Third Party Rights

Third Party Rights

I.  Introductory comments 

Third parties generally have no rights or liabilities from agreements that contracting parties create. However, important exceptions exist: third party rights are particularly important in contracts for companies involved in finance, banking, retailing and wholesaling. Those businesses and others would be severely limited without third party rights. The success of the nation’s economy depends on recognizing and protecting third party rights.

II. Assignment of Rights and Delegation of Duties

A. Assignment of Rights 

A party can assign or transfer their contractual rights to third parties. For example, Kirk borrows $250,000 from First Finance to finance his expanding Specialty Music Company. He signs a note stipulating that he’ll make monthly payments for the next ten years. First Finance specializes in originating loans and assigns its right to Kirk’s payments to Credit USA, a large financial institution that specializes in managing installment loans.

  First Finance, the assignor, assigns the note to Credit USA, the assignee. The assignment gives Credit USA the rights to Kirk’s monthly payments. First Finance is out of the picture. However, Kirk isn’t: as the obligor he’s obligated to make the payments to Credit USA. If Kirk refuses to pay Credit USA, it can enforce its rights against him since it has the same legal rights to payment that First Finance enjoyed: Credit stands in its stead.

Some finance companies arrange loans, referred to as mortgages for homebuyers and installment loans for cars, boat and airplane buyers, among other major purchases. Many assign their rights to payments to larger finance companies. Homeowners who keep their home for twenty years might have their loan assigned to three, four and even five different companies. The right to the homeowner’s payments attends each assignment. Millions of dollars change hands daily by assignment or transfer of rights.

[As an aside: Kirk signed a promissory note in his agreement with First Finance, which contained his promise to pay a specific amount at a specific rate of interest. A major difference exists between assigning contractual rights and transferring a promissory note by negotiation, but for purposes of this course, that difference is not at issue. Promissory notes are the subject matter in the chapter on commercial paper.]

B. Delegation of Duties

        Parties to a contract can delegate their duties to a third party. As it turns out, Kirk lost interest in his music business two years after securing his loan and jumped at the chance to work for a company that was developing a new line of Little League baseball bats. Fortuitously, Kirk’s new job opened the way for Gert, his assistant manager to realize her dream of buying his business. The two sealed the deal when Kirk delegated his duty to make monthly payments to Gert, a delegation that she welcomed.

C. Assignment and Delegation Compared

        In making the delegation, Kirk, the delegator transferred his contractual duties to Gert, the delegatee. As a result of First Finance assigning its right to Kirk’s payments to Credit USA and of Kirk’s delegating his duty to make payments, both of the parties to the original contract are out of the picture, with one difference. First Finance is completely out of the picture; once it assigned its right to payment, it extinguished its right to payments. However, Kirk will not be out of the picture until the debt owed Credit USA is fully paid.

D. Limits on Assigning Rights and Delegating Duties 

As a general rule, law and policy favors assignments, with a few exceptions. It’s against public policy to assign future workers compensation benefits and other limits imposed by state and federal statutes. Trusts can restrict or prohibit the beneficiary from assigning his benefits from the trust.

Contracting parties can include anti-assignment clauses, which are generally enforceable. Parties bargain about price and quantity; they can also bargain about assignments. One party might be indifferent to the matter, but the other might require an anti-assignment clause before making a deal. However, courts will not enforce anti-assignment clauses when money is assigned: money carries an objective standard, it can always be assigned.

While one person could easily value a tangible good more than another individual, a sum of money has the same economic value whether it’s paid to a bank, a retailer, a tall person, or the world’s shortest individual. It is, to use a different term, the medium of exchange, and is the most easily exchanged good in the economy. Consequently, anti-assignment contracts involving payments of money are unenforceable. A dollar in Joe’s hand is worth the same as a dollar in Josephine’s hand; likewise, a dollar from Sam has the same value as one from Samantha. And attempts to include anti-assignment clauses in contracts involving land are generally unenforceable. States have a public policy interest in the easy transferability of land.

Generally, personal service duties cannot be assigned or delegated. For example, when the concert hall owner contracted with a prominent vocalist for a concert, the vocalist could assign her right to the money from the concert, but she couldn’t delegate her duties. Similarly, the individual who hires an artist to paint his portrait has a right to the services of the particular portrait painter. Portrait painting is a personal service and the duty to paint it cannot be delegated.

However, if the same individual hired a company to paint his house, it could delegate its duties to another company since house painting is not personal. The individual has the right to have his house painted, but the company could delegate that duty to another company, unless the contract had an anti-delegation clause.

Assignments are not enforceable if they increase the duty or burden of the obligor. For example, Vern’s Orchard contracts with Baker Fruits to ship it 25 cartons of red delicious apples, but Baker assigns its rights to Corner Grocer. Baker Fruits is out of the picture; Vern’s Orchard is the obligor, required to ship the red apples to Corner Grocer. The Grocer cannot require that Vern’s ship golden, instead of delicious apples since that could increase its burden.

Analogously, delegations that increase the risks of the delegatee are not enforceable. Sadly for Kirk, Gert tired of the music business, sold the store and skipped town. When Gert made the payments, Kirk’s duty was subordinate to hers. However, when she skipped town with the debt unpaid, Kirk is liable for the balance. The case has major implications for credit transactions and transaction costs.