Comparison of Third Party Theory Between the U.S and China

Abstract: Privity of contract, which refers to that contracts can be only legally binding among certain parties, is an essential principle in regulating contract. Only a party to the contract can make a request for or bring a suit against the other party based on contract, while the parties cannot make contractual claims to a third party with whom it has no contractual relationship, neither can the parties set a contractual obligation for a third party. Usually only the parties to the contract can bring a suit concerned the contract. The privity of contract specifically manifest as the relativity of object, content and responsibility. The dispute resolution team of Beijing DOCVIT Law Firm are going to conduct a comparative analysis on the provisions and applications of the third party between China and the United States in order to discuss how to balance the breakthroughs and limitations on the privity of contract.

Just as its name implied, the third party is not one of the contract party, instead it is the outsider. The recognition of the third party is regarded as an exception to the principle of privity of contract, which is, to accept that contract affects the rights and obligations of the third party, and the third party is also entitled to such rights and obligations. Each country has certain principles, while accepting the principle of privity of contract, they prudently and restrictively breakthrough the privity of contract in order to protect the third party.

I. The third party beneficiary under the U.S common law.

As to whether the third party is granted benefits, the third party can be simply classified into third party beneficiary and obliged third party. In the book Business Law and the Legal Environment authored by professor Twomey from the Boston University and Professor Jennings from Arizona State University Business School, under the U.S contract law, the type of beneficiary third party can be further divided into intended beneficiary and incidental beneficiary.

When a contract is intended to benefit a third party, such a person is an intended beneficiary and may bring suit and enforce the contract. In some states, the right of the intended third-party beneficiary to sue on the contract is declared by statute. For Example, Ibberson Co., the general constructor hired by AgGrow Oils, LLC to design and build an oilseed processing plant, contracted with sub-constructor Anderson International Corp. to supply critical seed processing equipment for the project. Anderson’s formal proposal to Ibberson identified the AgGrow Oils Project, and the proposal included drawings of the planned AgGrow plant. Under state law, this contract made between the constructor and sub-constructor for the express benefit of the third-party AgGrow Oils could be enforced by the intended third-party beneficiary AgGrow Oils. The project was a failure. AgGrow was successful in the lawsuit against Anderson under the Anderson-Ibberson contract, having the standing to sue as an intended third-party beneficiary of that contract.

Not everyone who benefits from the performance of a contract between other persons is entitled to sue as a third-party beneficiary. If the benefit was intended, the third party is an intended beneficiary with the rights described in the preceding sections. If the benefit was not intended, the third party is an incidental beneficiary. For Example, real estate developer Ocean Atlantic Corp. purchased a series of bonds from American Southern Insurance Co. for the purpose of guaranteeing the performance of public improvement in a subdivision being developed in Yorkville, Illinois. The bonds representing the surety contract between Ocean Atlantic and American Southern were issued in favor of the City of Yorkville. Ocean Atlantic hired sub-constructor Aurora Blacktop, Inc., to perform several improvements, but the project stalled and Aurora was never paid for its work. Aurora lacked standing as a third-party beneficiary to enforce the subdivision bonds against American Southern because the contractual obligations ran only to the city. Aurora was deemed an incidental beneficiary rather than a third-party beneficiary.

As to the type of contract benefit third party, the third party beneficiary can be further classified.

(A) CREDITOR BENEFICIARY. The intended beneficiary is sometimes classified as a creditor beneficiary when the promisee’s primary intent is to discharge a duty owed to the third party. For Example, when Max Giordano sold his business, Sameway Laundry, to Harry Phinn, he had three years of payments totaling $14,500 owing to Davco, Inc., on a commercial Davco shirt drying and pressing machine purchased in 2006. Max (the promisee) made a contract with Harry to sell the business for astipulated sum. A provision in this contract selling the business called for Harry (the promisor) to make the Davco machine payments when due over the next three years. Should Harry fail to make payments, Davco, Inc., as an intended creditor beneficiary under the contract between Max and Harry, would have standing to sue Harry for breach of the payment provision in the contract.

(B) DONEE BENEFICIARY. The second type of intended beneficiary is a donee beneficiary to whom the promisee’s primary intent in contracting is to give a benefit. A life insurance contract is such an intended third-party beneficiary contract. The promisee-insured pays premiums to the insurer under the contract of insurance so that, upon the death of the insured, the promisor-insurer would pay the sum designated in the contract to the beneficiary. The beneficiary’s rights vest upon the insured’s death, and the beneficiary can sue the insurance company upon the insured’s death even though the insurance company never made any agreement directly with the beneficiary.

Other than above, there are two specialties of beneficiary.  

(C) Necessity of Intent. A  third party does not have the status of an intended third party beneficiary unless it is clear at the time the contract was formed that the parties intended to impose a direct obligation with respect to the third party. In determining whether there is intent to benefit a third party, the surrounding circumstances as well as the contract may be examined. There is a strong presumption that the parties to a contract intend to benefit only themselves. To be noticed a person who is not a party to a contract or a transaction, but has an involvement (such as one who is a buyer from one of the parties, was present when the agreement was signed or made an offer that was rejected). The third party normally has no legal rights in the matter, unless the contract was made for the third party's benefit.

(D) It is not necessary that the intended third-party beneficiary be identified by name. The beneficiary may be identified by class, with the result that any member of that class is a third-party beneficiary. For Example, a contract between the promoter of an automobile stock car race and the owner of the racetrack contains a promise by the owner to pay specified sums of money to each driver racing a car in certain races. A person driving in one of the designated races is a third-party beneficiary and can sue the owner on the contract for the promised compensation.

