If You Are a Third-Party Beneficiary, Make Sure the Contract Is Crystal Clear!

In Be Clear if You Want to Have a “Third-Party Beneficiary” in Your Contract, I discussed that if in-house counsel wanted to ensure that a person or entity achieved the status of a third-party beneficiary, it was critical to have language in the agreement that plainly said this. A 2013 decision from the District of Massachusetts, Pollak v. Federal Insurance Co., highlights the importance of this from the perspective of the third-party beneficiary.

In Pollak, the plaintiff entered into an agreement with EMS Financial Services that called for him to put over $1.3M into an escrow account controlled by the company. Unfortunately for both parties, EMS was defrauded and lost all of Pollak’s money. To make matters worse, EMS then filed for bankruptcy. Nevertheless, Pollak believed there was a silver lining, as the Federal Insurance Company had issued a crime-fraud policy that appeared to cover the fraud that led to EMS’s escrow account being liquidated. Further, Pollak contended that he was a third-party beneficiary of the insurance policy because, among other things, he had insisted that EMS increase the Federal Insurance crime-fraud coverage when he initially negotiated his business deal with EMS.

In light of these facts, Pollak demanded that Federal pay him under EMS’s policy, but the insurer refused. Pollak then sued Federal, and the company moved to dismiss. In deciding that motion, the court initially noted that:

While an intended beneficiary of a promise has standing to enforce a duty of performance, an incidental beneficiary acquires no rights against the contracting parties.

The court then focused its attention on whether, assuming Pollak was a third-party beneficiary, was he an intended third-party beneficiary. In this regard, the court noted that for a person to be an intended third-party beneficiary it “must appear from the language and the circumstances of the contract that the parties to the contract clearly and definitely intended the beneficiaries to benefit from the promised performance.” Significantly, however, based on the language in the insurance contract, itself, “there [was] no question that Federal was required to direct all payments to EMS if a valid insurance claim were brought.” Further, as the court explained:

Massachusetts courts steadfastly have refused to accord intended beneficiary status under a contract whose terms, interpreted in the particular transactional setting, do not provide for the benefits of a performance to flow directly to a third party.

Accordingly, the court ultimately concluded that even if Pollak “convinced EMS to increase its coverage when it bought the insurance policy, he was still not an intended beneficiary under the policy.”

The lesson that in-house counsel can learn from Pollak is very straight-forward. If you want your company to be assured of availing itself of being a third-party beneficiary, you have to make sure that the contract expressly states that your company can enforce whatever rights are at issue (as if it were a party to the contract). Failing to do so could result in your company being deemed to be an incidental beneficiary and having no ability to exercise the rights it expected to have.

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