California Corporations and the Third-Party Beneﬁciary Rule
Mostly, contracts are between two persons or businesses. Even with something as complicated as a building construction project, the contracts are bilateral — owner with architect, owner with general contractor, general contractor with subcontractors, etc.
In general, only the parties to a contract have the right to sue if there is a breach of contract. But, occasionally, a two-party contract is intended to provide substantial benefits for a third party. Under those circumstances, the third party has the right to sue for breach of contract under what is called the “third-party beneficiary” doctrine. This is codified in the California Civil Code. See Cal. Civ. Code, §1559.
A simple example might be this: A mother contracts with a repair shop to fix her son’s vehicle. The contract is clear that the son is the owner of the vehicle and is the intended beneficiary of the contract. If the repair shop breaches the contract, the son could invoke the third-party beneficiary rule to bring a lawsuit for breach of contract. In our example, it might not be necessary for the contract between the mother and the repair shop to specify that the son was the intended beneficiary. As stated by one California court, “[t]raditional third party beneﬁciary principles do not require that the person to be beneﬁted be named in the contract.” See Harper v. Wausau Insurance Corp., 56 Cal.App.4th 1079 (Cal. App. 1997). All that California law requires is that the repair shop understood that the mother had the intent to benefit her son in this manner.
The third-party beneficiary rule has some interesting implications for small closely-held corporations. A recent case example is Bozzio v. EMI Group Ltd. from the US Ninth Circuit applying California law. See 811 F. 3d 1144 (US Fed. 9th Circuit 2016). That case involved what is called a “loan-out corporation” for the lead singer of a 1980s rock band called Missing Persons. The lead singer, Dale Bozzio, sued the band’s record company and others for alleged unpaid royalties. The particular contract at issue with respect to the royalties was between the record company and the loan-out corporation. Bozzio had not signed the contracts and was, therefore, not a party to the contracts. Under traditional rules, Bozzio could not sue the record company for the unpaid royalties.
However, the loan-out company had gone out of existence. Under California rules, that means that the loan-out company was unable to file the lawsuit.
Bozzio, however, went ahead and filed a lawsuit against the record company under a third-party beneficiary theory. In brief, Bozzio argued that the record company knew that Bozzio — and the other members of the band — were the intended beneficiaries of the contract. Bozzio pointed to two provisions in the contract that — according to Bozzio — demonstrated the intent to benefit the band as the third party. The provisions were one providing that Bozzio and the band members could provide the services required under the contract personally if the loan-out company could not and one provision allowing royalties to be paid to the individuals under certain circumstances. The trial court dismissed the case holding that the third-party beneficiary rule did not apply and for other reasons. On appeal, the higher court reversed. The Ninth Circuit held that Bozzio had raised sufficient questions about her status as a third-party beneficiary to be entitled to continue her efforts. The case was returned to the trial court for further proceedings.
The legal lesson here is that if there are potential third-party beneficiary issues in your deal or transaction, seek the advice and counsel of a good San Diego corporate attorney. Third party beneficiary issues should be handled directly with specific contract language — either identifying the third parties or disclaiming any intent to benefit a third party.
Contact San Diego Corporate Law
For further information, please contact Michael Leonard, Esq. of San Diego Corporate Law. Mr. Leonard has been named a “Rising Star” four years running by SuperLawyers.com and “Best of the Bar” by the San Diego Business Journal. Contact Mr. Leonard via email or by calling (858) 483-9200. Mr. Leonard’s law practice is focused on business, transactional, and corporate matters.