A unanimous California Supreme Court recently issued an opinion providing further guidance on California’s third-party beneficiary doctrine. The third-party beneficiary rule relates to contract law and is important for San Diego businesses. In general, parties can agree to a contract that is intended to benefit some specific third party (the “third-party beneficiary”). In general, that third party can sue to enforce the agreement. As an example, I might make an agreement with you to purchase your used vehicle and we specify and understand that the vehicle is being purchased for my daughter. Let us imagine that I live in New York. I proceed with the deal and make all the payments to purchase the car. However, you refuse to tender the vehicle to my daughter. In terms of enforcement, I can sue for breach of contract and my daughter can sue to enforce the agreement because she is clearly and explicitly the third-party beneficiary of the agreement.

However, the rule is considered “dangerous” in a business setting because many persons and entities might be able to claim some beneficial interest in what appears to be a two-party contract. As an example, assume there is a contract between a construction company and a property owner to build a house. Part of the construction involves installing electricity. If the third-party beneficiary rule is too broad, then the electrician will be able to sue for breach of the contract. That creates too much marketplace and commercial risk. Thus, the third-party beneficiary rule is limited to explicitly defined and agreed persons or entities and California courts have been cautious about expanding the rule.

This was the result of the recent case decided by the California Supreme Court. See Goonewardene v. ADP, Inc., Case No. S238941 (Cal. Supreme Court February 7, 2019). In Goonewardene, the court held that a payroll service provider, ADP, Inc., cannot be sued by workers for errors it makes in issuing paychecks to workers. The workers can sue their employer and the employer can sue ADP, but workers cannot claim to be third-party beneficiaries. Further, aside from the contract law doctrine, the court held that payroll service providers like ADP do not have an independent duty of care to workers to ensure that employer comply with the California Labor Code and wage orders issued by the California Industrial Welfare Commission.

With respect to the third-party beneficiary doctrine, courts generally consider three factual issues:

• Does the third-party benefit from the contract?
• Is the “motivating purpose of the contract” to benefit that third-party? and
• Does allowing the third-party to sue for breach of contract consistent with the objective of the contract?

In the vehicle example used above, the answer is “yes” to all three questions. My daughter benefits, the motivating purpose is to provide her with a vehicle, and allowing her to litigate is consistent with the objective of the contract.

With respect to the Goonewardene case, the California Supreme Court said that these three factors were not established. Yes, there was some benefit to the workers in the sense that they received their paychecks through the efforts of ADP. But that was not the “motivating purpose” of the contract which was to help the employer meet its wage and withholding and tax and other wage-payment obligations. Furthermore, allowing workers to sue was not consistent with this purpose since workers were not suing to effectuate the employer’s purposes. The California Supreme Court kept the third-party beneficiary doctrine narrow, which can be considered ‘good” for San Diego businesses.

Contact San Diego Corporate Law Today

For more information, contact attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard can be reached at (858) 483-9200 or via email. Mr. Leonard can help draft and review contracts and can assist with employee-related matters such as drafting and/or reviewing company employee policies and procedures, creating and/or updating employee handbooks, and more. Like us on Facebook.

You Might Also Like:

What is a Third-Party Beneficiary of a San Diego Contract?

Employees Must be Paid for Off-the-Clock Work

Avoiding Employee Lawsuits With a Good Employee Handbook

Legal Services Needed By San Diego Businesses

California Corporations and the Third-Party Beneficiary Rule