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We have all signed different contracts like employment contracts, insurance contracts, etc. What are contracts? According to the American Law Institute, a contract is, "a promise or a set of promises for the breach of which the law has a remedy, or the performance of which the law in some way recognizes as a duty".

There are two parties to a contract; the promisor and the promisee. The promisor is the person who must fulfill the promise made in the contract to the promisee i.e. the person to whom the promise is made. In simple words, a contract is legally binding on the two parties who sign it to honor the promises made in it.

But there are cases where the contract benefits a third person. This person is the third party beneficiary; one who benefits from the contract or agreement in spite of not signing the contract. We can say that the definition can be, "an entity who has not been a party to the contract but still benefits from it."

Types of Third Party Beneficiary

Intended Beneficiary
Intended beneficiary is one who benefits directly from the contract. One party of the contract wants him/her to benefit from it. Life insurance is a very good example of this type. In a life insurance contract, the wife of the life assured gets the sum assured after the husband's death. Here the contract is between the person insured and the insurance company. The wife has not signed the contract. The wife is the intended third party beneficiary in this case.

For a person to prove that he is an intended third party beneficiary, he needs to fulfill the following parameters -
  • The promisee of the contract should intend for the third party to benefit from the contract.
  • The promisee should intend that the third party benefits due to some earlier obligations.
Thus, if the promisee does not purposefully intend that the third party should benefit, the third party cannot enforce legal rights.

The intended third party beneficiary can sue the parties of the contract under the following circumstances -
  • The contract is breached by either of the two parties to the contract.
  • The third party beneficiary faces loss due to this breach of contract.
There are two different types of intended beneficiaries -

Creditor Beneficiary
A creditor beneficiary is one who receives the benefit, as the promisee is legally bound to pay the creditor due to some earlier commitment. The best example to explain this is mortgage. If Mr. A has a mortgage on his house, the bank is the creditor beneficiary. It is Mr. A's obligation to pay back the mortgage amount with the interest to the bank.

Donee Beneficiary
A donee beneficiary is one who receives a gift from the promisee and it benefits him. The law states that when a person has been gifted and there is no return obligation, the contract can be enforced. This type of third party beneficiary can be explained with the help of a Trust Fund. Henry's grandfather created a trust fund that Henry would receive once he attains 21 years of age. Henry here becomes the donee beneficiary, and has the right to receive the money from the trust fund once he turns 21 years old.

Incidental Beneficiary
Incidental beneficiary is one who benefits from the contract though neither of the parties to the contract intended him/her to benefit. This can be explained with the help of the following example. Mr. A owns a showroom of Harley-Davidson bikes. Mr. B promises his son a Harley-Davidson bike if his son passes his exams with good grades. The son gets good grades and Mr. B buys him the bike. Mr. A here is an incidental third party beneficiary if Mr. B buys the bike from him. If Mr. B decides to buy the bike from some other dealer, Mr. A does not have the right to sue him, as there was no contract between the two for purchasing the bike.

Third Party Beneficiary in Insurance Contracts
There are different types of insurance contracts like health insurance, motor insurance, liability insurance, medical insurance, and the contracts that employers draw up with the insurance companies for the benefit of his employees. According to the law, the parties of the contract need to fulfill the promises made in the contract and benefit the third party, in the happening of the said event.

Please remember if you want to draw up a third party beneficiary contract, take good legal advice. Also, if you are in some way benefiting from a contract as a third party, see your lawyer for legal implications.