United States: Don’t Purport To Bind Third Parties To Your Contract

Picture the following: you're walking down the street, minding your own business, maybe eating some ice cream. All of a sudden — bam! You're hit with an obligation. You didn't even know it was coming. Before you know it, Big Brother just contractually bound you to an indemnification obligation under a contract that you didn't even sign.

And then you wake up in a cold sweat. It's ok. It was all just a bad dream. Imagine what life would be like were your nightmare to be reality.

Yet this is what I see all too often in contracts: the parties purporting to bind to their contract individuals or entities that haven't signed that contract. Here are some examples:

  • The Accountants shall deliver a report no later than 60 days after the Closing Date. What if the Accountants shalln't? You can't sue them under the terms of the purchase agreement in which this sentence is contained. Obligate the Accountants to produce and timely deliver their report under an engagement letter, not a purchase agreement that the Accountants didn't sign.
  • The Company's board shall meet each Tuesday at 10 a.m. Let's suppose that this purported obligation is contained in a joint venture contract, not the bylaws of a corporation. Unless the board members are signing that contract, don't purport to obligate them to meet. (Exception: there's law out there that says that managers of a Delaware LLC are bound by the terms of the LLC's operating agreement. This might be true in other contexts as well.)
  • The Company, the Company's affiliates, and the representatives of each of the foregoing shall not disclose any Confidential Information. Ok for the Company; not ok for the Company's affiliates and representatives. Here's an example of where you might want to use conditional language: if any of the affiliates or representatives discloses Confidential Information, then the Company is on the hook for damages or must take actions to stop that disclosure from continuing to occur.

The problem of "cause"

If you're trying to solve these kinds of problems, don't fall into the trap of solving the problem by obligating a party to "cause" another person that that party doesn't control to take or not take action. That won't completely work unless (1) that party can actually control the actions of the other person (e.g., a parent company controlling its subsidiaries) or (2) you include a concept in your contract of what the obligation to "cause" someone to do something means (e.g., the party must exercise that party's rights under its contracts with the other person to seek recourse against that other person).

Some examples:

  • The Company shall not engage (and shall cause the Company's affiliates not to engage) in any Competing Activities. The Company will not be able to exercise control over those entities that it does not control (e.g., parent companies and "sister" affiliates). There of course might be other bases for bringing action if sister entities engage in Competing Activities. For example, if the entities share common officers and directors, the beneficiary of that non-competition obligation might be able to bring some sort of action. (I leave the details of that claim to you litigators.) But any such action would be extra-contractual and I would not rely on it as a basis for breach of contract.
  • The Company shall cause the Company's suppliers to timely deliver all Raw Materials. There are probably arguments that you could make as to what "cause" means here, i.e., the Company has to take some degree of action to try to get its suppliers to deliver Raw Materials on time. But I'd want to flesh out exactly what the Company has to do (or at least include a non-exhaustive list of actions that the Company is required to take).

What to do

There are a couple ways to plug these third-party gaps. Consider using one or more of the following:

  • Have the person that you want bound sign the contract, even if it's for only limited purposes.
  • Have a party "cause" the third party to take action; just be sure that you define what "cause" means or are comfortable with the potential ambiguity that comes along with that concept given the context.
  • Include a "trigger"—a consequence under the contract if the third party takes unwanted action or fails to take required action—that will be binding on the parties to the contract.

So each time you try to create an obligation under a contract, just be sure that the person that you want to obligate is signing on the dotted line. Our wonderful freedom-of-contract world is not suited for Orwellian notions of spontaneous obligations.

This article is presented for informational purposes only and is not intended to constitute legal advice.

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