How to Address Third-Party Beneficiaries in Your Business Contracts

Everyone has experienced a time when a lunch date with a friend has evolved into a group event after bumping into someone while out to eat. This “third wheel” can hang around much longer than expected and change your plans drastically. While this is a boiled-down analogy, third-party beneficiaries within business contracts can be a similar experience. Companies signing contracts may not realize the straggling, unintended parties that may appear later down the road. Whether you are a small start-up or a well-established company seeking new business ventures, it is critical to be detail-oriented when drafting a new contract or considering signing one. The legal jargon used in these contracts as well as the high volume of content can cause some businessmen and businesswomen to sign a contract without recognizing the third parties it may bring along with it.

What Is a Third-Party Beneficiary?

Similar to the analogy used above, a third-party beneficiary is a company or business that benefits from the terms of a contract made between two other parties. These potential beneficiaries are sometimes unforeseen by the signees before putting their pen to paper. Depending on the circumstances, these third-party beneficiaries may have certain rights within the contract if the terms are not fulfilled by both signing parties.

It can be difficult to imagine an instance in which this would happen, but a common example involves life insurance agreements. Many people will sign life insurance policies that designate a third-party recipient, or beneficiary, who will receive payments of death benefits from the insurance company upon the signee’s death. In this case, the third-party beneficiary may not have personally signed the contract, but he or she is still entitled to its benefits in the future.

Avoiding Third-Party Beneficiaries

The example mentioned above is fairly cut-and-dry: The person signing up for life insurance is likely designating a loved one to receive compensation upon their death. However, in business ventures, the relationship is rarely as amicable or intentional. The American Bar Association (ABA) addresses the issue of third-party beneficiaries and how one can avoid this inadvertent third wheel. If the third-party, who did not sign the contract, is seeking to enforce the contract, he or she must demonstrate that the signing parties intended for the third-party to benefit while they were formulating the contract. This can be difficult to do if it is not explicitly stated in the contract, but it is not impossible. When drafting your contract, the ABA suggests including the following three steps to avoid third-party beneficiaries:

1. Identify instances in which such issues will appear.
2. Decide what the intentions are of the signing parties.
3. Include a clear statement about your intentions in the contract.

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Sources:

https://www.investopedia.com/terms/t/third-party-beneficiary.asp

https://www.americanbar.org/groups/litigation/committees/commercial-business/boilerplate-contracts/third-party-contract-beneficiaries/