Third Party Beneficiaries in Development Deals

As any developer knows, it’s always better to try to split the costs of the design and approval of a project than to bear them alone. Developers will typically go through the design and approval process while under contract to purchase the land for a project. While the developer of property will enter into a direct contract for professional services with a vendor, if the wind is blowing the right way, the seller will agree to split the design and approval costs with the developer.

The design and approval process can be a long, difficult road and it may result in a dead end. Architects, engineers, and other vendors who provide services during the development approval process may dedicate tremendous effort only to discover that their hard work is all for naught- the project will never be. Or, the closing may have occurred and the seller has yet to make good on its obligations to the vendor under a cost-splitting agreement. When things get messy, the vendor will look at all options available to get paid. It you’re a developer considering splitting a vendor’s costs with the seller of the land, what kinds of thing should you be considering?

Describe – don’t just name – the vendor as intended third party beneficiary.

It’s a good notion to name a vendor as a beneficiary of a land contract and it is not uncommon for drafters to include language in agreements describing a vendor as a “third party” or to provide that a seller will make payments to a vendor for services rendered during the design and approval process. Yet, drafting a land contract to give a vendor the legal status of a third party beneficiary can be more difficult than one might first realize.

There are no magic words. To actually make a vendor a third party beneficiary under a contract, the parties to the contract must mutually intend that the vendor receive a benefit pursuant to the contract. The benefit bestowed must be one “which might be enforced in the courts,” Snyder v. Freeman, 300 N.C. 204, 220, 266, S.E.2d 593, 604 (1980), and the parties to the contract must have intended “the benefit of the contract to run…to the third person” rather than to themselves, Lane v. Aetna Cas. & Sur. Co., 48 N.C. App. 634, 638-39, 269 S.E.2d 711, 714-15 (1980).

Because courts look first to the language of the contract itself to determine the mutual intent of the parties, one of the easiest things to do to ensure that the seller will remain on the hook for its agreed upon share of the cost of services is to include recitations that reference the law regarding third party beneficiaries. The developer will want the land contract to explicitly state the parties’ intent for the vendor to be a direct rather than incidental beneficiary, for the vendor to have an enforceable right against the seller, and that the benefit of the seller’s obligation to the vendor under the land contract run primarily to the vendor rather than to the developer or the seller. Additionally, to ensure that the early termination of the land contract does not affect the vendor’s right to pursue the seller for any deficit on the obligation stated in the land contract, the drafter will want to explicitly and specifically state that the rights of the vendor against the seller survive the termination of the contract as well as closing.

Don’t leave the payment schedule to the discretion of the vendor.

Because land contracts are often terminated prior to closing, the contract should never make the seller’s obligation to the vender conditional on a contingent event, such as closing or expiration of a feasibility period. These events can always be affected by the parties or external circumstances without the vendor’s consent, and as such they may never occur. The better practice is to put in the contract dates certain by which payments will be made by the seller to the vendor. If these dates need to change at some point after execution of the contract, then the changes can be made by modifications.

Prior to executing the services contract, negotiate for the seller to guarantee the payment of professional services fees.

If the developer has not already entered into the services contract with the vendor, advise the developer that the seller should guarantee a portion of the fees on the services contract between the developer and the vendor. Since consideration for a guaranty cannot usually be given after a contract is formed, and a guaranty will put the seller directly in the path of liability, the developer’s attorney will have limited time to recommend negotiating for the guaranty, and even then the developer will only be able to negotiate the guaranty if the developer is in a strong position. Another scenario is where the developer is able to provide in the land contract that the seller will provide a guaranty on the services contract, and to specifically provide a liquidated damages remedy for this obligation.

Include an indemnification provision in the contract.

In the event that the developer encounters a situation where he ends up paying or owing the vendor the full amount for the services, the developer will want to know that it will be able to recover from the seller what the seller agreed to pay the vendor. This can be addressed simply with an indemnity provision in the contract that allows the developer to recover any amounts paid to the vendor on behalf of the seller upon the furnishing of adequate documentation. Again, this is a provision that the drafter will want to specifically and explicitly provide survives the termination of the contract and closing.

The pitfalls of contract drafting for developers are numerous, complex, and nuanced. Third party issues are among the multitude of contract issues that developers have to confront in unique ways. Developers need a legal team that knows the ins and outs of the developmental process and the contingencies that go along with it.

If you are a developer in North Carolina, get in touch with the Commercial Real Estate team at the Forrest Firm as early as possible. We will start your project off with a solid legal foundation.

You can contact Patrick Lineberry by phone (336)660-2570 or email patrick.lineberry@forrestfirm.com