Business Contracts – Beware of Third Party Beneficiaries -They May Not Be Missing Persons

By: Robert Hawn

As a business attorney with a Silicon Valley practice, I create a lot of contracts for many different kinds of companies. It never gets boring! One of the issues we sometimes worry about is whether there are any other parties that might have rights under these contracts. This concept, which lawyers refer to as a “third party beneficiary right,” is often disclaimed in the agreement. Job done, right? Well maybe not.

In January of this year, a Ninth Circuit Court of Appeals looked at whether third party rights exist where they have been expressly disclaimed in an agreement and decided that, the facts need to be examined further. Whether this case will expand third party rights, or will just be limited to its particular facts, remains to be seen. It does, however, caution business people to make sure of the deals they cut so that only the parties with whom they deal with in the contract will be the parties they have to deal with in court if the deal goes sideways.

For you fans of 80s Rock, this case involved the lead singer of the band, Missing Persons. The facts, however, are not just a simple case of walking in L.A., so pay attention.

Dale Bozzio, the lead singer of the band, brought suit against Capitol Records, and its corporate parent, EMI, to collect royalties based on what was argued to be a mischaracterization of the source of the record company’s revenue for the band. Like many bands, Missing Persons had created a “loan-out corporation.” This is a corporation that is used to cut deals with, among others, record companies. Under the contract, Bozzio, along with her other band mates, agreed that they would not bring any claims for royalties individually against the record company, but only against the loan out corporation. Problem was, the corporation was suspended when the band broke up and therefor had no standing to sue. So, a lower court looked at the contract and said no corporation, no lawsuit, and besides you agreed not to sue, so go away. Bummer. Bozzio appealed.

The Ninth Circuit looked a bit closer at the contract, and said not so fast. To make a long song into radio format, the Ninth Circuit looked at some other parts of the law and the contract and said that Bozzio could have her day in court. They were swayed by prior case law that seemed to imply that the fact that the corporation could not sue did not necessarily mean that someone claiming third party beneficiary rights under that corporation could not sue. They were also swayed by a clause, presumably created to protect the record company, that said that if the loan out corporation could not provide Bozzio’s services, that she would provide them directly. In addition, the Agreement provided for royalty payments individually under certain circumstances, which allowed the court to conclude that the record company may have accepted the concept of individual rights for Bozzio under the agreement, and that her standing as a third party beneficiary of the loan out corporation’s rights against the record company existed, notwithstanding her promise not to sue the record company directly.

So what is the takeaway? First, just excluding a person as a third party beneficiary might not do the trick. You need to look and see if there are any other provisions affecting those shareholders that might allow them to assert rights sufficient to allow them to sue you. This case is particularly interesting because a clause that was, in my opinion, created to help the record company (i.e., the clause that allowed the record company to get Bozzio’s services when the loan out corporation would not provide them) was used against the record company. Second, and probably most important, you need to keep in mind that the law in this area is fuzzy and fact dependent, and you have to consider these types of rights as you evaluate the risk of any deal.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.