Third Party Beneficiary Rights in Construction Contracts

Last week the United States District Court in Massachusetts issued an important decision concerning third party beneficiary rights in construction contracts.  In Arco Ingenieros, S.A. de C.V. v. CDM International Inc., Civil Action No. 18-12348-PBS, a design-builder incurred damages due to delays and other issues, and it sued one of the project engineers alleging several counts, including breach of contract.  Facing a motion to dismiss, the design-builder argued that it had standing to bring the claim as a third party beneficiary of the contract between the project owner and the engineer.  The Court disagreed.

Massachusetts generally follows the Restatement (Second) of Contracts for determining whether a third party may recover on a contract, which is that only intended third parties who derive a benefit from a contract can sue to enforce that contract.  The right is not extended to parties that incidentally benefit from or rely on the contract.  Whether a third party is an intended beneficiary is determined by looking at the contract terms.  If the terms are ambiguous, courts will look at extrinsic evidence, such as other documents or exchanges between the parties.

In this case, a federal agency was undertaking rebuilding efforts in El Salvador following a tropical storm.  The project owner hired CDM International Inc. (“CDM”) to provide initial site analysis and prepare a preliminary design, among other services.  The owner then hired Arco Ingenieros, S.A. de C.V. (“Arco”) through a competitive bid process as the project design-builder.  Arco relied in part on the preliminary design by CDM in preparing its bid and performing the work.  Arco alleged the project was delayed because of errors and omissions in the preliminary design prepared by CDM.  Arco sued CDM alleging several counts, including breach of contract, tortious interference, and misrepresentation.

CDM filed a motion to dismiss the breach of contract claim on the grounds that Arco was not an intended beneficiary of the contract between CDM and the owner.  The court looked at the particular contract language and held that the contract did not reflect any intent to benefit the design-builder.  Rather, the contract listed the services to be provided by CDM, all of which served to benefit the owner and its reconstruction project.  The Court held that Arco was an incidental beneficiary and did not have standing to sue on the contract.

This decision is consistent with other jurisdictions which generally do not support third party beneficiary status in the construction context without a clear indication of intent.  As the Court states, “[t]his is because significant construction projects generally involve multiple contracts that are ‘inevitably intertwined’ to ensure the project is completed in a timely manner according to the agreed-upon specifications.”

This decision is important for two reasons.  First, it reinforces significant and necessary risk protections for construction project participants.  In order to successfully deliver a project, several parties need to work intricately and collaboratively, and need to be able to rely on one another in a dynamic working environment.  If each was exposed to the others’ contract requirements, the level of risk would be untenable.  Second, it reinforces that contract drafting and due diligence is imperative in order to identify and mitigate this type of exposure.  Had the contract between CDM and the owner been drafted differently, for example with specific flow down clauses or third party beneficiary clauses, the Court may well have denied the motion to dismiss, and CDM may have been left exposed.

About David Fine

David is an partner in the firm's Litigation Group and is chair of the Construction Law Group. David serves as litigation counsel for contractors, subcontractors, suppliers and other business concerns within the construction industry. He regularly advises his clients on matters such as contract drafting and dispute resolution, surety bond claims, mechanics liens and bid protests. David works closely with a number of local and regional trade organizations, and he often lectures and writes about topics pertinent to the construction industry.
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