Third-Party Beneficiaries: Can an Owner in Wisconsin Claim to be a Third-Party Beneficiary of a Contract Between a General Contractor and a Subcontractor?

WDC Journal Edition: Spring 2008
By: Ariella Schreiber

I. Introduction

In Linden v. Cascade Stone Co, Inc., the Wisconsin Supreme Court held that the application of the economic loss doctrine prevents an owner from bringing a claim in tort directly against a subcontractor.[1] In so holding, the court suggested that an owner may still have direct rights against subcontractors because the owner is a third-party beneficiary of the contract between the general contractor and the subcontractor.[2] This is an unresolved issue of law in Wisconsin.

The claim that an owner is a third-party beneficiary to a contract between the general contractor and a subcontractor may arise in any number of ways. For example, in Linden, the owners settled with the general contractor before trial and attempted to proceed with claims against two subcontractors, Cascade Stone Co. and Fern Construction.[3] This issue might also arise where a general contractor is insolvent and the owner can therefore no longer look to the general contractor for damages caused by a subcontractor.[4] This article addresses whether an owner in Wisconsin may claim to be a third-party beneficiary to a contract entered into between a general contractor and a subcontractor.

II. Third-Party Beneficiary Law in Wisconsin

Wisconsin courts have allowed third-party beneficiary claims in certain situations. To maintain an action as a third-party beneficiary, a plaintiff must show that the parties to the contract “intentionally entered their agreement directly and primarily for his benefit.”[5] More specifically, “[i]n order to entitle a stranger to a contract to recover thereon, the contract must indicate an intention to secure some benefit to such third party.”[6]

A third party cannot maintain an action as a third-party beneficiary if, under the contract, his was only an “indirect benefit, merely incidental to the contract between the parties.”[7] The contract must indicate that the third-party either was specifically intended by the contracting parties to benefit from the contract, or is a member of a class the contracting parties intended to benefit.[8]

An owner will attempt to argue that he or she is not an incidental beneficiary of the contract between a general contractor and a subcontractor because the direct consequences of the contract – the construction of a building – will accrue to the owner. After all, the contract between the general contractor and the subcontractor would not have been made without the owner, and the work performed by the subcontractor will be incorporated into the home. In light of some Wisconsin case law, this argument appears to have some merit. For example, in Auric v. Continental Cas. Co., the Wisconsin supreme court addressed whether privity of contract was necessary in order to sue an attorney who had not had a will properly executed.[9] Although the words “third-party” do not appear in the opinion, the court held that the beneficiary of a will did not need privity to sue the drafting attorney because it was “clear that this will was intended to bring direct benefit to the plaintiff.”[10] This holding reaffirms Wisconsin’s rule that a plaintiff must show that it was an intended beneficiary of a contract between other parties in order to reap the benefits of that contract.

There are no cases directly on point addressing the issue of whether an owner can be considered a third-party beneficiary to a contract between a general contractor and a subcontractor. In order to fully understand how this issue has been treated, I looked to other jurisdictions.

III. The Treatment of this Issue By Other Jurisdictions and Legal Commentators

Results from other jurisdictions are mixed, however the majority of other jurisdictions and legal commentators hold that an owner is not a third-party beneficiary to a contract between a general contractor and a subcontractor. Many cases have refused to permit an owner to bring suit against a subcontractor.[11] Others have permitted such a suit.[12] Still others have indicated that an owner’s right to bring suit depended on the facts of the particular case,[13] or held that the owner could recover on some theory other than third-party beneficiary law, such as negligence[14] or subrogation to the rights of the general contractor.[15]

  1. The Majority of Courts and Legal Commentators Hold that an Owner May Not Claim Third-Party Beneficiary Status to a Contract Entered Into Between a General Contractor and a Subcontractor

When an owner enters into a contract with a general contractor, the contract concerns the production of a finished product: a building. This view is supported by the Wisconsin supreme court.[16] Allowing an owner to directly sue a subcontractor for its defective work via a third-party beneficiary theory is, in essence, allowing the owner to sue the subcontractor for a breach of duty. But did the subcontractor ever actually have a duty directly to the owner? As discussed below, in the majority view such a duty only arises when an owner is an intended third-party beneficiary to a contract entered into between a general contractor and a subcontractor.

Section 302 of the Restatement on Contracts concerns intended and incidental beneficiaries.[17] Section 302 states:

(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.

