5.3 Third-Party Beneficiary Contract Claims

Updated 2013 by Kent Qian

Many government benefits are administered by private parties and local agencies. Health care under Medicaid and Medicare is provided by hospitals, nursing homes, doctors, and managed care organizations. Local housing agencies administer federal housing benefits, which are often delivered by private landlords. Private contractors frequently provide services to prisoners.  Authorization for private parties and local agencies to manage public benefits is conferred through detailed contracts with the federal or state government, and these contracts commonly contain many protections for beneficiaries. When private parties or local agencies that are not state actors1 fail to provide the benefits mandated by the government contracts, contract law may provide an avenue for relief. Injured individuals may be able to sue the private party or local agency to enforce the contract as a third-party beneficiary of that agreement.2

The core of this claim is that the government and the private party have entered into a contract for the benefit of the individuals for whom the government program was designed, and as a result, those individuals may seek to enforce the contract if it is breached. In light of recent Supreme Court cases emphasizing the need for detailed allegations in the complaint,3 it is important to plead the specific contract provisions that benefit your client and that are not being observed. If at all possible, before filing suit, acquire a copy of the specific contract at issue, or at least a copy of any model contract upon which it may be based. An undifferentiated reference in the complaint to the entire contract is unlikely to be sufficient.4

Contract claims based on third-party beneficiary status have been successful in Medicaid and Medicare, housing, and prisoner cases.5 Nevertheless, such claims generally fail when either the contract contains and express provision disavowing an intention to confer third-party rights or when applicable state law utilizes a presumption on behalf of housing residents with well established rights to reside at the property and those brought by applicants for housing benefits.

Most recently, the Supreme Court rejected a third-party beneficiary claim brought by a county to enforce drug price limits set forth in contracts between pharmaceutical companies and the federal government, suggesting that the federal courts are unlikely to be receptive to such claims when the federal government asserts exclusive authority to enforce the contract.6 Astra USA, Incorporated v. Santa Clara County concerned Section 350B of the Public Health Services Act, which imposes limits on the prices drug manufacturers may charge certain health facilities, generally those serving low-income patients. To participate in sales to such entities, the Health Resources and Services Administration, an entity within the federal Department of Health and Human Services, requires the drug makers to enter into standard Pharmaceutical Pricing Agreements which set forth the statutorily-prescribed pricing limits. Santa Clara County conceded that there was no private right of action to enforce the statutes containing price ceilings, but argued that it was a third-party beneficiary to these Agreements. The Supreme Court rejected the claim, holding that the Agreements were not subject to negotiation, contained only terms required by the statute, and that, as a result, a third-party beneficiary claim was no different than a private right of action. The Court acknowledged that the Health Resources and Services Administration had lacked the oversight and authority to enforce these Agreements, but that Congress responded by affording the Health Resources and Services Administration alternative mechanisms for enforcement, including audits, dispute resolution procedures and refund and civil penalty systems.

5.3.A. Standing

 The federal courts and most state courts follow the Restatement (Second) of Contracts in determining the viability of any third-party beneficiary claim.7 Section 302 of the Restatement provides that:

(1)  Unless otherwise agreed between promisor and promisee, a beneficiary of a promise is an intended beneficiary if recognition of a right to performance in the beneficiary is appropriate to effectuate the intention of the parties and either

(a)  the performance of the promise will satisfy an obligation of the promisee to pay money to the beneficiary; or

(b)  the circumstances indicate that the promisee intends to give the beneficiary the benefit of the promised performance.8

The Restatement defines beneficiaries of a contract as being either intended or incidental. Only an intended beneficiary has standing to enforce a contract between two other parties.9 Whether a person is an intended beneficiary with the resulting right to sue depends upon the intent of the parties to the contract. That intent may be articulated in the contract itself, or discerned or imputed from the statutory context that prompted the contract to be executed.10

Generally, courts do not require that plaintiffs who contend they are third party beneficiaries be expressly identified in the contract as third party beneficiaries, or that an express provision grant them the right to sue to enforce the contract.11 The Federal Circuit recently explained that:

“Exceptional” though it may be, third-party beneficiary status is not reserved for those parties who benefit expressly under a given contract. We note, too, that “the intended  beneficiary need not be specifically or individually identified in the contract, but must fall within a class clearly intended to be benefited thereby.” Evidence of intent can be adduced. In short, it is sufficient to ask in the typical case "whether the beneficiary would be reasonable in relying on the promise as manifesting an intention to confer a right on him.”12

In two recent cases permitting third-party claims, the Alaska Supreme Court focused on the intent of the state government to provide a benefit to third parties, minimizing the importance of the intent of the private parties: a hospital and a private prison operator.13 In another recent case, the Virginia Supreme Court rejected the argument that a prisoner was only an incidental beneficiary due to his transient presence in the prison. The Virginia court stated that a third-party contract right “does not depend upon permanent membership in the class of persons entitled to receive the benefit of the contract” but instead exists so long as the person is a part of that class.14

