How to Protect Yourself Against Surprise Parties to Contracts

Michael Polentz

Under classic contract law, if a party breaches a contract, in most cases only the parties to the agreement have the right to enforce its terms. However, courts are increasingly granting third parties the right to enforce a contract, even when they are a stranger to said contract. Those thoughts are according to Michael Polentz and Payvand Abghari at law firm Manatt, Phelps & Phillips. “The driving force behind the third-party beneficiary doctrine is not the desire to contradict the will of the contracting parties, but to decipher what the parties actually intended where the document itself may not be so crystal clear.” The sources dive deeper into the subject in the commentary below. The views expressed below are the author’s own. While courts throughout the country vary on how they may interpret these agreements, the overarching concept is for the contracting parties to have intended for a third party to benefit.  In a California case, Sessions Payroll Management, Inc. v. Noble Construction, Inc. , the court held that “a party not named in the contract may qualify as a beneficiary under it where the contracting parties must have intended to benefit the unnamed party and the agreement reflects that intent.”  The mere fact that a third party is incidentally named, or that the contract benefits them, does not entitle them to enforce it; the intent of the parties to benefit such third party must be clearly established in the language of the contract and the circumstances of the transaction. The implications of the third-party beneficiary doctrine are far reaching. For example, in the construction industry, while the majority rule is that a property owner is not an intended beneficiary of a subcontract between a general contractor and a subcontractor, at least one California court has ruled this to be the case.  In Gilbert Financial Corp. v. Steelform Contracting Co. , a building owner entered into a construction contract with a general contractor, who then entered into a subcontract with a roofer.  After the project was completed, the roof began to leak. The owner sued the roofer directly, claiming that the owner was a third-party beneficiary to the roofer’s subcontract with the general contractor. On appeal, the court concluded that since the general contractor’s prime contract with the owner required it to furnish all necessary labor and materials to complete the project, and since the roofer entered into the subcontract for the purpose of furnishing labor and materials for the roof, then clearly the roofer must have realized it had assumed the general contractor’s duties for this phase of the project and that the owner was the ultimate, intended beneficiary of its performance under the subcontract. While more recent California rulings have taken deliberate steps to discourage parties in construction defect matters from placing blame on outside parties with whom there is no “privity”, the rules are not always steadfast and parties are encouraged to take protective measures against unintended liability to outsiders. To make their intentions clear, contracting parties often include a “no third-party beneficiary” clause in hopes such language will insulate them from third-party claims. However, parties relying on such a term may be surprised to discover that the inclusion of a “flow down clause” elsewhere in the contract may muddy the waters. Suppose a homeowner hires an architect to design a home, and the architect then hires an engineer to prepare the plans.  If the engineer’s subcontract includes a provision that the terms of the architect-owner contract also governs the engineer’s services, the owner may well be able to file suit against the engineer for breaching its obligations under the subcontract, which flowed down to the owner pursuant to that flow down clause. Given the evolving nature of the law, it is important to take care to either explicitly provide third parties with enforcement rights or unequivocally exclude them. Even if the intent is to confer some enforcement rights on a third party, the parties should still consider clear limits, conditions or carve-outs of such rights to protect themselves—and their bottom line—from potential claims by unintended third parties.