A third-party beneficiary clause in a contract expressly states that the performance of a contract confers contractual rights to a third-party. Conversely, a no-third-party beneficiary clause states that performance does not confer contractual rights to a third-party. These clauses are common in construction contracts, insurance contracts, employee benefit plans, merger and acquisition contracts, trust deeds, and wills. [1]
Key points about third-party beneficiary clauses
- A third-party beneficiary clause expressly states that a third-party benefits from a contract, even though they are not party to it.
- A no-third-party beneficiary clause states that non-contracting parties do not benefit and therefore do not have legal rights under the contract.
- If the intent is for a third-party to benefit under a contract, the best practice is to identify the third-party beneficiary, expressly state that it is an intended beneficiary under the contract, and state its rights under the contract.
What is a third-party beneficiary?
A third-party beneficiary of a contract is a person or entity, other than the parties named in the agreement, that benefits from its performance. For example, a franchisor is not a party to a lease agreement between a tenant (franchisee) and a landlord; but the franchisor benefits by having its franchisee enter the lease and operate, which provides financial benefit to the franchisor. The franchisor may have other rights, such as to receive legal notice under the lease or the opportunity to cure a default.
What legal rights does a third-party have?
A third-party beneficiary will have the same legal rights as a contracting party if that beneficiary: 1) is intended (and not merely incidental) and 2) has rights under the contract that have vested [2] and 3) if there is not a “no third-party beneficiary” clause.
Intended v. incidental beneficiary
A third-party’s rights in contracts depends on if the contracting parties actually intended for the third-party to benefit under the contract.
- Incidental beneficiary. If a third-party incidentally benefits under a contract, that party likely would not have rights under the contract.
- For example, in a contract between a construction company and a property owner, subcontractors are often incidental beneficiaries to the contract. However, if the construction company and the property owner both intend for a certain subcontractor to benefit from the contract and have contractual rights, the contract should contain a third-party beneficiary clause that expressly names the subcontractor as an intended beneficiary of the contract. [3]
- Intended beneficiary. If the third-party beneficiary is intended (as in, the parties to the contract intend to convey a benefit to this third-party by performing the contract) then the third-party will likely have rights under the contract.[4]
- The intent to benefit a third-party should be explicitly stated in the contract and the third-party should be named. If a court finds ambiguity, or if there is no stated intent to benefit a third-party in the agreement, then courts will look to extrinsic evidence; but typically, the courts presume that the parties did not intend for a third-party to benefit.[4]
Vested rights
The third-party’s rights must vest under the contract in order for the third-party to have any legal rights. Vesting occurs when the beneficiary has knowledge of the promise and: manifests assent to a promise in a manner specified by the contract, or; sues to enforce the promise, or; materially changes position in reliance on the contract’s promise. [5]
No no-third-party beneficiary clause
As contracts can be tailored to the wishes of the parties, even if there are intended beneficiaries whose rights have vested, if the contracting parties do not wish to confer a contractual right to those third-party beneficiaries, they may do so by explicitly including a “no-third-party beneficiary” clause. This clause, as illustrated below, would prohibit a third-party beneficiary from asserting any rights under the contract.
Examples of third-party beneficiary clauses
Third-party beneficiary contract language
Example: “Third-Party Beneficiary. Each party acknowledges and agrees that [Company Name] is a third-party beneficiary of the representations, warranties and covenants of this Agreement, and that [Company Name] is otherwise an express third-party beneficiary of this Agreement, entitled to enforce the terms of the Agreement as if it were an original contracting party.”
The above example can be used for an SEC filing from a purchase agreement between two corporations, in which there is an intended third-party beneficiary.
Third-party beneficiary clause in a confidentiality agreement
Example: “The State of California, acting through the Judicial Council of California, Administrative Office of the Courts, is an intended third-party beneficiary of this Agreement and shall have the right to enforce provisions of this Agreement directly against Company.”
The above is a third-party beneficiary clause in a confidentiality agreement. The clause is from an NDA that the Judicial Council of California, Administrative Office of the Courts drafted for companies that bid on state projects: [6]
Third-party beneficiary clause in an arbitration agreement
Example: “Third-Party Beneficiaries. The Sellers and the Investors acknowledge that this Agreement benefits [the third-party beneficiary corporation and its officers and agents], and that such persons shall be entitled to the benefits of this Agreement and shall be entitled to institute an arbitration proceeding based upon this Agreement.”
In arbitration agreements, a third-party beneficiary should be able to both compel arbitration and be compelled to arbitrate, if the third-party is clearly identified as a beneficiary in the agreement. Arbitration agreements should always expressly identify any third-party beneficiary, as courts are reluctant to compel arbitration when the intent of the contracting parties is not clear [7].