Courts have also found intent to benefit a third party when one of the contracting parties owes the third party a pre-existing duty. This “duty owed” interpretation is drawn from the language of § 302(1)(a) of the Restatement (Second). Consequently, in an action under a contract that has been executed in conjunction with a government benefit program, the complaint should allege, when appropriate, that the recipient is the intended beneficiary of the contract between the state and the private entity because the state had a pre-existing duty to provide coverage to the recipient. A Tennessee appellate court, for example, upheld a third party claim based on its finding that "a nursing facility which has entered into a provider agreement with the state has a duty to assist a resident or applicant in applying for Medicaid eligibility."15   

When examining the issue of intent, it is important to distinguish between the implied intent of Congress when enacting federal law to create a cause of action and the implied intent of the parties to a contract to benefit a third party under state law. Thus, courts have held that even though there is no implied private right of action in the Medicaid or Medicare statutes, state law permitting third party claims can be utilized to enforce them.16 Nevertheless, courts have relied upon the purpose of federal statutes, such as the purpose of the Medicaid statute to provide medical care to needy people, in determining whether Congress intended to benefit eligible third parties.17

Despite the apparent breadth of § 302, several courts have denied third-party rights based on Restatement (Second) § 313, which deals specifically with government contracts.18 The Rule provides:

(1)  The rules stated in this Chapter apply to contracts with a government or governmental agency except to the extent that application would contravene the policy of the law authorizing the contract or prescribing remedies for its breach.

(2)  In particular, a promisor who contracts with a government or governmental agency to do an act for or render a service to the public is not subject to contractual liability to a member of the public for consequential damages resulting from performance or failure to perform unless

(a)  the terms of the promise provide for such liability; or

(b)  the promisee is subject to liability to the member of the public for the damages and a direct action against the promisor is consistent with the terms of the contract and with the policy of the law authorizing the contract and prescribing remedies for its breach.19

Section 313(2)(b) has been commonly interpreted to establish a presumption against third-party enforceability “unless the contract contains specific language providing [plaintiffs] with the right” to enforce its terms.20 Numerous commentators contend, however, that third-party claims for injunctive relief under government contracts should be analyzed solely under Restatement (Second) § 302.21 Indeed, Section 313 speaks only to claims for consequential damages.22

A line of decisions from the Federal Circuit holds that Section 313(2) applies only to suits “against promisors who had contracted with the government to render services to the general public and, therefore, [is] not relevant to third-party beneficiary analysis.”23 Commentators explain that Section 313(2) is intended to apply to commercial contracts with the government, not to public-benefits programs such as subsidized housing, Medicaid, and Medicare.24 This view is supported both by Section 313(1), which focuses on “the policy of the law authorizing the contract,” and by the illustrations in Section 313, which include contracts with mail carriers, utility companies, railway companies, and construction firms.25 Yet, while the prospect of money judgments against commercial contractors might become an impediment to public works projects, injunctive enforcement of public benefits contracts by individual beneficiaries may further the goals of those programs.26 In addition, it may be possible to argue that the contract at issue is not intended to benefit the public generally, but a defined group of person, thus rendering Section 313 inapplicable.27

Some contracts between the government and a private entity specifically state that the contract is not intended to create rights in third parties. In recent cases, courts have overwhelmingly held that such provisions defeat third-party beneficiary claims.28

5.3.B. Applicable Law

In general, state law governs third-party contract claims against private parties and local agencies.29 This is true even where the contract is with a federal agency under a federal-state program so long as no federal agency is a party to the suit. However, in the less common situation where "substantial rights or duties of the United States hinge on [the case’s] outcome,” federal common law applies.30

State courts vary in their receptivity to third-party claims, with some applying a “strong presumption” against finding third-party rights, and at the other extreme, others utilizing a presumption in favor of third-party rights.31 For example, in rejecting the third-party claims of housing residents seeking to enforce relocation rights when their homes were demolished, the court noted that Illinois law is “much more stringent” than federal law, and concluded that the agreement did not show that the parties “unequivocally intended to confer a benefit enforceable by Plaintiffs.”32

The Restatement (Second) of Contracts Section 212(2) provides that the interpretation of contracts is a question of law except where “it depends on the credibility of extrinsic evidence or on a choice among reasonable inferences to be drawn from extrinsic evidence.” State courts, however, vary widely as to whether third-party beneficiary status is a question of fact, law, or a mixed question of law and fact.33

5.3.C. Available Relief

Injunctive relief is available to remedy contract violations harming intended third-party beneficiaries. Sections 357, 365 and 366 of the Restatement (Second) make clear that both negative and mandatory injunctions (in the form of “forbearance”) are authorized as relief in third party beneficiary actions.

However, courts have split on the question of whether the Restatement (Second) Section  313 bars damages awards to third-party beneficiaries in suits involving government contracts. Section 313(2) provides that for damages claims involving government contracts, the plaintiff must demonstrate that the contract evinces a specific intent to benefit the third party. Indeed, in a recent case permitting third-party claims for injunctive and declaratory relief to proceed, the Alaska Supreme Court stated that the Restatement (Second) Section 313 does not subject government contractors to "liability for consequential damages resulting from their performance or failure to perform."34 Yet, several other recent cases, including one from the Alaska Supreme Court, have permitted third-party damages claims to proceed, without analyzing § 313.35

Updated 2013 by Kent Qian