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Third-Party Beneficiaries of a Contract - by AllParadox
Thursday, December 23 2004 @ 07:48 AM EST

Groklaw's AllParadox thought you might enjoy an explanation of a contract concept called third-party beneficiaries. As you will see, it has a bearing on what the 1994 USL-Regents of California Settlement Agreement means to Linux users. AllParadox is an attorney, now retired.

*************************************

The USL-Regents of California Settlement Agreement:
What it means to the Linux User
~by AllParadox

With the recent publication of the 1994 settlement agreement from the USL v. BSDi lawsuit, a question may arise: what does it mean to Linux users today? The answer to that requires explaining a contract concept, “third-party beneficiaries", because with respects to the settlement, that's what we Linux users are.

In any specialty, understanding the special meanings of terms underpins understanding their application, and law is no different. In law school, first-year law students are taught that a contract is an exchange of promises: a promise for a promise.

A party to a contract may make a promise, or be a promise recipient. Under the Common Law, a contract may be oral or written. When a contract is written, one of the first steps is to write out the names of the parties. Contracts may be among any number of people, but by far the most frequent situation is two-party contracts. The archaic but familiar phrases are “the party of the first part” or “the party of the second part”. Maybe you saw the old Marx Brothers skit.

Parties to a written contract negotiate terms, come to an agreement on terms, and consummate the transaction by signing the contract. Often, the negotiation, agreement and consummation by one party amounts to nothing more than voluntarily signing a pre-prepared document, but that is enough. The special relationship the parties engage in -- negotiations, agreement, consummation -- has an ancient name: the parties are said to be “in privity”.

Making things more interesting, a contract may confer a benefit on a person who has not participated in the negotiations, has not agreed to the terms, and has not signed the contract. In an atmosphere of “a promise for a promise”, these people have made no promises. The lack of participation, of commitment, can cause distinct problems.

In keeping with the other archaic terminology, these people who benefit, or beneficiaries, are given a specific name. Being not the parties of the first part or the second part, they are designated third-party beneficiaries.

Contracts are enforced in courts, sometimes sitting as equity but usually sitting as civil. In dealing with these persons, the Common-Law courts have given names to various categories of third-party beneficiaries:

  • A donee beneficiary is someone who receives the benefit as a gift.
  • A creditor beneficiary receives the benefit as a satisfaction of an obligation by one or more of the parties.

Donee beneficiaries and creditor beneficiaries are collectively called intentional beneficiaries. Any other third-party beneficiary is called an incidental beneficiary. If you are interested in more depth on this subject, try the Tennessee Supreme Court Opinion of OOIDA v. Concord EFS, Inc., Flying J, Inc., et al., 59 S.W.3rd 63 (Tenn. 2001). I have not shepardized OOIDA recently, so I do not know if it is still good law, but I think the court’s explanation and analysis is informative.1

“Donee” is the word used because it holds a special position in contract law. As stated above, a contract is an exchange of promises. A glaring exception is gifts. Often, a promise to make a gift, with no return obligation whatsoever, is an enforceable contract. The donee may go to court and enforce the naked promise. Beware pledges to charitable organizations if you do not intend to honor them, because they may be enforced.

Probably the most commonly known example of an explicit third-party beneficiary is the life-insurance policy. The owner is the individual that purchases the policy and is usually the insured life, the insurance company is one of the parties, and the third-party beneficiary is the beneficiary.

Commercial transactions can be quite complicated, requiring many persons to complete a task. Often, a single proprietorship or company cannot satisfy all the requirement of contract, so they will enter into other contracts to fulfill their obligations.

A common example of that situation is the home builder, or general contractor. The general contractor subcontracts various construction tasks to specialized craftsmen: carpenters, electricians, plumbers, architects, and civil engineers, as needed. Depending on local law and the terms of the subcontract, the person having the building built may enforce the subcontract as a creditor beneficiary.

A more frequent example, though hardly mentioned, is third-party beneficiaries of warranties. Many states have enacted laws that make family members of a purchaser the beneficiaries of any warranty on a purchased product. (See, for example, www.moga.mo.gov/statutes/C400-499/40002A0216.HTM, which lists Missouri’s statutory version of a Uniform Commercial Code (UCC) regulation, 400.2A-216, “Third-party beneficiaries of express and implied warranties”.

Simply put, intended third-party beneficiaries of a contract may enforce the contract in court. A beneficiary of a life insurance policy may sue in civil court in his own name to enforce the policy after the death of the insured. Incidental beneficiaries may not sue to enforce a contract, but they may still receive contractual benefits without assuming any obligations under the contract.