The above is a clause that creates a third-party beneficiary of an arbitration agreement. The clause expressly states the third-party beneficiary identity and that they have the same arbitration rights as the contracting parties. The clause is from a stock purchase agreement. [8]
Examples of no third-party beneficiary clauses
Generic clause language & things to consider when drafting
Example: “No Third-Party Beneficiary. This Agreement is made solely and specifically for the benefit of Navios Maritime Holdings and its successors and assigns and no other Person shall have any rights, interest or claims hereunder or be entitled to any benefits under or on account of this Agreement as a third-party beneficiary or otherwise.”
A no-third-party beneficiary clause (the clause that does not confer contractual rights) can be an independent clause, but it is often located near any third-party beneficiary clause (the clause that does confer contractual rights). The above is an example of no third-party beneficiary contract language from an SEC filing of an LLC agreement: [9]
No third-party beneficiary clause in an arbitration agreement
Example: “Nothing in this Agreement, express or implied, is intended to (a) confer upon any Person other than the foregoing Persons, the parties to this Agreement, and as set forth in Sections 8.4 and 8.12, any rights or remedies under or by reason of this Agreement as a third-party beneficiary or otherwise; or (b) authorize anyone other than the parties to this Agreement or the Persons named in this Section to institute an arbitration proceeding pursuant to or based upon this Agreement.”
The above is a clause expressly stating that there is no third-party beneficiary of an arbitration agreement. The clause is from a stock purchase agreement.[10]
How do states differ in third-party beneficiary clause interpretation?
Third-party beneficiary in California
A third-party beneficiary in California does not need to be expressly mentioned in the contract, but circumstances surrounding the formation of the contract must show that the contracting parties intended for a third-party to benefit. Courts will examine the contract as a whole and the extrinsic evidence regarding the parties’ intent.
Although the court will consider extrinsic evidence of intent, it is best practice (for the third-party beneficiary, in particular) to expressly mention a third-party beneficiary. In Hernandez v. Meridian Management Services, LLC, Hernandez, an individual and Intelex Enterprises, LLC (Intelex) (collectively, parties) entered into a contract that contained an arbitration clause. Hernandez worked for other companies that were legally separate but functionally related to Intelex; these companies would also benefit from the contract between Hernandez and Intelex (“Companies”). Companies argued that they were third-party beneficiaries under the contract because they were intended beneficiaries by parties and their rights had vested, even though they were not explicitly mentioned in the contract. The court held that the third parties were not third-party beneficiaries under the law for lack of sufficient proof; whereas express mention of the third-party beneficiary would have been more persuasive evidence of third-party beneficiary status. As such, the third-party beneficiary could not benefit from the contract's arbitration provision as it desired and was forced to litigate its claims.
Therefore, even though California examines the contract as a whole and allows for extrinsic evidence in this discussion, it is in the best interest of the third-party beneficiary to be explicitly mentioned in the contract.” [11]
Third-party beneficiary in Texas
The Texas Supreme Court has explained that, when a contract is unambiguous, the issue of whether a non-contracting party is a third-party beneficiary in Texas depends solely on the contracting parties’ intent as expressed within their agreement. Citizens Nat’l Bank, 150 S.W.2d at 1006. In 2017, the court underscored this holding by stating that extrinsic evidence is irrelevant and inadmissible if the contract is silent on the contracting parties’ intent to benefit a third-party [12]
Third-party beneficiary in New York
A third-party beneficiary in New York must have clear, unambiguous evidence that the contract was intended to benefit them. However, New York also recognizes a third-party’s contractual rights when the third-party is the sole party able to claim damages for breach of contract.
[1] Legal Information Institute, Third-Party Beneficiary, Cornell Law School
[2] Supra note 1
[3] Legal Information Institute, Incidental Beneficiary, Cornell Law School
[4] Legal Information Institute, Third-Party Beneficiary, Cornell Law School
[5] Legal Information Institute, Incidental Beneficiary, Cornell Law School
[6] Non-Disclosure Agreement for Request for Proposal – California Courts Protective Order Registry Development
[7] Harper & Cantrell, If You Want the Benefits of an Arbitration Agreement, Say So, Littler 2020
[8] STOCK PURCHASE AGREEMENT AMONG PANAGIOTIS ZAFET, SIMON ZAFET AND THE INVESTORS, 2008
[9] LLC Agreement of NAVIOS MARITIME CONTAINERS GP LLC
[10] STOCK PURCHASE AGREEMENT AMONG PANAGIOTIS ZAFET, SIMON ZAFET AND THE INVESTORS, 2008
[11] Hernandez v. Meridian Management Services, LLC, 87 Cal.App.5th 1214 (Cal. Ct. App. 2023)
[12] First Bank v. Brummet, 564 S.W.3d 491 (Tex. App. 2018)
