As discussed in CPCU® 530, the named parties to a contract generally have a right to sue if they fulfill their duties but the other party fails to go through with their end of the bargain, mainly because the victim stands to lose something. In some special situations, there may also be a third party that does not have any duties under the contract but could also stand to lose something if the contract falls through. These parties are called third-party beneficiaries, and some of them also have rights to sue. This tip will explain the three types of third-party beneficiaries and what their rights are under contract law.

Creditor Beneficiary

The first type of third-party beneficiary is the creditor beneficiary. In a typical contract, the buyer has a duty to pay the seller for the seller’s good or service. However, a seller might request that the buyer pay someone else that the seller happens to owe money to. That third party who the seller has a debt with is called a creditor beneficiary, because they are a creditor who will benefit under the contract.

Creditor beneficiaries will often demand this of a contract if they have provided something to the seller, such as the good being sold, but they are concerned that the seller might take the buyer’s whole payment and fail to forward the portion owed to the creditor.

If the contract does not go through, the creditor beneficiary has the right to sue the seller for damages because, ultimately, the seller’s outstanding debt still hasn’t been paid yet. The creditor beneficiary also has the right to sue the buyer as long as all parties explicitly agree that the buyer was to pay the creditor directly instead of paying the seller. In a sense, the buyer is assuming an extra liability that they otherwise wouldn’t have had under a normal contract that did not involve a creditor beneficiary. But, a buyer might be willing to do so if they really want to take the offer the seller is making (maybe the seller is offering a fantastic price or is selling something the buyer couldn’t find elsewhere). Because this arrangement requires the buyer to be responsible to one more party than he otherwise would be, it has to be an explicitly stated contract term that they agree to before the buyer is also liable to the creditor.

Donee Beneficiary

Another type of third-party beneficiary is the donee beneficiary. In this situation, again, the buyer is being asked to pay an outside third party instead of paying the seller directly. The difference, however, is that the seller does not owe any debt to the donee beneficiary. In other words, the seller is donating the money to the third party beneficiary. For example, a parent selling a car might want to the buyer to just give the money to the seller’s son or daughter. Or, someone might asked the buyer to just pay the money to a charity of the seller’s choice.

If the contract does not go through, the donee beneficiary has no rights at all to sue the seller because the seller never had any obligation to give the donee anything in the first place. However, the donee beneficiary can sue the buyer as long as all parties explicitly agreed that the buyer was to pay the donee directly instead of paying the seller. Like with the last situation with a creditor beneficiary , the buyer is assuming liability to another party that they otherwise wouldn’t have had to under a normal contract that did not involve a donee beneficiary involved, so this arrangement also requires the buyer to explicitly agree to take on that extra responsibility before the donee beneficiary to has that legal right to sue.

Incidental Beneficiary

Sometimes, a third party will happen to benefit from a contract even though neither party to the contract intends for that third party to have a legal right to sue should the contract fail to go through. For example, the buyer of a new car might casually mention to his neighbor that once the buyer gets the car, he can give his neighbor a ride to work for free everyday since it is on the way. Technically, the neighbor now has something to lose if the car sale doesn’t go through. In this way, the neighbor has become an incidental beneficiary because he incidentally benefits from the contract.

However, this type of beneficiary has no right to sue because neither party has any legal obligation to the neighbor. The buyer has no legal obligation to give the neighbor ride, and the seller has no legal obligation to ensure that the neighbor somehow has a ride to work.

Now you know the difference between these three concepts. If you encounter any questions about these terms on your exam, read carefully to see what the question says about the buyer’s & seller’s intentions with respect to what rights they want to give the third party. If there is no explicit agreement to include the third party in legally, you know right away it is an incidental beneficiary who has no rights to sue. If they confirm that their intention is to give rights to the beneficiary, look at what the nature of the relationship is between the seller and the beneficiary. If the seller owed the beneficiary money, it is a creditor beneficiary relationship. If the seller did not owe the beneficiary anything but is choosing to give the money anyway, it is a donee beneficiary situation.

Learn all the concepts to pass CPCU 530!

These are only three of the many, many concepts you need to know for your CPCU 530 exam. Use our CPCU 530 study guide to make sure you’ve got everything covered!

CPCU 530 Study Materials

• Based on 1st edition of CPCU 530: Navigating the Legal Landscape of Insurance
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