that an express statement that the parties do not intend to create rights in a third party will be effective. It also follows that the promisor and promisee enjoy broad powers to shape the rights created in favour of the beneficiary. In this context the word “rights” should be interpreted liberally. In principle, a third party beneficiary will have the full range of contractual remedies including the right to performance and damages.
The beneficiary must be identifiable with adequate certainty by the contract but need not be in existence at the time the contract is made.
The parties may well wish to make a contract in which the identity of the third party is not known at the time the contract is made, but a mechanism is provided by which it will become known by the time performance is due. This might be by providing that the parties, or one of them, can identify the beneficiary at a later date, or by choosing a definition of the beneficiary, of which later circumstances will serve to make the identity clear.
1. A, a married man with children but no grandchildren, makes a contract with the XYZ insurance company under which A pays GBP 10 a month to the insurance company and they promise to pay GBP 10,000 to each of his grandchildren on his death. Grandchildren born after the date of the contract but before A’s death are entitled to GBP 10,000.
2. Company A launches a takeover bid for company B, a public company the shares of which are traded on leading stock exchanges. B engages C, a leading firm of accountants, to prepare a report on B for distribution to shareholders. The contract between B and C requires C to produce an honest, thorough and competent report. Owing to incompetence C produces a report that is much too favourable to B. As a result the majority of shareholders vote to reject A’s offer. Some shareholders show copies of the report to friends who buy shares in B. The old shareholders can acquire rights under the contract between B and C but the new shareholders cannot.
The conferment of rights in the beneficiary includes the right to invoke a clause in the contract which excludes or limits the liability of the beneficiary.
Contractual provisions limiting or excluding liability of those who are not parties to the contract are very common, particularly in contracts of carriage, where they often form part of a settled pattern of insurance. Perhaps the best known example is the so-called Himalaya clause, which in some form is frequently to be found in bills of lading. In general the autonomy of the parties should be respected in this area too.
A, the owner of goods, makes a contract with a sea carrier to carry them from country X to country Y. The bill of lading is subject to the Hague-Visby Rules and purports to exclude the liability of (a) the master and crew; (b) stevedores employed in loading and unloading the cargo; and (c) the owners of ships onto which the goods may be transhipped. These exclusions will be effective.
Another situation which would be covered by this Article arises where the promisor and promisee agree that the beneficiary shall be released from an obligation which it owed the promisor.
The promisor may assert against the beneficiary all defences which the promisor could assert against the promisee.
Under Article 5.2.1 the content of the beneficiary’s right may be made subject to any conditions or limitations devised by the parties. The promisor and promisee may devise a contract in which the position of the beneficiary is significantly different from that of the promisee. The parties’ autonomy is in principle unlimited but they may well not provide expressly for all possibilities. The normal default rule will therefore be as stated in this Article.
1. A takes out a policy of life insurance with insurance company B in favour of C. The contract provides for the payment of premiums for 25 years but after 5 years A stops paying premiums. The position of C will be modelled on that of A if the policy had been in A’s favour. Such policies do not usually deny all return on the premiums paid. If, however, the policy had been liable to be set aside by the insurance company, for instance because A had not made material disclosure, then B would normally be entitled to raise this defence against C.
2. Company A takes out a policy of fidelity insurance with insurance company B to cover dishonest employees. The insurance policy provides that B will indemnify in full customers who are defrauded by employees of A and that it will indemnify A only if A has not been negligent in the selection or supervision of the employees. Clearly in such a contract B will have defences against A which it cannot raise against the customers.
The parties may modify or revoke the rights conferred by the contract on the beneficiary until the beneficiary has accepted them or reasonably acted in reliance on them.
It might be the rule that the promisor and promisee are free to revoke the third party’s rights at any time or, contrariwise, that the third party’s rights are immutable once the contract is concluded. It appears that few systems adopt either of these extreme positions. The solution adopted is that the third party’s rights become irrevocable once the third party has either accepted the rights or has reasonably acted in reliance on them. It will, of course, be open to the parties to provide for a different regime in the contract either by making the beneficiary’s rights irrevocable sooner, or by preserving a right of revocation even after the beneficiary has acted in reliance on the rights. There may well be situations where a right of revocation is given only to one party. For example, in a contract of life insurance it might be provided that the insured can change the beneficiary. There might be relevant usages which limit the possibility of revocation.
A, the main contractor on a major construction contract, takes out a policy of insurance with insurance company B to cover damage to the work in progress. The policy is expressed to cover the interests of all sub-contractors involved in the contract and the sub-contractors are all told of the policy. C, a sub-contractor, does not take out any insurance itself, but does not tell A or B. Absent clear words to the contrary, C’s reliance makes the contract between A and B irrevocable.
The beneficiary may renounce a right conferred on it.
The scheme of this Section assumes that, absent contrary provision, the contract between promisor and promisee creates rights in the beneficiary at once, without any need for acceptance by the beneficiary.
Although the third party will usually welcome the benefit which the parties have conferred upon it, it cannot be forced to accept it. It follows that the third party may expressly or impliedly renounce the benefit.
However, once the beneficiary has done something that amounts to acceptance, it should not normally be entitled to renounce.
On the facts given in the Illustration to Article 5.2.5, C, a sub-contractor, may not wish to take advantage of the insurance taken out by the main contractor because it already has relevant insurance in place (and it knows that there will be difficulties if there are two insurances covering the same risk). C is entitled to renounce.