What Is a Third-Party Beneficiary?

A third-party beneficiary is a person or business that benefits from the terms of a contract made between two other parties. In law, a third-party beneficiary may have certain rights that can be enforced if the contract is not fulfilled.

Understanding the Third-Party Beneficiary

There are certain standards that need to be met for the third party beneficiary to have legal rights to enforce a contract or to share in the proceeds. In particular, the benefit to the third party must be intended, rather than incidental.

Key Takeaways

  • A third-party beneficiary receives a benefit from a contract made between two other parties.
  • The beneficiary may have a right to compensation if the contract is not fulfilled.
  • The rights of the third-party beneficiary are strengthened if the contract includes a third-party beneficiary clause.

The clearest example of a third-party beneficiary is found in life insurance contracts. An individual enters into a contract with an insurance company that requires the payment of death benefits to a third party. That third party does not sign the contract and may not even be aware of its existence, yet is entitled to benefit from it.

The Rights of a Third-Party Beneficiary

Most examples are less clear-cut. Say the owner of a new office building signs a contract with a big company to lease four floors of space. The landlord then signs a separate contract with a small business person who wants to open a coffee shop on the ground floor, promising a steady stream of customers from the big company. The big company then reneges on the deal. Now the coffee shop owner is going bust.

Third-party rights are more enforceable if the benefit was intentional and the third party was aware of it.

Can the coffee shop owner demand compensation for the loss of business from the big company, based on its breach of contract with another party? As a third-party beneficiary, the coffee shop owner might or might not have a case.

The company could argue that the coffee shop owner was merely an incidental beneficiary, not an intended beneficiary. That is, the company did not plan to open offices in that building with the intention of enriching a coffee shop owner.

Clarifying Third-Party Beneficiary Rights

The rights of a third-party beneficiary are more clear-cut if that person or business is specifically named in the contract. In such cases, a third-party beneficiary clause is added that identifies an individual or company that expects to benefit from the agreement. This right is strengthened in law if the third-party beneficiary is aware of the agreement and the intended benefit.

For example, say a parent signed a lease and made a security deposit on a rental apartment for a child to live in while attending college. The student arrives in town and is denied access to the apartment. Adding insult to injury, the apartment has been rented to someone else. The student and the parent both have the right to demand compensation for the failure of the landlord to meet the terms of the contract.