(2) An incidental beneficiary is a beneficiary who is not an intended beneficiary.[18]

Under this theory, only an intended beneficiary may exert rights to a contract of which he or she is not a party.

Comment e to Section 302 notes that unless the third person fits the definition of an intended beneficiary, as therein defined, then “no duty to him is created. . .”.[19] Illustration 19 to Comment e offers the following example pertaining to construction contracts:

A contracts to erect a building for C. B then contracts with A to supply lumber needed for the building. C is an incidental beneficiary of B’s promise, and B is an incidental beneficiary of C’s promise to pay A for the building.[20]

Thus, C, the owner of the building, is an incidental beneficiary of the contract between A, the general contractor, and B, the subcontractor unless A and B specifically agree otherwise in their contract.

Corbin notes that “[contracts between a general contractor and subcontractor] are made to enable the principal contractor to perform; and their performance by the subcontractor does not in itself discharge the principal contractor’s duty to the owner with whom he has contracted.”[21] He uses the example of the installation of a plumbing fixture or the construction of cement floors by a subcontractor to illustrate this point, and notes that the completed installation does not discharge the duty of the general contractor because that duty is to “deliver a finished building containing those items. . . [I]f after their installation the undelivered building is destroyed by fire, the [general] contractor must replace them for the owner, even though he must pay the subcontractor in full and has no right that the latter shall replace them.”[22] Ultimately, both Corbin and the Restatement conclude that unless the general contractor and the subcontractor otherwise agree and intend that the owner will be a third-party beneficiary, an owner is only an incidental beneficiary to their contract.

Some courts have attempted to resolve this issue by applying an “intent to benefit” test. That test provides that there must be evidence, on the part of the promisee, that he intended to directly benefit a third party, and not simply that some incidental benefit was conferred on an unrelated party by the promisee’s actions under the contract.[23] There must be evidence that the promisee assumed a duty to the third party.[24] Under that reasoning, an owner may be considered a third-party beneficiary to a contract between a general contractor and a subcontractor, but only if the subcontractor has intentionally assumed a duty to the owner, the third party.

The intent to benefit test, however, has lead to inconsistent results. For example, both the southern district of Georgia[25] and the New York court of appeals[26] have held that the owner was not an intended beneficiary of the contract between the general contractor and the subcontractor. In a case addressing the same issue, however, the Alaska supreme court held that the owner was “obviously” an intended beneficiary. [27]

Unfortunately, most cases do not go beyond a summary conclusion that the owner is,or is not, an intended beneficiary. Those that do go further purport to discern the requisite “intent” by looking for references to the owner in the contract between the general contractor and the subcontractor, or in other communications between them.[28] Since the object of all construction contracts, however, is ultimately to “benefit” the owner with the finished product, such references to communications or contractual relations between the subcontractor and general contractor are not necessarily indicative of the parties’ intent to benefit the owner.

Under both the Restatement and Corbin, then, without clear words or indications to the contrary included in the contract between the general contractor and the subcontractor, “the owner has no right against the subcontractor.”[29] The owner is not a beneficiary of the contract, and the benefit that the owner receives from performance must be regarded as merely incidental. This is because the duty assumed by the general contractor – to construct a finished building – is not discharged by the subcontractor’s completion of its portion of the work. The completion of the plumbing or flatwork in a home does not complete the actual construction of the home; it is the general contractor who has assumed that duty. Both Corbin and the Restatement require that any plaintiff claiming third-beneficiary status to a contract show that the contracting parties intended the plaintiff to receive the benefit of their bargain.

  1. A Minority of Courts and Legal Commentators Allow an Owner to Claim Third-Party Beneficiary Status to a Contract Entered Into Between a General Contractor and a Subcontractor

Some jurisdictions endorse the view that the owner is a beneficiary of the contract between the general contractor and the subcontractor, on the theory that the subcontractor has agreed to perform an obligation that the general contractor owes to the owner. Such a conclusion would support the dictum in Linden that an owner may have direct contractual remedies against a subcontractor.