II. The third party in contract law of China

a) In General

In contract law of people’s republic of China, the term “third party ”appears 73 times in 29 statutes, including where the parties prescribed that the obligor render a performance to a third party. In addition, the detriment of the third party could be a reason to invalidate a contract. Furthermore, the term “third party” also appears in a voluminous terms concerning leasing contracts, contracts for financial leasing, carriage contracts,  technology contracts and entrustment contracts. Though not being clarified, third party here contains both beneficiary and obliged third party.

In those statute, where the contract is made under conspiracy to the detriment of the third party, the third party could bring a tort suit on or it can bring a suit based on the contract it have signed with a party to the original contract. For instance, the third party as the leasee in a contract which applies the principle that sale cannot devastate lease, can defend by its right of use against the buyer’s request to possess based on the lease.

Under the apparent agency theory, once the court strictly examine the burden of proof of both parties and consequently find the act of agency is valid, the principal will be obliged to contract as one party other than the third party. By confirming that agent possesses the status of parties to contract, to a considerable extent the court maintains the principle of contract privity and avoid the effect of protecting the third party to be affected by the intervention in contract. Under which circumstance that the third party causes the contract cannot be performed, the court sticks to the privity of contract principle. Even in the case that third party causes breach of contract or the third party is obliged to debtor (in the original contract), it remains to be the parties to contract who shall be held liable.

b) The Comparison of Third Party Beneficiary

The above mentioned third party beneficiary under the U.S law is in fact same to the creditor of debt assignment contract under China law. In other word, in debt assignment contract the assignor agreed with the assignee that the contract should be performed by the assignee to the creditor of the original contract. However, Article 84 in Contract Law states that a debtor shall obtain consent from the relevant creditor if it intends to transfer its obligations under a contract in whole or in part to a third party. It shows that the contract to benefit the third party based on the debt assignment is also protected by the China Contract Law, which is quite different from the right to sue and request under the U.S common law.

In the previously mentioned AgGow case, AgGow held the right to sue as a beneficiary of the contract. Although in China, as the contract-awarding party, it cannot list the sub-constructor as the only defendant. The court shall add the general constructor as co-defendant, whom shall be held joint responsible.

It is specified in the Contract Law that the general constructor or the prospecting, design or construction constructor may, subject to consent by the contract-awarding party, entrusts a third party with the completion of the part of its contracted work. The third party shall bear joint and several liabilities together with the general constructor or the prospecting, design or construction constructor to the contract-awarding party with regard to its completed work results. In the construction contract, the contract- awarding party usually contracted with the general contract. The sub-constructor is not a party to the contract.

However, in order to ensure the quality of the construction project, court breaks through the principle of the privity of contract to hold the sub-constructor liable for the project.

On the contrary, if the constructor is in arrears on the project funds, can the sub-constructor being a suit against the general constructor according to the general contract? There is no specific provision for that. There are lots of cases in which the contract-awarding party is in arrears on project funds. From the cases I represented, in absence of the provision in contract, the court normally declines the sub-constructor’s request for payment from contract- awarding party by the reason of lack of standing as contract party. Therefore, the sub-constructor could only make a request to the general constructor. From the view that the sub-constructor bears jointly liabilities for the quality of project, the obligations and rights of the sub-constructors are obviously not balanced.

The beneficiary third party is also protected by China law. A beneficiary refers to a person who, as designated by the insured or the policy holder in an insurance of person, is entitled to claim for the insurance benefits. 

The amount insured refers to the maximum amount of indemnity or insurance benefits which the insurer is liable to pay.

c) The limitations and breakthroughs of privity of contract

To solve the problems appear in the construction contract in recent years and to clear the obstacles in the practice of law. Legislating has made some breakthroughs in the privity of contract. Take example of the regulation of actual constructor:

Interpretation of the Supreme People's Court on Certain Issues Concerning the Application of Law in the Trial of Cases Involving Project Construction Contract Disputes Article 26 states if the actual constructor files an action against the party that transfers or unlawfully subcontracts the contracted construction project as defendant, the people's court shall try the case according to the law. If the actual constructor files an action against the employer, the people's court may add the party that transfers or unlawfully subcontracts the contracted construction project as a party to the case. The sub-contractor shall only be liable to the actual constructor regarding overdue payment of the construction price.

In QiHeHuanDun v. YongJunWuZi (2011 No. 104 civil tribunal supreme ) tried by the supreme people’s court, “this court decided that despite the lack of direct legal relation concluding from the formality of construction contract between 9th metallurgical construction and HuanDun company, and the absence of obligation and rights from the content of construction contract, HuanDun company provided… ; second, the bill of loading provided by HuanDun company proves that … all has been delivered to HuanDun Company. Therefore, the recognition of HuanDuan Company as the actual constructor was due to no errors. this court held for HuanDun Company.

Still, such breakthrough is restricted by the principle of limited and strict application as the 2015 national civil trial conference summary article 50 states, the suit brought against the sub-constructor, general constructor, contract- awarding party must be strictly reviewed according to the law. The scope of Interpretation of the Supreme People's Court on Certain Issues Concerning the Application of Law in the Trial of Cases Involving Project Construction Contract Disputes Article 26 cannot be expanded at will. Moreover, courts should be aware of that contract-awarding party shall be held liable to the actual constructor only in the scope of due construction payment.

For the above reasons, the privity of contract could be understood as a protection to parties of contract. As lawyers, we are supposed to predict the nature of contract so that to avoid risk. How to balance the breakthrough and restriction is something worth to ponder.

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