Let me bring you back again to that simple statement where we began the analysis: a contract is an exchange of promises. This says nothing about the title at the top of the document. If a document codifies an exchange of promises, it is a contract. That is how it works.

So, for example, suppose we have a document titled simply: Settlement Agreement, with a first paragraph of:

This Settlement Agreement is entered into between UNIX System Laboratories, Inc. ("USL"), a Delaware corporation, and The Regents of the University of California (the "University"), a California corporation.

If, within the body of the document, it contains a promise for a promise, it is a contract, and is to be interpreted according to contract law. The fact that it settled a lawsuit does not prevent it from being a contract. Indeed, that fact reinforces the contractual nature of the document. The fact that the lawsuit itself was started when USL was owned by AT&T but was settled by Novell after Novell purchased from USL is irrelevant because if Novell is the successor-in-interest, it had the power to settle and to contract.

We at Groklaw find this document fascinating merely for its meaning in the context of the ongoing SCO lawsuits, but there is something else very interesting buried within it, almost casually thrown in:

c. USL agrees that it shall take no action against any person who utilizes any methods and concepts in the Restricted Files which as of this date have become available to the general public by acts not attributable to the University, its employees or students. Nothing in this provision shall limit USL's rights against a third party arising out of a breach of any license agreement with USL or AT&T. . . .

and

i. USL agrees that it shall take no action based on the use or distribution by any person of material contained in the Unrestricted Files.

The Regents of the University of California are no ordinary profit-making corporation. They are a non-profit organization, with a specific mandate from the State of California to equip members of the general public, and California residents in particular, with the education and intellectual tools that are valuable and necessary to engage in commerce and to promote social welfare.

You and I, dear reader, are the intended third-party beneficiaries of this contract.

And to make it even more concrete, think of this settlement in context. At the time the parties signed the contract, a college student named Linus Torvalds had recently written and released a kernel called Linux, and together with the GNU system, it became a complete operating system. You may have heard of it. Although the OS was not used by a large number of people at the time, it was all the buzz in software development circles. I think it is a reasonable and enforceable inference that the users of Linux code were specifically included members of the third-party class created by the contract.

The USL-Regents Settlement is a broad shield. The way I see it, if you or I are ever sued by any USL successor-in-interest -- SCO, Novell, oldSCO/Tarantella, or any conceivable USL successor-in-interest -- for infringing USL copyrights on the code described in the Settlement, we have a powerful copyright infringement defense.

Remember: it only applies to the code specifically covered by the Settlement Agreement, and we are only discussing persons claiming ownership as successor-in-interest. The defense can be used against every person claiming to be a copyright-owning USL successor-in-interest, claiming to have owned the copyright from before the agreement.

As we know, much of the code copyrights were actually owned by others and there are issues about the validity of "The SCO Group" as successor-in-interest, but it doesn't matter. In trial work, it is often easier to win the obvious than to litigate murky foundational questions like chain-of-ownership.

All successors-in-interest hold the copyright and the restriction in the same hand (assuming anyone holds a valid copyright in this picture). To assert the copyright in court is to concede the Settlement restriction. If a plaintiff neglects to mention the Settlement in the complaint, then the defendants may interpose the Settlement. That will settle all copyright claims founded on the code described in the Settlement, with no further evidence or proof. It is a complete defense to those copyright claims.

Of course, new material, including new code created since the adoption of the Settlement and added to UnixSysV, will have its own copyright issues, and none of this discussion applies to any new material.

One last point: the Settlement was apparently concluded in the State of California. If so, then this analysis is affected by a California statute, Civil Code Sec. 1559, which provides that “a contract made expressly for the benefit of a third person may be enforced by him at any time before the parties rescind the contract.”



1 The decision is not available for free on the Internet, but here is a detailed review of what the Court wrote. An excerpt:

"Specifically, the Court held:

A third party is an intended third-party beneficiary of a contract, and thus is entitled to enforce the contract's terms, if

1. The parties to the contract have not otherwise agreed;
2. Recognition of a right to performance in the beneficiary is appropriate to effectuate the intention of the parties; and
3. The terms of the contract or the circumstances surrounding performance indicate that either:
a. the performance of the promise will satisfy an obligation or discharge a duty owed by the promisee to the beneficiary;
or
b. the promisee intends to give the beneficiary the benefit of the promised performance."


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