For example, the California court of appeals has held that an owner may be an intended beneficiary of a contract between a general contractor and a subcontractor:

[T]he general contractor, Appel, had the duty under its contract with Gilbert [the owner] to furnish all the material and labor necessary to construct the building in question. Steelform [the subcontractor] subcontracted with Appel to furnish the materials and labor necessary for the construction of the roof. Clearly, Steelform (the promisor) realized it was assuming Appel’s (the promisee) duties for this phase of the construction, and that Gilbert was the ultimate beneficiary of its performance as the owner of the building. . . . Gilbert would obviously be a creditor beneficiary.[30]

The rationale for allowing the owner to receive the benefit of the contracting parties’ bargain was that the subcontractor “realized it was assuming” the general contractor’s duties for that aspect of the construction, and that Gilbert was the “ultimate beneficiary” of that work.[31] Thus, rather than the “intended direct beneficiary” requirement utilized by the majority view, California read between the lines of the contract and allowed a homeowner to maintain third-party beneficiary status even though the owner was not in privity of contract with the subcontractor.

This theory also finds some support in at least one legal commentator. As stated by Farnsworth, an owner (C) has contracted with a general contractor (B), who has contracted with a subcontractor (A). The subcontractor then performs some defective work on the building, and the owner makes a claim “vertically” against the subcontractor.

[S]ome [cases] have allowed the owner to recover as a creditor beneficiary despite the fact that the subcontractor’s performance is not performance of the general duty to the owner to furnish a completed building. To the extent that an owner is in a better position to insist on a contract clause to support its claim than is a contractor in a ‘multi-prime’ situation, the owner who has not done so may be in a weaker position to seek judicial relief.[32]

This analysis, however, is not supported by either the Restatement or Corbin, and appears to apply only to a limited exception where there are multiple prime contracts. Comparing this example to the ones used in Corbin and the Restatement may be comparing apples to oranges because the examples themselves are not analogous. Neither Corbin nor the Restatement address situations in which there are multiple prime contractors, and Farnsworth does not address whether an owner could maintain third-party beneficiary status in the absence of multiple prime contracts.

IV. Conclusion

In Wisconsin, the third-party beneficiary doctrine unequivocally holds that a party cannot be considered a third-party beneficiary to a contract unless the contract clearly intends that party to be a beneficiary. The language in Linden suggests that the supreme court may intend for owners to have some contractual remedies against subcontractors in the event that none exist against the general contractor.

The great majority of case law and the analyses by legal commentators suggest that subcontractors do not normally have duties to anyone other than the general contractor. Those commentators propose that an owner is not a third-party beneficiary to a contract between a subcontractor and a general contractor because the owner is not in privity of contract with the subcontractor.

Depending upon whom an attorney represents, the analyses outlined above will be useful in different ways. An attorney representing an owner would obviously want to advance the minority view in order to gain contractual rights against a subcontractor. This may also be true of an attorney representing a general contractor. On the flip side, an attorney representing a subcontractor will want to advance the majority analysis on this issue.

Wisconsin’s failure to address this issue has left circuit courts and the Wisconsin court of appeals with little guidance as to how to determine whether a third-party beneficiary is either intentional or incidental.

If the Wisconsin supreme court follows the majority rule detailed above, then an owner will be considered an incidental beneficiary to any contract between a general contractor and a subcontractor, unless the contract otherwise names them as an intended beneficiary. If the minority rule is followed, then the fact that an owner accrues a benefit from the subcontractor’s performance of its work is enough for the owner to derive the benefit of that bargain. At this point, under Linden, the only way for an owner to make any claim against a subcontractor is to sue the general contractor, who will have contractual contribution and/or indemnification rights against its subcontractors.

[1] 2005 WI 113, ¶ 32 , 283 Wis. 2d 606, 699 N.W.2d 189.

[2] Id. at ¶ 31 (“Additionally, we have never addressed whether a third-party beneficiary action by a homeowner could lie against a subcontractor, and if so, under what circumstances it would be appropriate. In some jurisdictions when a general contractor is insolvent, courts have permitted contract actions against the subcontractors under a third-party beneficiary theory. Some of the jurisdictions that permit claims by a homeowner against a subcontractor do so because “the subcontractor has agreed to perform an obligation that the [general] contractor owes to the owner.” Melvin Aron Eisenberg, Third-Party Beneficiaries, 92 Colum. L. Rev. 1358, 1403 (1992). . . However, because the Lindens did not present their contract claim for our review, we take no position on whether such a claim could be maintained.”) (footnotes omitted).

[3] Id. at ¶ 3 n. 1.

