Boilerplate Series: Contractual Third-Party Beneficiaries

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Tom Wolfe, Managing Partner of Moore Brewer Wolfe Jones Tyler & North.

In the credit union vendor world, it is not unusual for a credit union to contract for services with a vendor, often a credit union service organization (“CUSO”), who in turn has contracted with some other third party who is the actual provider of the services. For purposes of this article, let’s assume we are dealing with a CUSO as the credit union vendor. Often a CUSO recognizes that another vendor (let’s call them Gumby Industries) can provide a significant value to the credit union space. So far, Gumby has either not recognized the value of the credit union market or has always dreamed of entering the credit union space (and rightfully so, as we all know) but cannot see a way to penetrate that market.

CUSO/Gumby Contract

The CUSO and Gumby decide to enter into a contractual relationship whereby CUSO is the marketer to credit unions and Gumby provides the actual services. All are happy.  Lawyers are added to the process to draw up to terms of the contract and, of course, some of the joy is lost.

  • CUSO and Gumby agree that it is CUSO’s job to directly contract with the credit unions (the “customers”). This also means that CUSO is directly responsible by contract to the credit union customers for the services provided by Gumby.
  • While CUSO is happy to take on that responsibility, it also recognizes that CUSO is just a marketer; Gumby is actually providing the services and should bear some responsibility.
  • Gumby sees serious financial gain in its future, but to actually recognize that gain, it concedes that it must ultimately be responsible to the credit union customer for its services.
  • There are significant caveats to that concession. For example, if CUSO commits fraud to induce a credit union to enter into a contract, or if CUSO fails to meet a contractual duty, such as the duty to report problems a credit union is having with Gumby’s services, then Gumby’s liability is eliminated or reduced.
  • Otherwise, assuming CUSO meets its contractual obligations, Gumby is on the hook for its services.

The CUSO/Gumby contract is executed (lawyer’s term for signed) and everyone rejoices. (After all, it’s almost always late on Friday when this happens.) Then Monday comes around and the CUSO recognizes that we need yet another agreement – one between the CUSO and the credit union customer. That means we need to bring in the lawyers again. (Typical Monday!)

CUSO/Credit Union Contract

So how do the lawyers ensure that Gumby can be held liable in a contract between CUSO and a credit union? After all, one of the basic tenets of contract law is that, for a party to be liable under a contract, they must have assented to the agreement. That is most often done by executing a written contract. (Note: There are other ways to find assent, but we’ll leave that fun, and oh such fun, for another article.)

To the rescue comes an old common law (i.e., non-statutory) concept of third-party beneficiaries. Simply stated, the law recognizes the concept of where two parties may enter into a contractual relationship not solely for their own benefit, but at least in part for the benefit of a third party who is not a party to that contract. In our scenario of the three-way relationship between Gumby/CUSO/credit union customer, who is our third-party beneficiary?

Survey of our readers says...credit union customer! (Of course, you are right. You are brilliant.)

So, where and how does this come about? It’s pretty simple and it’s now supported in California express statute (Calif. Civil Code §1559); no need to rely on the Common law doctrine.

While the law and cases surrounding the law can add layers of complexity to the third party beneficiary concept, for our purposes, when considering signing such a relationship contract, you want to be sure that your credit union is made an express or intended beneficiary of the underlying contract between the CUSO and Gumby.

How then do we make sure that protection is in the CUSO/credit union agreement? While a paperwork hassle (and not so good for trees), adding the underlying CUSO/Gumby contract as an exhibit to the CUSO/credit union agreement is a good “belt and suspenders” protection for the credit union customer.

Another approach is to add what we lawyers call a “representation and warranty” from CUSO to the credit union customer that the CUSO/Gumby contract contains the third-party beneficiary protections. “Reps and warranties” (our shorthand term) is merely the CUSO’s written contract provision saying we (the CUSO) are promising and it is a fact that you are protected as a third-party beneficiary in our Gumby contract. While this too is a bit of belt and suspenders, it helps the credit union’s lawyer go to court to put CUSO in the liability seat should the Gumby contract not provide the protections CUSO promised.

One last point – as with all contractual provisions, whether business terms or boilerplate, your contract protections are only as good as the party signing the contract. The regulators require that, and your lawyers love it when, you conduct thorough and effective business due diligence on your proposed vendor. It is the foundation of a good vendor relationship. Also, if I may, bring your lawyers in before you negotiate every last point of your business relationship. Remember, in all likelihood, they are going to bring up legal issues that are just as important as business issues. If you have nothing left to use as bargaining power, you leave the credit union in a weakened position when it needs (sometimes must) have legal issue concessions. So, bring in counsel early and often to protect your credit union. No joke.

Article by Tom Wolfe, Managing Partner of Moore Brewer Wolfe Jones Tyler & North.

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