[4] It is, of course, possible for an owner to sue a general contractor’s bankruptcy estate for construction defects. Once the general contractor has entered bankruptcy, however, the owner’s claim against the general contractor can only be brought against the bankruptcy estate, and the general contractor’s claim against the subcontractor can only be brought by the bankruptcy trustee. See 11 U.S.C. §541(a)(1) (2008). The owner will normally have no incentive to sue the general contractor’s estate because the returns in a suit against a bankruptcy estate typically constitute only a fraction of the debt. Likewise, the bankruptcy trustee has no incentive to bring suit because the proceeds of the suit would benefit the general estate, not merely the owner. In fact, the trustee has no obligation to pursue an action that is either “burdensome” or “inconsequential”, making it likely that the trustee would not elect to pursue this remedy. See, e.g., Midwest Concrete Prods. Co. v. LaSalle Nat’l Bank, 418 N.E.2d 988, 990 (Ill. App. Ct. 1981).

[5] Schell v. Knickelbein, 77 Wis. 2d 344, 348, 252 N.W.2d 921 (Wis. 1977) (internal quotation omitted) (citation omitted).

[6] Id. at 349 (internal quotations omitted) (citation omitted).

[7] Id. (internal quotation omitted) (citation omitted).

[8] Dorr v. Sacred Heart Hosp., 228 Wis 2d. 425, 450, 597 N.W.2d 462 (Ct. App. 1999) (citation omitted).

[9] 111 Wis. 2d 507, 331 N.W.2d 325 (1983).

[10] Id. at 514 (emphasis added). It is important to note that the court emphasized an attorney’s duty to its clients and public policy aspects of enforcing a will when it made this decision. Such public policy aspects may not exist in the owner-general contractor-subcontractor relationship, and thus Auric is not dispositive on this issue.

[11] See, e.g., Pierce Assocs., Inc. v. Nemours Found., 865 F.2d 530, 535-39 (3d Cir.), cert. denied, 492 U.S. 907 (1989); Vogel v. Reed Supply Co., 177 S.E.2d 273, 277-79 (N.C. 1970); Manor Junior College v. Kaller’s, Inc., 507 A.2d 1245, 1246-48 (Pa. Super. Ct. 1986).

[12] See Syndoulos Lutheran Church v. A.R.C. Indus., 662 P.2d 109, 113-14 (Alaska 1983); Oliver B. Cannon & Son, Inc. v. Dorr-Oliver, Inc., 336 A.2d 211, 215-16 (Del. 1975).

[13] See Chestnut Hill Dev. Corp. v. Otis Elevator Co., 653 F. Supp. 927, 930-31 (D. Mass. 1987).

[14] It should be noted that the holding in Linden forecloses a Wisconsin owner’s ability to bring such a cause of action in tort.

[15] See National Cash Register Co. v. Unarco Indus., Inc., 490 F.2d 285, 286-87 (7th Cir. 1974).

[16] See Linden, supra, 2005 WI 113, ¶ 25 (holding that the general contract is a contract for a finished product, the building).

[17] Restatement of the Law 2d, Contracts, § 302 439-440 (1981).

[18] Id.

[19] Comment e to Section 302, at 443 (stating that “[p]erformance of a contract will often benefit a third person. But unless the third person is an intended beneficiary as here defined, no duty to him is created . . .”).

[20] Id. at 444.

[21] 9 Corbin on Contracts (2002 Interim ed.) Section 779D, at 40-41.

[22] Id.

[23] See, e.g., TRINOVA Corp. v. Pilkington Bros., P.L.C., 70 Ohio St.3d 271, 277-78, 638 N.E.2d 572 (1994).

[24] Id.

[25] Kaiser Aluminum & Chemical Corp. v. Ingersoll-Rand Co., 519 F. Supp. 60, 72-73 (S.D. Ga. 1981).

[26] Lake Placid Club Attached Lodges v. Elizabethtown Builders, Inc., 521 N.Y.S.2d 165, 166 (App. Div. 1987).

[27] Syndoulos Lutheran Church v. A.R.C. Industries, Inc., 662 P.2d 109, 114 (Alaska 1983).

[28] See, e.g., Chestnut Hill Dev. Corp. v. Otis Elevator Co., 635 F. Supp. 927, 930 (D. Mass. 1987).

[29] See 9 Corbin on Contracts, Section 779D at 40-41.

[30] Gilbert Fin. Corp. v. Steelform Contracting Co., 145 Cal. Rptr. 448, 451 (Ct. App. 1971).

[31] Id.

[32] 3 Farnsworth on Contracts (2 ed. 1998) 30-31, Section 10.4.